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Good afternoon, ladies and gentlemen, and welcome to the Metro Inc. 2023 First Quarter Results Conference Call. At this time, all participant lines are in a listen-only mode. But following the presentation, we will conduct a question-and-answer session. [Operator Instructions] Also note that the call is being recorded Tuesday, January 24, 2023. Thank you. Good afternoon, everyone. And thank you for joining us today. Our comments will focus on the financial results of our first quarter which ended on December 17. With me today, is Mr. Eric La Flèche, President and Chief Executive Officer; François Thibault Executive VP and Chief Financial Officer. During the call, we will present our first quarter results and comments on its highlights. We will then be happy to take your questions. Before we begin, I would like to remind you that we will use in today's discussion different statements that could be construed as forward-looking information. In general, any statements which does not constitute a historical fact may be deemed as a forward-looking statement. Expression such as expect, intent, or confident that, will and other similar expressions are generally indicated a forward-looking statements. The forward-looking statements are based upon certain assumptions regarding the Canadian food and pharmaceutical industries, the general economy and our annual budget as well as our 2022-2023 Action Plan. These forward-looking statements do not provide any guarantees as to the future performance of the company and are subject to potential risks known and unknown, as well as uncertainties that could cause the outcome to differ materially. The description of these risks could have an impact on the statement could be found under the Risk Management section of our 2022 Annual Report. As with the preceding risks, the COVID 19 pandemic constitutes a risk that could have an impact on the business operations, project, synergies and performance of the company. We believe these statements to be reasonable and pertinent at this time and represent our expectation. The company did not intend to update any forward-looking information as required by applicable law. Thank you, Sharon and good afternoon, everyone. Total sales for the quarter were $4.7 billion, an increase of 8.2% over last year, with food same store sales up 7.5% in the quarter, and pharma same store sales up 7.7%. Our gross margins stood at 19.6% of sales versus 19.9% in Q1 last year. The decrease mainly the result of higher cost of goods sold in food, the portion of which we absorbed. Operating expenses stood at $458.2 million or 9.8% of sales, versus 10.2% of sales in the same quarter last year. The decrease in SG&A ratio was mainly due to good cost control and good leverage on a high level of sales. EBITDA for the quarter totaled $462 million, that's up 8.9% year-over-year and as a percentage of sales EBITDA was 9.9% versus 9.8% last year. Total depreciation and amortization expense for the first quarter was $120.1 million versus $112.5 million for the same quarter last year. The increase reflects the additional investment in supply chain and logistics as well as in store technology. Adjusted net earnings were $237.6 million compared to $14.2 million last year, a 10.9% increase. And our adjusted net earnings per share amounted to $1, that's up 13.6% versus last year's adjusted EPS of $0.88. After one quarter, capital expenditures amounted to $129.3 million versus $141.5 million last year. As mentioned in our -- on our previous call, we are planning a record level of CapEx this year of about $800 million, resulting mainly from our ongoing investment in the modernization of our supply chain in both provinces. On the retail side, we opened two new Super Cs this quarter, one in Saint Jerome and another in Beauharnois and we also carried out major innovations in three Metro stores, representing a net increase of 100,000.4 square feet or 0.5% of our food retail network. On November 18, we renewed our normal course issuer bid program, enabling us to repurchase 7 million shares between November 25, 2022 and November 24 of this year. As at January 13, we had repurchased 696,000 shares for consideration of 52.2 million representing an average share price of $74.94 In closing, the Board of Directors yesterday declared a quarterly dividend of $0.3025 a share, or $1.21 on an annual basis, and that's an increase of 10% versus last year. This is the 29th consecutive year of dividend growth and represents a payout of about 31% of last year's adjusted net earnings in line with our policy. Thank you, François and good afternoon, everyone. We delivered solid results in the first quarter in a very competitive and challenging operating environment, growing market share driven mainly by our discount banners. As inflationary pressures persist, our teams did a good job to provide the best value possible to customers in our stores, pharmacies and online. For the quarter, total sales grew by 8.2% adjusted EBITDA by 8.9% and adjusted EPS by 13.6%. Food same store sales were up 7.5% compared to a decrease of 1.4% in the same quarter last year. Our internal food basket inflation was 10%, same as that in the last quarter. Compared to last year, traffic was up while the average basket remained flat. Not surprisingly, customers are searching for value and promotional penetration continues to increase and private label sales growth is outpacing national brands. Discount continued to outperform conventional and we are well positioned to capitalize on this trend with our Super C stores in Quebec, and Food Basics in Ontario. We are accelerating the growth of our discount footprint with the opening of two new Super Cs this quarter, and two more plans for fiscal '23 in addition to two Food Basics. Pharmacy comparable sales were up 7.7% and 16% over two years, with a 6.5% increase in prescription drugs helped again by COVID related activities, such as the distribution of rapid test. Food store sales were up 10.2% driven by strong growth in the over-the-counter medications due to cough and cold symptoms, as well as strong sales of cosmetics, and health and beauty products. Our online food sales were up 40% for the quarter as we continue to grow by expanding our service coverage and adding more capacity to meet evolving customer needs. This is being accomplished by adding new markets, the rollout of click and collect to our Super C stores and expanding our presence on third party marketplaces such as Cornershop and Instacart offering two hour delivery. We are pleased that the Metro online service was ranked number one in grocery in the most recent Leger Digital WOW index. As we begin our second quarter, market challenges and inflationary pressures persist, and our focus remains on delivering value to our customers while executing on our strategic priorities. We can't predict future inflation as many vendor requests for price increases continue to come in, and the root causes outside of our control are still present. However, we will be cycling high inflation figures recorded last year in the second half of this fiscal year. And we would normally expect inflation to moderate later this year. Again, we don't make predictions. Metro is proud of its commitment to reduce food insecurity in our communities. Last week, we announced that the company donated $50 million worth of food in fiscal '22 to food banks in Quebec and Ontario, equivalent to $9 million meals, in addition to giving $5.5 million to different charities and also raising $6.8 million in our networks thanks to the generosity of our customers. Moreover, in November and December, we held our first Healthy Eat together campaign and raised an additional $2.2 million from generous customers and Metro donated $550,000 to our longtime Food Bank partners. To conclude we continue to execute on our business plans to deliver a strong value proposition to our customers, invest in our retail network and infrastructure and support our communities. As the company proudly celebrates its 75th anniversary, we look forward to continued growth and success for all stakeholders. Thank you and good afternoon. Eric, I want you to provide some insight into the relative performance of discount in Quebec versus Ontario or if that getting a little too specific, perhaps you could provide some insight into sort of the consumer behavior in each of those two markets and how you've seen that evolve in the face of the macro pressures? So as I said, in my opening remarks, discount continues to outpace conventional and it's been the case for several quarters. It continued that into Q1. So both Quebec and Ontario, our discount banners are growing very nicely. Similar growth, I would say. So I won't give you more color than that. But we're pleased with our performance, overall performance and we're pleased with our relative performance versus competitors, either in discount or unconventional. So yes, conventional is trailing behind discount, but holding its own versus peers. And discount is doing well, in both markets. Consumer behavior is more of the same in this high inflationary period. Our features and specials are selling more and more every month. So people are looking for value and stretching their dollars, no big surprise. Our teams are working really, really hard to give -- to provide the best value possible in this tough period for customers, tough period for everybody. We're receiving -- we received in the fall, a lot of cost increases, we continue to receive some. So the search for value continues by customers, and we're well positioned to do our best to do that. Thank you, Eric. That's great. If I could just switch to pharmacy for one more quick question. Flu season had a very big start, and also appears to perhaps tapered quicker than somebody expected. Could you provide an insight of just how material flu season was in quarter, and how you were thinking about the impact of this performance on sort of OTC given the tough comps going forward? Thank you. Yeah, thank you for the question. So the flu season, you could call it a pandemic, it's the flu, it's respiratory viruses, it's continued COVID, causing a lot of cough and cold flu like symptoms, which is generating traffic to our stores, and generating OTC sales at higher than normal pace. So it was strong in Q1, same as the previous couple of quarters, and it's continuing so far into Q2. How long that will last? I can't predict but it was material in Q1, no question about that. Yep. I hope that answers it. Thanks. Good afternoon, everyone. Just looking at the income statement with the pressure on both gross margins and on SG&A, or SGMA down one house setting the other? Can you talk about to what degree that's the result of the mix shift towards discount, and what you're seeing just on the cost side in general, and how we should be thinking about cost pressures as we move through F'23. So the gross margin declined again like we said, in the last few quarters, on the food side, we've seen a decline of our gross margin. It was offset by pharmacy and cosmetics, and the like -- in the previous quarters. And this quarter, the food decline was a little more and we overall was not completely offset by the pharmacy performance, which was quite strong. So the gross margin is caused by a higher cost of goods sold, that we are not passing completely to consumers at retail for competitive reasons and for market reasons. Very competitive out there. There are price points that we can't get to or we can't pass on on a regular shelf price and also on promotion. So that's causing an impact on gross margin. The higher feature penetration and all of banners discount and conventional is also impacting the gross margin. Produce this past quarter was a challenge. You've all read about the weather conditions in certain areas where we get supply in California and others. Very challenging very volatile markets, high prices that we can't pass on. So gross margin in produce suffered in all of our banners discount and conventional. And last you say the mix to discount yes, as discount sales grow faster. It's a lower gross margin business and it also has an investment. There's not just one thing, it's a combination of factors. So the good news is, I think our sales performance is strong, our market share performances is very healthy. So I think our value proposition resonates with customers. And our expense control was good in the face of high inflation on the cost side, too. So there was a bit of leverage, there were sales expenses grew at a slower rate than sales grew so the SG&A rate went down, which offset the decline in gross margin. So pleased with that, but it's a challenging operating environment. And it takes a lot of attention and experience to the middle, that's for sure. Absolutely. So if we're thinking about the magnitude, Eric of cost increases for this year, minimum wage, et cetera, should we be thinking sort of low mid-single digits on the cost side, and that's first part. And then second part is, what's the magnitude of the vendor price increase request that you're getting at this point. I'll start with the vendors, and François Thibault can take the cost side. So we explained and it was covered in the media that we had an effect that -- we have an effective blackout from November 15 to about February 1 where we don't accept costs increases. But that doesn't mean that the cost increases are not there and then coming. So over the next weeks and months, there will be more cost increases. We're getting a significant number of cost increase demand so that we have good conversations with our vendors to, to manage it to mitigate and to control the rate of increases, because we want to protect his customers and protect the pricing at retail. But there are increases coming. The root causes of worldwide food inflation are still there. And we're going to have to accept some of these increases. Hopefully, we will manage to mitigate as best we can. So there's more of that ahead. While we will remain always competitive in a very competitive marketplace. Yeah. Irene I think your low single digit, up to mid is not an unreasonable assumption. This quarter year-over-year our OpEx grew by 4.2%. So when your top-line is 8.2, then obviously, this will be met by good leverage on the high level itself. Across the board, increases in labor, maintenance, energy supplies, publicity for these are -- they were all increases, but they were lower, smaller increases than top-line. So that's what we mean by good cost containment, but that's going to be our job going forward is to make sure that we have visibility and that we manage those costs. And we'll have to show the same discipline that we've shown in previous years because that's an inflationary environment. This not just does not just affect the gross margin, it affects the OpEx as well. That's great. Thank you. And also thank you for calling out all of the donations of food donations and to the community. We all know how important that is right now. Thank you. Yeah. Hi, François. Just following up on that comment about growth rate and OpEx costs. So the 4% growth was pretty good. Is there anything coming up in 2023? Could there be a large labor contract or an unusually high number of labor contracts that are coming up that could inflate that number? Is it kind of those labor contracts, kind of -- is a kind of smooth curve as they mature. So there's a lot of components that OpEx, so there's not one big number that can make or break the year. I think it's -- there's always labor agreements coming due for negotiations. There's several contracts the transport supply, et cetera, that you have to renew. So, there is going to be as I said, several components that we have to keep a very close eye on and make sure that we contain the increases in line with the top-line growth. That's nothing unusual this year versus other years. Labor pressures. Labor pressures remain. Quebec announced a 7% increase in the minimum wage. So that gives you an indication on the labor side, there's pressure. We expect that to continue. But to your question, is there a one single event that's going to make a huge difference between '22, '23? As François said, there's not one single thing, but there are pressures in the system on the expense side, labor, labor is our biggest expense. So we manage as best we can. There are rate increases. We have technology, we manage productivity. We manage as best we can, but there's clearly pressure in the system. Okay. And a different question. Eric, from your comments, it sounded like, discount is strong, and you picked up, you felt you've picked up market share and discount. And I'm just wondering, and it sounds like you've picked up market share in both Ontario and Quebec. And I'm just wondering what you attribute that to? Did you have any particular promotions that worked well, or was there anything you could attribute to? Or is it just daily blocking and tackling and merchandizing? Well, it's daily blocking, merchandizing, good merchandizing, the right product, the right week at the right price in a challenging environment, with all the inflation that everybody talks about. Good execution at store level. It's a total package. I'm pleased with the performance. So like I said, our discount banners are growing and a little better than the competitive set in discount. So pleased with that. Our price indices versus the market are very competitive, we monitor that very closely. We have a strong private label program. It's resonating well, by these days, for sure. Private label sales are growing significant significantly faster than the general sale. So discount, as you know, sells more private labels as a percentage of their sales. So that's all in there to contribute to the good performance. Stores are in good shape. The renovation program. Every year, we renovate stores expand others, so the physical plant, if you call it is in good shape, and Super C and Food Basics, I think that helps too over time. So a bunch of factors, but good execution. Okay. And then just lastly, question on your online business. You touched a little bit about your comments, Eric. But you had very high growth rate and online sales at a time when consumers are generally returning to store. Like what's the larger factor that caused that huge discount? Is it because you introduced your click and collect into discount? The largest contributor was partnerships, expansion of the partnerships, third-party marketplaces. So we've added markets and banners to, to Instacart and to Cornershop in the case of Ontario. So those are the largest contributors to our online growth. Our hub stores are pretty consistent. Click and collect is growing, but not at crazy base. So I think our multi-service model where we have our own platforms click and collect home delivery either same day or next day and the short window immediate delivery with third party partners is serving us well enabling us to capture our fair share of online sites. Well, let's just say an online sale is a lower margin sales than in store sale, let's be clear on that. But for those customers that are expecting online service, we are there to serve them and to provide the offer is it short term or next day, we're click and collect. So it's a piece of the market. Not a very big piece of the market. We want our fair share. So that's why we have the offer we have. Yeah, good afternoon. Just to follow up on a couple of things. First, on the gross margin, is it fair to say that the gross margin performance in the pharmacy business was consistent in Q4 versus --or sorry, in Q1 versus Q4? Okay. And I also wanted to ask about sort of how supply chains are affecting your business today. I mean, one of the dynamics over the last couple of years is, we've heard of low service levels for manufacturers and, then we're reducing their skews to sort of ease some of those challenges on their side. How has that evolved? And what's the sort of state of that today for you? The supply chain is better than it was it's improving, I would say every quarter, positively. But it's not back to a pre-pandemic levels. So there are vendor service issues to our warehouses. We are still on allocation with certain vendors and certain categories. So an evolving situation, the assortment reductions or production reductions by certain vendors. As far as I know it's not that much better. They're still concentrating on their best selling items to ensure supply. So that remains. So you can still see holes in some on of our shelves, most of them are vendor related. At some point, it's self-inflicted, for sure that sometimes. But net net that supply chain service levels from our vendors has improved, but we're not quite where we want to be. And does that affect sort of, the promotional tactics that those customers or those suppliers may be adopting? Or how do you sort of look at that dynamic with regards to sort of product availability affecting promotional tactics? Clearly, it does. Our merchandizing teams sometimes they want to advertise a certain product at a certain price. And they can't do it because they're not going to get supply. So when I say we're on allocation, sometimes it means that we can't advertise X,Y, Z product the week we want to. So it's again, collaboration and discussions with our vendors to be able to serve our customers, but it is a factor that's affecting merchandizing for sure. Okay, thanks. That's helpful. And I guess just one last one, regarding the competitive environment, appreciating that it's always very tough and extremely competitive. I'm curious if this sort of prolonged shift to discount has led to any sort of disruption or changes in behavior in in the competitive market? Well, it's extremely competitive. All banners, the conventional or discount want their fair share, and are promotionally aggressive. The regular prices are -- there's a difference. The base shelf price, there's a difference. Promotional activity, like I said, it's strong in both formats, by all competitors. So does it create reaction? So yes, when discounts growing more some confessional competitors can become more aggressive, which affects the whole market. So it's a reality, that's always been a factor. And that's why we say we're well positioned with both of our banners. I think we're very competitive in pricing with our competitors. And the projects, we consistently do prove it, where our price indices are where they need to be. And when I look at our sales performance and our market share performance, I think it's proving that it resonates with our customers. Hi, good afternoon. I wanted to ask first on your unit volumes. Last quarter, you indicated that you're still seeing unit volume growth, even though inflation was higher than your same store sales. So curious if that was still the case this quarter, and how you're explaining that gap? Like where are the biggest, one of the biggest factors explaining that gap? Well, our data and information or tonnage is about flat this quarter, year-over-year. You wrote about that Michael, family size private label. So the gap between the total dollar sales and the inflation that we report does not equal tonnage. It's a little bit more complicated than that. So we look at units go through the cash. We look at cases shipped from our warehouses in all of our markets. And this quarter the tonnage was about flat. That's what I can give you. Okay, thank you. And then on the gross margin, one thing I didn't hear you talk about was shrink. And I don't think you've mentioned that in a while, I'm wondering if shrink is becoming more of an issue with prices the way it is, you hear about increasing in social media and that. I'm wondering if that's something you can actually see. Well, I called out produce as a contributor to gross margin decline in all of our format and food. So, the high cost and the volatility in pricing for vegetables in particular, fruits, also led to some, we try to manage the prices, the sticker shock as much as we can. We certainly can't recoup all the increases we're getting. So that's causing some decline. And there's also sticker shock that can lead to shrink in store. So, in our produce departments, for sure, shrink was a little higher. But I wouldn't call it out as the biggest main source of all the decline. It was a contributing factor. But even more than that, the whole base pricing and promotional pricing in produce environmental the last quarter was a bigger factor than shrink, that's the good way to put it. Okay. And then finally, can you talk about the benefits you're expecting to see from your modernized supply chain? And one, what's the timing roughly that we can expect to start seeing that? Okay, so we have done, projects are up and running phase one of fresh fruits and vegetables in Toronto, and the freezer, which is fully automated and strong. So we are seeing productivity gains cases per hour. So the throughput, we're doing more volume with less people in those warehouses, especially in the automated frozen warehouse, very happy with our performance there. We're ahead of plan on productivity so that bodes well. So the gain and efficiency is more volume with less hours, so better productivity. So better assortment, better freshness for consumers, and more efficiency at our end. We're bringing in-house some of the direct to store volume that's done by third parties. So again, that enables some savings for us treating the merchandize. So we have expenses for it, but as part of the whole thing, it's more efficient, and less deliveries to our stores, which generates some savings at store level too. So it's a big project, a lot of change management. But we have a very good team managing it. It's a lot of work. But we're pleased with our progress. And we're looking forward to opening Terrebonne, which is fresh meat, fish, dairy in Quebec, 600,000 square feet plus, fully automated also. And that starts up in September. So, it's going to be gradual. We're not going to be record productivity day one, but we're confident that we can get the same kind of results at Terrebonne that we're getting in Toronto. So, we're pleased with it. Thank you. Okay. All right. And then just final question is, in Q4, you had an 8% increase in your OpEx, but excluding the gain that you had, it was more like a 10.7% increase. And then now this quarter, your year-over-year increase was 4% yet your top-line is growing around the same pace. So can you explain the difference in that growth rate? I do believe you said something about catching up a little bit in cost last quarter, but I didn't seem like there one time in nature. So maybe you could explain the difference in those two growth rates? And how much in Q4? No, you're right. That Q4 we call it out, it was -- there was a -- we had some cost increases that were higher than sales growth. Energy was one, transportation was another. Transportation is still expensive this quarter by the way. So yeah, it was a -- we had a -- year over year, there were higher increases with some key components that drove that deleverage, if you will. And I did say that in some of these contracts, it was a bit of a catch up with respect to inflation that was not reflected last year or in the beginning of fiscal '22. So again, this quarter was much better. And we intend to continue to do that discipline to make sure that we can contain those thoughts as sales growth decreases, eventually when we comp higher inflation at the latter part of the year. But you're right, we had a couple of contracts, couple of components that were higher than the normal last quarter. Okay. So, this Q1 growth rate, and rate as a percentage of sales is more reflective of what we should expect going forward, except for once we get Q4 and you're lapping that high number, you should see a little bit of relief, I guess by -- Listen, it's really hard to predict. We got -- our job is to make sure we have visibility on a contract that come do. When we go for a pretender, we negotiate. We try to contain that those costs increases as much as possible, given the top-line. And I think that's what we've demonstrated in previous years, and will continue to do this year. Hi, good afternoon. Eric, just maybe a follow up to your answer to Mike's last question about the benefits from the DC modernization? I'm just curious, did we see most of those benefits being reflected in this quarter's result. Or a majority of them seem to come. As a DC is again more experienced, they get better and better. So we expect every quarter are suddenly every year that the DCs that we opened one in '21 one in '22 will continue to improve. So I think there's more ahead of us. And the Project and Quebec gradually will ramp up and we're confident we'll deliver efficiencies as it matures. And then we go back to Toronto with phase two of Fresh, which will be more automated. So we're looking for gains, efficiency gains over there, too. So I wouldn't say it all. We've all captured it, I think we will continue to improve gradually and reach our objectives. So these are long term projects. A lot of work. Not easy to -- not easy to start a new DC with new technology, new warehouse systems, new everything. New ways of doing things with the team has done a good job. Always hard at first, but it will serve us well. I'm confident of that. Okay, that's helpful. Thanks for that. And I think you mentioned that the AGM this morning that like last year, you will see something like 27,000 price increases with an average ask of more than 10%. I know you you're continuing to get price increases this year. Just curious, what is the average ask in terms of price increase this year? Is it more in line with the historical average? I don't have a precise number for you. The discussions are ongoing. We're trying to manage these cost increases as best we can to make them progressive and over time. So we have conversations with our vendors as we speak and some prices increase have been accepted and will start to materialize at retail in the coming weeks. Rather not say a an average percentage, there's still, like I said the root causes worldwide food inflation are still present, for the most part, and some of our vendors are living through that and their costs are going up and they're looking for increases. So mid to high single digits and double digit, it really depends by category by commodity. So I don't want to make a general statement here that there's inflationary pressures are persisting. Okay. And is it fair to assume just maybe quick on gross margin that, most of the gross margin pressure that you saw in Q1? Is it fair to assume that they will continue in the foreseeable future? And I know you don't give guidance, but rationally speaking, is the 30 basis point decline in Q1, is that a reasonable boundary for Q2, or do we expect that to improve or accelerate in the foreseeable future? Chris, it's hard to predict a precise number. We have to be competitive and we want to protect our market? But we've said all along, we've been saying these inflationary pressures, put pressure on margin, there's no question about it. And every quarter in fiscal 2022, our gross margin food was slightly down year-over-year made up by pharmacy. So nothing new this quarter, it was just a little more pronounced perhaps in previous quarters. So if inflation pressures persist, it does put pressure on margin. But I think the team is doing a good job both in terms of growing as a horse, the dollar the margin as opposed to certain percentage, and making sure that we contain costs. So overall, when you look at the EBITDA performance, I think we're very pleased with that. Okay, that's helpful. And maybe the last one for me just on prescription drugs. As the industry approaches the end of the five year agreement between the government and the generic drug manufacturers in March, are you hearing any update from the government or what your expectations? Will you get a new agreement by then? Just any update on that front? Thank you. So as far as we know, discussions are ongoing. And there's no decision made. So negotiations between the manufacturers and the governments, the association of provinces or the federal for the ethical drugs, discussions are ongoing. The price reductions that have been mentioned, are not, we're not there yet. We're trying to make everybody understand that the distribution model of drugs is based on the price. So in these inflationary times where costs are going up for everybody, manufacturers, distributors, it's very hard with the distribution economics to say that a price reduction can happen just like that would have an impact on inventories, it would have an impact on service level. So discussions are ongoing, negotiations are ongoing. And hopefully, we'll come to a solution where price reductions are negotiated, that they will be offset somehow for distribution would have to be. Thank you. 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.
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EarningCall_1201
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Good morning, and welcome to PACCAR's Fourth Quarter 2022 Earnings Conference Call. All lines will be in a listen-only mode until the question-and-answer session. Today's call is being recorded and if anyone has an objection, they should disconnect at this time. Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Ken Hastings, PACCAR's Director of Investor Relations. And joining me this morning are Preston Feight, Chief Executive Officer; Harrie Schippers, President and Chief Financial Officer; and Michael Barkley, Senior Vice President and Controller. As with prior conference calls, we ask that any members of the media on the line participate in a listen-only mode. Certain information presented today will be forward-looking and involve risks and uncertainties, including general economic and competitive conditions that may affect expected results. For additional information, please see our SEC filings and the Investor Relations page of paccar.com. Hey, good morning. Harrie Schippers, Michael Barkley and I will update you on our record fourth quarter and full year 2022 results as well as other business highlights. First, I appreciate our outstanding PACCAR employees. They consistently deliver the highest quality trucks and transportation solutions to our customers and excellent financial results for our shareholders. They're truly an impressive team. In 2022, PACCAR achieved record annual revenues of $28.8 billion and record net income of $3.01 billion. PACCARâs financial performance benefited from strong business growth across all of PACCARâs major truck markets, and record results in our parts and financial services divisions. PACCAR has achieved 84 consecutive years of net income and has paid a dividend every year since 1941. In 2022, PACCAR declared dividends of $4.19 per share and announced a 50% stock dividend. PACCARâs fourth quarter revenues were record $8.1 billion and quarterly net income increased from the prior year by 78% to a record $921 million. PACCAR Parts achieved fourth quarter revenues of $1.47 billion and record pretax profits of $380 million, which was 23% increase compared to the same period last year. PACCAR delivered 51,600 trucks during the fourth quarter. This was 7,300 more than the third quarter and was a result of higher truck production, and the completion of nearly all the vehicles that were awaiting components. The supply chain is improving, though there may be some supplier constraints throughout the year. In the first quarter of 2023 deliveries are forecast to be strong and in the range of 49,000 to 53,000. In 2022, US and Canadian Class 8 truck retail sales were 283,500 units. PACCARâs market share increased to 29.8%. The US economy is projected to expand modestly in 2023. In this truck sector, there's pent-up demand from the prior three years of industry under production, and customers need to replace aging fleets to benefit from the superior performance of the newer Kenworth and Peterbilt models. The 2023 US and Canadian Class 8 truck market deliveries are forecast to be in a range of 270,000 to 310,000 vehicles. European above 16-ton truck registrations were 298,000 last year, and DAF market share increased to a record 17.3% reflecting the success of the new generation of DAF trucks. In 2023, confidence in the European economy is growing and with pent up demand for new trucks we expect the above 16-ton truck registrations to be in the range of 270,000 to 310,000. In 2022, the South American above 16-ton truck market was 138,300. And this year, the South American market is expected to be in the range of 125,000 to 135,000 units. In Brazil, DAF achieved a record 6.9% share in the above 16-ton market, up from 5.7% last year. DAF Brazil has gross steadily since we opened the factory 10 years ago, and makes a healthy contribution to PACCARâs global success. Truck, Parts and Other gross margins expanded to 15.9% in the fourth quarter, reflecting strong global performance, higher truck deliveries, excellent parts of business and supply chain improvements. We estimate PACCARâs worldwide first quarter truck and parts gross margins to be in the range of 16% to 17%. In 2022, PACCAR and its customers realize the financial benefits of the new range of heavy and medium duty Kenworth, Peterbilt and DAF trucks. These new trucks are successful in the market due to their premium quality, excellent fuel efficiency and low operating costs. Last year, PACCAR earned recognition in several areas. The new DAF XG distribution and vocational truck was named the 2023 International Truck of the Year. Kenworth and Peterbilt earn six manufacturing leadership awards from the National Association of Manufacturers. The reporting firm CDP again recognized PACCAR as an environmental leader with an elite A rating. This rating places PACCAR in the top 1.5% of over 18,000 reporting companies. And PACCAR was recognized as a top place for Women to Work by the Women and Trucking Organization for the fifth consecutive year. Demand is strong in all markets for PACCARâs industry leading new trucks and transportation solutions. And we look forward to 2023 being another excellent year. Thank you, Preston. In 2022, PACCAR Parts set new records for annual revenues and profits. Annual revenues increased by 17% to $5.8 billion and annual pretax profit increased by 30% to $1.45 billion. Annual gross margins expanded to 30.4% from 28.6% in the prior year. PACCAR Parts is a high margin and high growth business. PACCAR Parts expanded its global distribution network in 2022 by opening a new parts distribution center in Louisville, Kentucky, and its 18 PDCs worldwide. We estimate Parts sales to grow by 10% to 13% in the first quarter of this year, compared to the same quarter last year, as high truck utilization contributes to strong global demand for parts. PACCAR Financial Servicesâ fourth quarter pretax income increased to a record $151 million which is a 12% increase from last year. Annual pretax income increased 35% to a record $589 million. Portfolio assets increased to $17.2 billion. The portfolio continues to perform well with very low past due and low credit losses. PACCAR Financial benefited from strong used truck prices in 2022. Last year, PACCAR Financial opened a new retail used truck center in Madrid, Spain, bringing the total to 13 used truck facilities worldwide. This retail used truck centers contribute to higher price realization compared to wholesale channels. In 2023, we expect used truck prices to moderate but remain historically strong. With its larger portfolio and superb credit quality, PACCAR Financial should have another very good year. In 2022, PACCAR invested $505 million in capital project and see another $41 million in research and development. PACCARâs return on invested capital improved to an industry leading 35.2%. In 2023, we are planning capital investments in the range of $525 million to $575 million and R&D expenses will be in the range of $360 million to $410 million as we invest in key technology and innovation projects. These include next generation clean diesel and hydrogen conversion engines, battery and hydrogen electric power trains, autonomous driving systems, connected vehicle services, advanced manufacturing and enhanced distribution capabilities. PACCARâs independent Kenworth, Peterbilt and DAF dealers continue to invest in their businesses to provide our customers the highest level of service in the industry. These investments are enhancing our industry leading distribution network, making a significant contribution to PACCARâs long-term success and supporting the growth of PACCAR Parts and PACCAR Financial Services. PACCAR had an outstanding year in 2022. And we're very positive about 2023. Thank you, we'd be pleased to answer your questions. Hi, thank you. My question relates to the gross margin for the first quarter and how do we think about the cadence from there? So for the first quarter, you have deliveries very similar to the fourth quarter, the mix between truck revenues and parts revenues seems like it's pretty similar. So for the stronger gross margin in the first quarter and the fourth quarter, is that essentially that you're shipping less red tag trucks a little more overhead absorption and price cost gets better? And I'm just trying to think about price costs moving forward after the first quarter. Thank you. Yes, sure. David, good to talk to you. The way we're looking at it as the offline units that have been limited by supplier constraints have been largely resolved. So it's fairly behind us right now. But there were some of those that were taken care of in the fourth quarter. So when we think about deliveries in the first quarter, that's basically production is good run rates, we would say that our margins are doing well on both the parts side and the truck side. And that's really a factor of all of the new trucks being in the market and pretty much fully released now in Europe and North America. So the customers are getting the benefits of those trucks, as are we. And I would add one more thing, which is the strong global performance of the team, whether it's in Australia, or in South America is going well and that's contributing. So taking that from the first quarter, then if you're pricing your backlog, I assume isn't going to dissipate the next few quarters. I would like to think some costs may be come down as the year progresses. If that's what you're able to do in the first quarter in price costs, maybe gets a little better over the next couple of quarters, not worse. How should we think about the gross margins moving forward after the first quarter? Well you know that we guide, we share information and we think the first quarter will be in general, we think 2023 will be a good year. Thanks. Nice quarter with the better-than-expected deliveries, to what extent are you backfilling that backlog? Or are you perhaps or net just burning that backlog a bit faster than expected? And I guess I'm curious how much visibility you have later in the year and how much you -- how full your backlog is for say Q3 and Q4. I mean I think the macro way to think about it is, since 2020, the industry has really been not able to supply all the trucks that have been needed. So there is a strong pent-up demand for the trucks. And in addition to that, obviously, we've launched more new products at any time in our history. So that's contributing, we have excellent visibility looking into the year, we're full through the first half filling the third quarter nicely. Demand continues to be strong in line with build. And so it's looking like a really good year. Okay. And just in terms of the cost and inflation side of things. I'm curious what you're seeing from your suppliers in terms of prices. Is there sort of a range that you're seeing where some of them are still raising prices? Some are holding or falling? What are you seeing in terms of the net inflation and actions from your suppliers here? I think you did a great job of characterizing it. You see some raising some holding some where there's commodity costs where there have been improvements, but it's a mixed bag. Obviously, labor is still a factor as far as our supplier, for our suppliers, and all of those wash into the mix. Great quarter. Thanks for the question. Just wanted to ask the first one on the parts growth, 10% to 13% in the first quarter is pretty admirable, just considering some of the rumblings you heard in the channel with regards to truck utilization, maybe being a bit more challenged, but you've obviously been getting the benefit of the MX engine penetration. Can you just maybe pair off those two kinds of headwinds and tailwinds going into the first quarter. How much of that growth is coming from MX engine penetration versus any headwind from truck utilization, maybe moderating a bit. Yes, the 10% to 13% growth rate that we expect for the first quarter really reflects all of those things. So we continue to see the PACCAR engine performing really well. That of course, drives incremental part sales. But the parts team is doing an amazing job launching new programs, whether its fleet sales, ecommerce, our MDI system continues to improve. It also means that we continue to grow our share in the parts business. We're announcing our TIP business, adding stores, selling more parts with TIP. So it's a mixture of all of those things that allow us to do really well in the first quarter and so we are well put. Got you, thanks, Harrie. Then can I just ask a second one on the FinCo, the margin performance in the quarter really strong considering the deceleration we've seen in used truck pricing more recently. Is that just reflective of PACCAR trucks commanding a premium in the market on used basis, or what would you contribute that more recent strength to considering the decline we've seen in used truck prices more recently? Yes, we continue to see a 10% or 15% premium for Kenworth, Peterbilt used trucks in the marketplace. That's been around for a long time that continues. But we also see more and more benefits of the used truck centers that we have been developing and opening over the recent years, we now have 30 used truck centers worldwide, allows us to sell more used trucks at retail prices instead of wholesale, to all those things have contributed to the finance company. Like we said, the portfolio is in really good shape, past dues are low, less than 0.005%. So, yes, customers continue to pay their bills and the finance company continues to benefit from that. Hi, good morning. Thank you so much. So my first question is how should we think about seasonality of bills and delivery in 2023? Is the first quarter delivery number a good run rate for the rest of the year? Well, Tami, itâs good talk to you, I think what we see is we have had increasingly steady production. And that's why you're seeing this first quarter number be pretty high with without any of the offline issues of last year that are behind us. So it feels pretty steady there. And I think there's opportunity for us in 2023 as we look forward. Got it. That's super helpful. And then my second question is, how should we think about your market share gain expectation this year. Should share capture, continue at a clip similar to â22? Or do you see any reason or chances of that accelerating this year? Well, I think that our teams have done a fantastic job around the world of introducing new products over the last year and a half on the truck side. And as Harrie mentioned on the parts side and the financial services side. So the totality of what benefit PACCAR providing to our customers is very high. And I think that that high benefit to them helps us grow our share. And so when our customers are successful, and our dealers are successful, then we're successful. And that's how we think of it. Hi, good morning, everyone. So I was hoping you could talk about the, your industry view on the first half versus the second half like production cadence just given that there are a number of crosscurrents with the car pre buy well -- kind of demand. So there's like how should we think about that production level? Well, I think that, again, I'll come back to the, for our sector. We as an industry have not built enough trucks over the past few years. And that combined with excellent new trucks that provide really good operating cost advantage to our customers, is incentive for them to continue to buy trucks. I think that the pre buy for 2024 is a non-issue. It's too limited and really only California. And customers end up benefiting in most cases when we bring in new products because we bring them features and content and advantages that help them run their operations better. But I think that when we think about the year it feels steady and strong throughout. That's helpful. And then just over to your EV offering. Can you just talk about what the composition of production is for this year and then how has the passage of the Inflation Reduction Act just changed like the conversations that you're having with customers? And ultimately, how are you seeing that translate into your demand curve shift in production? Yes, I'll take a couple of comments within and Harrie or someone can add in. What we see is I think what we've shared before and it's coming true is that we think that the EV market, the zero-emissions vehicle market will just gradually grow. Customers are experimenting with it now trying to understand it, they're buying chargers putting an infrastructure around it. PACCAR has nine electric vehicle models in production, nine. So our teams have done a fantastic job of putting the products out there for customers to get used to and applications that fit all their needs. And we think it'll grow as we've shared previously; we think it'll be in the hundreds, and it'll stay in the hundreds for a little while. And then as regulations come in, and experiences become more familiar, it'll grow and turn into the 1000s and extend from there. So I think that at the moment, it's in the hundreds, and we're well positioned for that growth. And we have some fantastic vehicles out there that are providing great experiences. Anything to add, Harrie? Thank you. Preston, you mentioned a couple of times how the industry has been tight. Obviously with COVID over the past couple of years and customers haven't been able to get all the trucks they want. Are you able to split that in North America at all into sort of the straight truck category versus more fleet trucks? Presumably the Infrastructure Act will drive demand for cement and dump and things like that. I don't know if that's happening already. If you're seeing any early orders, or if that's more of a â24 effect, and I don't know how the fleet age and tightness on that side of the market compares with the more trade markets. Yes, Rob, it is an issue we need to think about it, I think what we've seen is generally strengthen both sides, truck and tractor. Obviously, it's, there's local market impacts there, but the total general statement would be strong demand for trucks and strong demand for tractors. And I would add, if anything, industry truck segment, PACCAR has a market share of more than 40%. So any growth accelerated growth in that area, Kenworth and Peterbilt will definitely benefit from that. Okay, great, thank you. And then you touched on supplier, supplier component inflation or whatever to you earlier. There's a lot of debate or speculation as to whether the logistics fall, logistics costs are falling or will fall materially. Do you have any sense the current trend for PACCAR and how that looks in the early â23? And I'll stop there. Thank you. I think the logistics costs have been varied. And obviously over last year, they increased and now I think what we're talking about is there's high input costs there. But it's moderating now, and I don't think we're especially concerned about it for 2023. Hi, good morning. Nice quarter. I guess just two questions. One, I was impressed with the incremental margins you guys put up this quarter, I think 35.5%. I don't think I've ever seen you put up incremental margins that high. So can you talk about how we should think about normalized incremental margins going forward just with some of the new product introductions that are seem more favorable to mix versus some things that might be more one time in nature. And then my second question is just a follow up on. I know, you said the order book is that for your backlog through the second quarter building through but starting to build for the third quarter. Is that across the board in North America or Europe? If you could just distinguish between the two? Thank you. Sure, I would, when we think about it, the entire part of team of PACCAR is doing a good job. So our margin performance is based upon providing great trucks that are providing value to our customers. They're realizing those benefits at time with those trucks now. And so that is effective for them. And then consequently, effective for PACCAR on the truck side as Harrie did a really nice job of outlining the parts business growth has been strong and continues to be strong, and we predict it will continue to be strong. So that's helpful to our margins. And I also say that to kind of tie in your second question is we've seen strength globally for PACCAR, right, Europe is doing very well for us, the new trucks there, XG, XF, XG product lines are the only trucks in the industry in Europe that are taking advantage of the masses and dimensions regulations which allow a different shape. So that gives us a distinct advantage in Europe. So the European market for PACCAR is strong as is understood by our 17.3% record market share, we enjoyed there. And I would say that Brazil, Australia, North America, all are doing well. So there's not a single market or a single sector right now we've just got a great team of people that have done a good job of giving our customers what they want. And those products are working really well. Yes. Thanks, guys. Maybe just starting with a question on parts. Margins there continued to surprise to the upside, looks really strong, I guess, how do you think about the ability for that business to continue expanding margins into 2023 and beyond? Well, Harrie offered some commentary on Q1 growth and said itâs very positive. One of the things that we should highlight, in addition to some of the ongoing initiatives is our continued integration of PACCAR Parts with our customers and our dealers. I think it's a really important growing part of our business, as it adds to recurring revenue strength for the future. So for us, the future looks very bright for the parts team as they bring data and capabilities into the truck into the dealerships and into the customers. So there's a higher degree of connectivity there. And that'll all be helpful to us. Got it. Thank you. And then maybe in the shorter-term question. In the outlook for 1Q delivery is of 49,000 to 53,000. Any distinguishing features among the regions like what youâre expecting sequentially for Europe versus North America versus rest of world? Thank you. If you look at the range for the first quarter, we expect build rates to improve, basically, in all the geographies we're in so Australia, Brazil, Europe, North America, and we're going to be building more trucks and all of those areas. So it's going to be across the board. Good morning and good afternoon. So last year, we saw some big monthly spikes in Class 8 orders as you guys and other OEMs, open more of the order books like in September. Would you say order or logs are open for much of 2023. And that should be in a less erratic order numbers month to month going forward. I think that following orders on a month-to-month basis is a risky thing to do and to try to get any guidance out of that. Because sometimes it's fleet buying season. Sometimes there's different OEMs will handle it differently. And for us, we're taking orders in the second half. They're coming in nicely. And it seems like it'll fill in 2023 well. Got it. And just one more question now, Preston. Any update on the natural gas engine you announced back in August with Cummins. Anything to report on that? No, I think nothing else other than to say that we continue to be the leader in the natural gas offerings in North America. And our partnership with Cummins was fantastic. They're doing a really good job. And I think that the development of, the ongoing development of natural gas engines is something that will survey a portion of the market. You can get lower emissions in that. And so that's a part of the total portfolio of PACCAR to give our customers what they need. Thank you very much. And I'll echo Jamie's comments. Terrific quarter, two questions. First one focusing on PACCAR Financial. I was just kind of curious just a big jump in assets almost 8% sequentially after assets and kind of been flattish for the previous four to six quarters. I was just wondering kind of what PACCAR Financial percentage of PACCAR aggregate unit sales are if there was a jump in that that accounted for that differential or what would have driven the assets and PFS up so much sequentially. So the assets of PACCAR Financial Services fees that of course benefitted from nice [inaudible] deal of scoring towards the end of the year, our share is about 26% to 36% of the trucks that kind of Peterbilt and DAF have sold were financed by Packer Financial Services. That's about the same as it was a year ago. I think the big increase that we see in the asset growth. In fact, our financial is the higher finances for trucks, the trucks are sold at a higher price, and that creates more assets for the finance company. And that's also one of the reasons that we expect the finance company to continue to perform well as we go into 2023. Okay, thanks, Harrie. And just real quick. I was at CES and I saw something I didn't expect, which was a fuel cell truck that you are starting to market. I know that's not going to be big numbers anytime soon. But can you talk a little bit about that? Sure. When we think about the technologies that will bring us to the future, we think this will be the dominant path forward for the next several years. But we're all trying to understand whether it will be driven by battery electric, hydrogen question or hydrogen fuel cell as the capabilities for zero emissions products and PACCAR has made prudent investments into each of those technologies. So we understand them, so that if one brings a distinct advantage to our customers, we're ready to offer it to them. And as you noted, we had that both trucks, we had a battery electric and hydrogen fuel cell at CES. Because we're working on both of them. And we'll put it on the market with financially. And the fuel cell truck, I'm assuming that's Toyota engine with the partnership. But is that a commercial grade engine? Or is that more passenger cells that you're using? I think what we're doing is developing a product that's specific for the truck market. And we're doing that in close collaboration with them. Hey, thanks. So if you guys hold this 16%, 17% gross margin for the year, it's, it'll be your best gross margin ever. I guess how should we think about the new range of gross margins through a cycle meaning if in the last decade, it's been 12% to 15% give or take is the right range? What do you think the new range is for gross margin to recycle? Well, I think of it is PACCAR has an incredibly capable team of people around the world. And they're doing a fantastic job of giving our customers the trucks and transportation solutions they need. This is a really strong company. It's a growing company in all elements of the business. So we look forward to the future pretty well. And the margins will be good, we think but they'll obviously be what the market is. Okay, and then is there, I know there is some mix changes with wholesale versus retail on used? Is there any kind of sensitivity you can give us on used prices and the FinCo margins earnings and any help you can help us with? Yes, used truck prices have come down a little bit from the historical highs earlier last year. But I would say that even at today's valuations, used trucks are a very, very attractive business for the finance company selling used truck and making profits while we do so. Well, we don't guide that specifically on the FinCo earnings for the year. But I would say that 2023 will be another excellent year for the finance company. Hi, hello, everyone. A couple of questions for me. The first one, just on your market guidance for Europe and North America just wanted to understand why would you not expect more growth from both markets assuming supply chains keep easing. So what could be kind of the headwind on production for 2022? And also, why are you less positive on European markets versus North America given that your exit rates are much stronger in Europe versus the US? Thank you? Well, I think we're positive on the European market, positive on the North American market. And I think that we feel good about the year, I think that our production rates are increasing. Obviously, we see that in the fourth quarter first quarter production plans. And though there could still be uncertainties in the supply base and that could have an impact. But right now, it looks pretty good. Yes, I would like to emphasize too, that the supply base has been improving. But we still see uncertainties in the supply base. And that's why we have the ranges that we have for the first quarter. And for the markets for North America, Europe for the entire year. Great. And then my second question just on shareholder returns. This is obviously a record net cash position. Can you give us a sense on how much cash you need to run the business? And how are you thinking about capital allocation going forward? Thank you very much. Well, we have a very good history of how we allocate capital, and return excellent, returns for our shareholders. As we noted, 70% return last year, we pay dividends every year, that goes well for our shareholders. And we use money in a smart way, make future investments in a way that's also good for our shareholders. So anything you'd add, Harrie? Of course, it's nice to see that the cash balance increased to more than $6 billion at the end of December. So that's really nice milestone that we that we achieved. And bear in mind we paid a nice yearend dividend, almost $1 billion that we will be paid in January. So we use the cash to make the investments that the Preston mentioned, but also to make a nice return for our shareholders. Yes. Thanks, everyone. Just two questions, one on a longer term and the shorter term, just first off, is there anything you think the industry, the OEM learned in 2022 that is more sticky, and structural in terms of managing orders, production pricing strategies, even as production bottlenecks ease and normalize? Is there anything that sticks out to you that could be kind of a more structural thing going forward? Maybe pricing discipline with some of these more public players? Love to get any comment on that? I think in answer to that I think our teams do a fantastic job of working closely with our customers, to understand what their needs are, and making sure we meet their needs as quickly as possible. I think the teams specially in 2022 did a great job of, our production teams, or purchasing teams or materials teams and our suppliers together, of producing as many trucks as we could for the customers with that strong demand. And I think that PACCAR has a long history of trying to work well in all market conditions. And I think we'll continue with that. Understood. And just for a more shorter-term question, some market participants point to a rollover and freight spot rates and this gap between spot rates and contract rates. I'd love to know how you view that? Is that just a smaller portion of the customer base doesn't really accurately reflect maybe the strength of the freight market or pent-up demand. Just curious how you in your seat, how you view that distinction? I think we try to take a broad look at it and think that freight tonnage is up over 3%, 3.7% for the yearend 2022. So that's a good indicator of what's really going on out there. And as I've shared and we've talked a lot about, I think older trucks are more expensive to operate. And with our introduction of new trucks, coupled with strong ton miles being driven, that's good for PACCAR and bodes well for a strong year. Yes. Hi, and good afternoon, everyone. I just want to go back to the really strong margin performance and the outlook. So when we look back when you were posting anywhere close to this level of margins, your partsâ margins are up significantly from that timeframe. OEM margins are a touch lower than where they were in 2006. And I'm wondering, Preston, just earlier in the conversation, you mentioned that they improved fuel economy and other features. Are we at a point where we can expect new truck margins to also be up versus the last cycle as well as we think about what that looks like over the next couple of quarters? What I think I'd point you towards is the good performance of the trucks. Kenworth, Peterbilt and DAF have brought out trucks that are really performing well. I mean, they're winning awards. They're the most fuel-efficient trucks in the industry, they are most desired trucks in the industry. And that bodes well for our truck margins. Okay, and then you spoke about a new approach to the telematics part of the business. Can you just talk about the revenue opportunity for PACCAR, if you can charge $20 per month per truck on your field population, that would suggest a pretty healthy subscription opportunity? I'm wondering, what could the economics look like to you folks based on the partnership structure? And how do you think about the cadence of the product rollout? We think that there's a growing business in connected vehicles, and it's growing because we have our vehicles connected, there's a lot of interesting and useful data to our customers on the vehicles that we have. We've offered our PACCAR Connect System. And that PACCAR Connect System is now going to be intertwined with platform sciences operating system and application store. So with the combination of those, it gives us an opportunity for further growth. That's one thing. I'd also say that our parts team is working closely with the data that comes from the truck, our financial services team works closely with the data that comes from the truck all to the benefit of our customers and our dealers. And we think that will be a growing opportunity in recurring revenue. And can you just talk about your expected economics? Would you expect to charge for the enhanced features? So for some comparable systems that are available after market they do go as high as at $20 per month, is that feasible for your offering? Hi, I might try to squeeze in two quickly a little longer term and one short term sorry. Longer term, the idea of a pre buy mid-decade, I am curious. If you think about your builds for the industry, yourselves in â24 being influenced by an assumed recovery in â25 and â26, the pre buy before the â27 models are out in sort of spring of â26. Just theoretically, should that provide a higher floor to â24 builds? Because of we've seen in the past, obviously some of these pre buys get well ahead of supply. Is that thing [inaudible] thinking about â24 builds whatever macro view someone may have, that they can be influenced by some order [inaudible], some sense of a pre buy in â25 and â26. And then I'll be quick on the near-term question. But if you can answer that. David, I'm going to let you work that, that's not how we are looking at it. We just think about the products we're offering, the benefit to the customers and making sure that we're the leader in the market with those products. So how the market [Multiple Speakers] Oh, yes, of course we do. But the market will be in â24 and â25, I think is beyond this call. Okay. And then real quick on the near term, that the gap between used and new prices on tractor sleepers is getting obviously a lot wider than it was six months ago. How does that usually manifest itself? Is that more about maybe residual values getting marked down a little bit on leases, like how does that usually begin to flow into your business model when you see the gap between your used tractors and the new prices widening the way it's been the last few months? David, I would say that both on tractors and sleepers. PACCAR Financial does really well selling those trucks at premium pricing. And it's part of the success of the company that we build trucks that get a premium, whether it's in a new truck market or in the used truck market and benefits the finance company and benefits the truck divisions as well.
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EarningCall_1202
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Good morning, and welcome to the United Rentals Investor Conference Call. Please be advised that this call is being recorded. Before we begin, please note that the companyâs press release, comments made on todayâs call and responses to your questions contain forward-looking statements. The companyâs business and operations are subject to a variety of risks and uncertainties, many of which are beyond its control, and consequently, actual results may differ materially from those projected. A summary of these uncertainties is included in the Safe Harbor statement contained in the companyâs press release. For a complete description of these and other possible risks, please refer to the companyâs annual report on Form 10-K for the year ended December 31, 2022, and as well as to subsequent filings with the SEC. You can access these filings on the companyâs website at www.unitedrentals.com. Please note that United Rentals has no obligation and makes no commitment to update or publicly release any revisions to forward-looking statements in order to reflect new information or subsequent events, circumstances or changes in expectations. You should also note that the companyâs press release and todayâs call include references to non-GAAP terms, such as free cash flow, adjusted EPS, EBITDA and adjusted EBITDA. Please refer to the back of the companyâs recent investor presentations to see the reconciliation from each non-GAAP financial measure to the most comparable GAAP financial measure. Thank you, operator, and good morning everyone. Thanks for joining our call. Yesterday we reported record fourth quarter results to cap the best full-year financial performance in our history. And we definitely raised the bar in 2022 and we intend to raise it again in 2023. Weâre moving forward with a larger sales and service team, a more expansive footprint and a fleet thatâs significantly larger than a year ago, and thatâs a lot of tailwind at our back in another year of high demand. And Iâll start with a recap of fourth quarter results, which kept us on a strong trajectory. We grew both rental revenue and total revenue by a solid 19% compared with fourth quarter last year. And we grew adjusted EBITDA by 26% with a 280 basis point improvement in margin, and that brought our margin to 50% in the quarter, and that came in at a very strong flow through of 65%. We also continued to generate significant cash. For the full year, we delivered $1.76 billion of free cash flow, and thatâs after investing over $3.4 billion in fleet. And none of this would have been possible without our people. First off, as you know, our top priority is always safety. And our team delivered another first-class recordable rate in 2022 in a year when we onboarded over 6,000 new employees. On the financial side, you can look at every metric I just mentioned and see the quality of Team United behind the result. For example, our revenue growth comes from keeping our customers front and center in the field. Our people are laser-focused on helping our customers succeed. And our flow-through comes from the teamâs ability to leverage our growth and maintain good cost discipline. Inflation was a factor, but that didnât stop us from delivering very good margins. We also reported a record return on invested capital of 12.7% at year-end. And on the ESG front, we made good progress with sustainability, including new investments in zero-emission vehicles and fleet. And the customer adoption of our new emissions tracking tool has been excellent. This is the technology we launched on our total control platform, and itâs an industry first. Another highlight of the quarter was the Ahern acquisition, and Iâm pleased to say the integration is going very well. We closed the deal on December 7. And then by the 16th, our new team members were already operating with the rest of the company on the same technology system. And this means our branches are sharing fleet and customer information seamlessly. One of the main reasons we like M&A is the capacity we gain. And that comes in three forms: people, fleet and facilities. And we always focus on the people first, because itâs critical to get that right. And weâre really bullish about the talent we onboarded in this acquisition. We had over 100 of the Ahern managers at our Annual Meeting earlier this month, and they fit like a hand in glove. And theyâre excited to be part of United and theyâre raring to go. Now weâre focused on optimizing the fleet and facilities. Weâre running on schedule, and itâs boosting our resources at an ideal time to capture share. The diversity of demand that we pointed to a year ago turned out to be a major tailwind in our operating environment, and that continues to be true. And Iâll share some fourth quarter data to underscore how we translated this opportunity into top-line growth. Demand in our key verticals was broad-based, with total construction up 19% year-over-year and non-res up 22%; and industrial, up 11%. We leaned into that opportunity across the board and grew rental revenue by solid double digits in all of our gen rent regions as well as all of our specialty businesses. Our specialty segment delivered another strong performance with an 18% increase in rental revenue year-over-year. And itâs notable that every line of business in that segment reported solid gain led by our mobile storage business. Our greenfield investments in specialty are highly strategic and theyâre targeted by geography and line of business to generate attractive returns. And we opened 35 of these locations in the past 12 months, and our plan calls for at least another 40 cold starts in 2023. So that brings us to 2023. So there are plenty of reasons to feel confident about our operating environment. We have terrific internal and external momentum with good visibility into revenue. And the teamâs done a great job of driving strong fleet productivity to help offset the cost inflation weâve experienced. Contractor backlogs are growing, and not surprisingly, the employment reports indicate that U.S. contractors continue to be in expansion mode. Industry indicators like Dodge Momentum Index show healthy growth trends in commercial construction, and this includes the planning trends for future projects. Thereâs also a strong institutional component to the trends which we see in our business. And a number of our multi-year projects are in sectors like healthcare and education. And the industrial indicators like the PMI still have room for improvement. But the construction activity and manufacturingâs going strong. Weâre winning business on a wide range of new plant construction including automotive and batteries, semiconductors and petrochem. And importantly, our own survey shows that customer sentiment remains strong with the majority of our customers point to growth over the next 12 months. One final indicator of market strength and an important one was at our annual management meeting. We had over 2,000 field leaders with us in Houston two weeks ago, and their take was extremely positive. And Iâm throwing that into the mix because this is coming directly from people on the front lines. We took all this into consideration when we developed our 2023 guidance. And as you saw yesterday, we expect our revenue and adjusted EBITDA to hit new high water marks, including free cash flow of more than $2.1 billion, while our return on invested capital should be another milestone for us. In addition to the capacity we carried into January, we plan to invest more than $3.4 billion in gross CapEx this year. And at the same time, weâll continue to take advantage of a strong used equipment market to optimize our fleet. Longer-term outlook for our industry continues to be very favorable driven by several tailwinds that we believe are largely independent of macro conditions. And weâve talked about these before, things like infrastructure spending, the Inflation Reduction Act and the return of manufacturing to North America as well as investments in both energy and power. Now, before I wrap up, I want to mention two important announcements we made yesterday regarding capital allocation. First off, weâre reactivating the $1.25 billion share repurchase program that we pause when we announce the Ahern deal. We plan to buy back $1 billion of stock this year. And weâll also be instituting quarterly dividends for our shareholders, totaling $5.92 per share this year. These two decisions underscore our confidence in the durability of our cash generation and the strength of our balance sheet. And together, theyâll return $1.4 billion of capital to our shareholders in 2023. So to come full circle, 2022 was a demand environment that through the door wide open for a record year and we ran with it. But to quote Babe Ruth, we also know that yesterdayâs home runs donât win tomorrowâs games. So now itâs onwards and upwards. 2023 is officially the start of the next quarter century in business for United Rentals, and by all accounts, this will be another memorable year. Thanks, Matt, and good morning, everyone. As you saw in the results we reported last night, the team did a great job delivering across the board, both in the quarter and for the full year. And importantly, as you can see in our guidance, we expect these trends to continue in 2023. Combined with the enhancements to our capital allocation strategy that weâve announced this quarter, we are confident that we will continue to drive meaningful long-term value creation for our shareholders. Iâll dig into this more in a bit, but first, letâs dive into the quarter. Fourth quarter rental revenue was a record $2.74 billion. Thatâs an increase of $435 million or nearly 19% year-over-year. Within rental revenue, OER increased by $354 million or 18.6%. Our fleet average â our average fleet size increased by 14.2%, which provided a $270 million benefit to revenue and fleet productivity increased by healthy 5.9%, which added another $113 million. This was partially offset by our usual fleet inflation of 1.5% or roughly $29 million. Outside of rental, fourth quarter used sales increased by roughly 26% to $409 million as we sold some fleet weâve held back on selling earlier in the year. To help accomplish this, we brought in our channel mix for used sales in Q4 to something closer to normalized levels. The net of this was our adjusted use margins increased by 940 basis points year-over-year to 61.6% supported by strong pricing. Letâs move to EBITDA. Adjusted EBITDA for the quarter was $1.65 billion, another record and an increase of $338 million or 25.8% year-on-year. The dollar change included a $291 million increase from rental within, which OER contributed $256 million. Ancillary added $34 million and re-rent was up $1 million. Outside of rental, used sales added about $83 million to adjusted EBITDA, while other non-rental lines of businesses contributed another $18 million. SG&A was a $54 million headwind to adjusted EBITDA due primarily to higher commissions and the continued normalization of certain discretionary costs. As a percentage of sales, however, SG&A was down slightly year-over-year. Looking at fourth quarter profitability, our adjusted EBITDA margin increased 280 basis points to 50.0%. Excluding the benefit of used sales, flow-through was in line with recent quarters at a healthy 59%. Iâll add that within the fourth quarter results, in the roughly three weeks we owned Ahern, the business contributed about $54 million of total revenue, the vast majority of which was rental and roughly $20 million of EBITDA. And finally, fourth quarter adjusted EPS was $9.74 per share. Thatâs an increase of $2.35 per share or almost 32% year-on-year. Turning to CapEx. Fourth quarter gross rental CapEx was $980 million, and net rental CapEx was $571 million. This represents an increase of $205 million in net CapEx year-over-year, which positions us well for the growth we see in 2023. Now, letâs look at return on invested capital and free cash flow. ROIC was another highlight at a record 12.7% on a trailing 12-month basis. Thatâs up 50 basis points sequentially and an increase of 240 basis points year-on-year. Free cash flow also continues to be very strong, with the year coming in at $1.76 billion or a free cash margin of better than 15%, all while continuing to fund growth. Turning to the balance sheet. Our leverage ratio at the end of the quarter was 2.0 times on an as-reported basis, including the impact of the Ahern acquisition. More importantly, on a pro forma basis, our year-end leverage ratio was flat sequentially at 1.9 times. And finally, our liquidity at the end of the quarter was a very robust $2.9 billion with no long-term note maturities until 2027. Now, letâs look forward and talk about our 2023 guidance. Total revenue is expected in the range of $13.7 billion to $14.2 billion, implying full year growth of about 20% at midpoint and pro forma growth of roughly 12%. This increase is supported by the momentum weâve carried into the New Year, particularly within rental revenue and the contribution from Ahern. Within total revenue, Iâll note that our used sales guidance is implied at $1.3 billion, with the expectation that weâll sell roughly $2 billion of OEC. This 35% increase in used sales year-over-year primarily reflects two things. First, is the normalization of our used sales as the supply chain continues to improve. And second, a substantially larger fleet, including the addition of Ahern to our business. We remain focused on efficiently converting this growth to our bottom line. Our adjusted EBITDA range is $6.6 billion to $6.85 billion. On an as-reported basis, including the impact of Ahern, at midpoint, this implies roughly flat full year adjusted EBITDA margins and flow-through of about 48%. On a pro forma basis, however, which we think is the more appropriate way to think about it, our guidance would imply at roughly 80 basis points of margin expansion and flow through in the mid-50s. On the fleet side, our initial gross CapEx guidance is $3.3 billion to $3.55 billion, with net CapEx of $2 billion to $2.25 billion. And finally, our free cash guidance is $2.1 billion to $2.35 billion. To be clear, this is before dividends and repurchases. Assuming these two factors are a use of cash of roughly $1.4 billion that leaves $825 million of remaining free cash flow to fund additional growth or reduce net debt. Now before we go to Q&A, I want to make some additional comments on our updated capital allocation strategy. Specifically around our plans to return excess cash to our investors. As you heard Matt say, we are very pleased to be adding a dividend program to our mix. Based on an initial yield of 1.5%, we expect to pay $5.92 in dividends per share in 2023. This will translate to approximately $400 million this year or roughly 18% of free cash flow. We expect that our first quarterly dividend payment of $1.48 will be made on February 22, with all four payments expected within the calendar year. Following the transformation of the company over the last decade or so, we feel that itâs the appropriate time to add this last element to our capital return strategy to help drive greater shareholder value. Not only will this help expand the universe of potential investors, we expect that it will also provide another means of enhancing total returns for our investors over time. It also reflects the confidence we have in our operating model to consistently generate considerable excess free cash flow after investing in growth. Weâre also very pleased to announce the restart of our share repurchase program, which we paused in November with the announcement of Ahern. The restart is probably a bit ahead of schedule, but the integration is off to a great start and the decision is well supported by the financial performance we expect this year. Itâs our intention to repurchase $1 billion of the $1.25 billion authorization in calendar 2023. As Matt said, these two programs combined, should return approximately $1.4 billion to our shareholders this year or about $20 per share at the same time that we continue to see substantial growth in our earnings. Finally, I want to be clear that these announcements are being made in the context of our continued commitment to a disciplined balance sheet strategy. Our financial strength has served the company and its shareholders very well, and weâre not planning any changes there. Hi, thank you for the time. Two questions. One, where thereâs some worry by investors and another where thereâs a clear cementing of a structural improvement on peopleâs minds about the business model. First, in the area of [indiscernible], equipment availability, I think, Matt, you had mentioned earlier about maybe taking some market share this year. Can you let us know what youâre seeing and hearing regarding competitors and even include OEM dealers, rental fleets in this comment? What are you hearing about their incremental ability to get equipment? What are you hearing about their adding fleet for the year? Just the overall availability from that side? And what are your equipment suppliers suggesting about increased availability versus last year? And Iâll follow up the other question. Yes, sure. So we â itâs still a tight market. Iâm hoping it will be a little better as far as delivery slots than we got last year. But we donât expect the supply chain to be fully back to normal this year, maybe to the back half, but to be fair, I thought maybe the back half of last year would have and we still saw slippage. There are some niche products that are being quoted out to 2024. Now thatâs the exception, not the rule. But I think that that kind of underlies another year of some supply chain challenges. And weâre mitigating that by, as you saw, we brought in some fleet in Q4, and youâll probably see us do a little bit more in Q1 than usual to make sure weâre ready for the build season. And then from there, weâll adjust according to demand appropriately. So, I think there will still be a little bit of a challenge. I think our vendors work hard, David, to get us a fleet they did in 2022, and we think theyâll work hard to get this number. Iâm not seeing a remedy to the supply chain challenges. Yes. Can I asked one question related to what you just said the first quarter, a little larger than normal. Iâm just curious, just the cadence for the CapEx for the year, Iâm talking gross, the 3.425 [ph] midpoint. Can you give us some sense of cadence is â I know you pulled forward, but on the idea of roughly flat gross for the year. Is the down quarter more the fourth quarter because of the pull forward in the fourth quarter? Thatâs our expectation as we sit here today, David. What I really wanted to refer to is youâll prop because itâs the one that we feel pretty sure of is that youâll probably see us do more about 20% of our capital spend here in Q1 as opposed to maybe in a standard year, it would be 12% to 15%. And that pull forward is really just to get ready for the spring season, and making sure specifically in these high time categories that have been the most challenged in the supply chain that weâre ready to respond to the customers. Is that really what I was referring to as far as the cadence for the rest of the year, Q2 and Q3 really will depend on how fast weâre absorbing the fleet that we brought in as well as how well weâre doing with the Ahernâs fleet. So, weâll adjust as we had the past three years accordingly. Itâs pretty interesting. Thatâs taking about $1.6 billion of fleet in the fourth quarter and the first quarter when you combine the two. I assume youâre seeing project backlogs that are really focused on we need this equipment for certain projects. This is not a presumption of demand? I mean, is that just a pretty big first quarter number to follow the fourth quarter, is that⦠Yes, it absolutely David. And that is because we see the underlying demand, and weâve talked a lot, right, in the last quarter as well about the mega projects. So theyâll require a lot of this high time utilization assets. Additionally, weâll also get more to a more normal cadence of used sales than we have. We held back, and we hope we donât have through this year. Weâre planning on selling about 35% more use sales to get back to a normal fleet rotation. So that some of that capital will be to make sure that we have the ability to sell, and we donât have the team losing confidence in their ability to rotate fleet out so that we can still meet demand. Just a strong â obviously, youâre seeing very strong demand in the year is going to start very strongly with that much fleet over the six months even with the used sales as well. Second question. So if we do the dividend, we do the repo if you look at the guide, it implies net debt-to-EBITDA at the end of the year at 1.55 [ph], which is almost a half turn below the low end of your range. Can you give us a sense of the capital allocation, how we should think about that? Where would you be comfortable with the leverage? Or should we think of it as you want to get the leverage back to the low end of the range and thus, M&A? David, this is Ted. Iâll take that one. Thereâs no change to that longer-term framework weâve provided of two times to three times being that optimal level. Weâd always said there was nothing religious about the low end. And so living there for some amount of time to us is something that is consistent with what weâve articulated. The idea really would be the kind of stockpile dry powder for potential growth opportunities. If we were to kind of decide to live in a different ZIP code entirely, we would certainly update â the Street. But certainly for the immediate future, weâre comfortable at these levels. Thanks. Good morning. So just, Iâm curious how the fleet productivity you reported in Q4? How did that compare to what you thought you could do going in some of the investors we chat with kind of seem to note the moderation in fleet productivity as the year progressed. I guess, whatâs the message you want to give to them about how they should think about sort of lower level of fleet productivity in 2023? Is it just more that itâs settling into a more normalized level, still above your hurdle rate, but just kind of moving beyond these unusual dynamics of utilization and inflation in 2021 and 2022 and itâs just sort of steadily into a more normalized path. Is that what message you would give? Or how would you frame that? I think thatâs â first of all, this is an output, right? So, weâre going to manage the heck out of rate and time even though we donât report it out individually. And Iâm very pleased that the whole industry is doing that, and we see the discipline shown in the industry from that perspective. But I think the way you characterize it is fair, we were pleased with our Q4 fleet productivity. It was what we expected. And just for clarity for those that may not have picked it up, the 5.9% as reported when you take out Ahern, that would be 6.5%. So thatâs about three weeks of Ahern built into the fourth quarter. So, we will report next year fleet productivity on as reported and on a pro forma basis, so you could see that impact. And what weâll really be focused on is making sure we take the entirety of the fleet and drive more value out of it. And any time this number exceeds our threshold we expect to comfortably do next year will â thatâs a net gain. And weâll be measuring that on a pro forma basis for you see what weâre doing with the Ahern fleet against their baseline as well. Okay. And then Iâm wondering about the general cadence of project activity that you expect during the year and where you are with these large projects. Obviously, you talked about taking all the extra CapEx more front-end loaded. I guess Iâm wondering how you compare whatâs in the â still in the planning stages on these large projects compared to what you have on rent at the moment because there are some investors that, I think your business is slowing down, but Iâm wondering if thereâs actually â if youâre seeing more large projects in the planning stages than whatâs on rent, Iâm wondering if that could actually lead to some type of acceleration as the next year or two plays out? Yes. Weâll stay away from quarterly cadence, but obviously, it gets held by our pulp that we expect to need more fleet come the spring build up. Weâre not â Q1 is always going to be the slowest quarter seasonally, but we see strong demand here today, and we expect that to continue to ramp up from big projects. And then once you really get to the peak season, once you get past May, June and even all the local market stuff starts popping. So when you hear about this pull forward, we donât feel the fleet that we would normally have had ready is going to be enough when we get to the real build season in April. And thatâs really more what that pretends to be in Q1, isnât really the focus, the focus in is, are we going to be ready for the build, all these projects that are scratching dirt or coming out of the ground that weâre going to need, weâre going to need to mobilize fleet for in the spring. Okay. Just a quick clarification, if I could. Whatâs the embedded flow-through that you have on the Ahern business in 2023? And compared to 2022, you got a 55% pro forma for legacy or? Whatâs the Ahern flow through? Yes. Steve, that one is harder to speak to just because of the way we integrate acquisitions, especially in gen rent, and thatâs why itâs easier to frame as a function of pro forma. So I think you hit the nail on the head, certainly as reported, flow-through would look like 48 â or excuse me, as reported looks like 48% pro forma 55%, but itâs hard to kind of discretely break apart the businesses. The one thing I would note, just to remind people of, we do think weâll achieve about $30 million of the cost savings out of the $40 million we talked about. So we can certainly share that. Yes, in 2023, weâll hold $40 million, but we only get about $30 million of it in 2023 as to our expectations. Hi, thanks. Good morning everybody. I wanted to kind of circle back to the demand side or at least the end market support thatâs out there in the short and the long-term. And so if you look at the dynamics, I guess, we have the mega projects that people talk about you have the fear or the risk that rising interest rates and the potential recession will cause project delays or cancellations? And then you have the infrastructure bill, which is kind of different from some of the chips and semiconductors and stuff that will flow in. So, I wonder if you could level set us on those. Are you seeing any delays, cancellations, et cetera? The mega projects I assume are flowing in? And are you seeing any of the infrastructure bill starting to flow? And I assume thereâs pretty good duration on some of the stuff. So, I wonder if you have any comments on what your visibility is now versus past errors in the history. Yes. Sure, Rob. So broadly, weâre â we believe that these â many of these projects are not macro relining. You heard me say that in our opening comments, and weâre talking about the type of mega projects weâre talking about. We feel really good about that. As far as infrastructure, weâve been saying all along, we expected this to be a 2023 event, and Iâm pleased to say that we are seeing projects coming out of the ground and projects that are taking fleet as we speak. Mostly, youâre think looking at bridges, airports, whether it be expansions or remodels. So weâre pleased, and we think that will carry out and accelerate through this year and beyond, right, be a multiyear event. So, weâre very pleased with that. Ted, I donât know if you had anything to add? Yes. No. I mean we really have not seen anything along those lines, Rob. Probably the one area where maybe weâve seen some delays just as weâve talked about it, has been more in the alternative power side, and I think thereâs been some stuff written about this publicly. Solar has had some supply chain issues. And within wind, weâve seen a couple of permitting issues. All that said, our Power business in the quarter was up about 9%. And for the year, weâre up about 10%. So while weâre seeing kind of reports that youâre seeing delays on project starts. That business for us has continued to be very robust. And just for clarity on the broadness that weâve been talking about, right, in just the mega projects, the mega projects are really the kicker, while you hear us this strong tone and guidance that weâre coming out with, but we have seen this breadth growth throughout all geographies. So itâs not mega project reliant, but theyâre kind of a kicker that maybe could offset if the commercial retail is going to drop or you think office space is going to drop. So we really feel that the balance is appropriate for this type of guide and the bullishness â you here in October. And just to clarify on that, I was going to ask anyway, but we all talk construction, you have a lot of non-construction verticals youâre seeing strength kind of throughout the industrial side? We are, yes. I mean if you really go through all the verticals with the exception of midstream, which throughout the years, youâve been the only vertical down for us, everything is up and even though the rate of change across those verticals has been negligible. I mean, itâs really been very consistent across the year. Hey guys. Good morning. You guys are obviously planning to sell a lot more fleet used fleet this year. And Matt, I think I heard you reference something about a broad mix or something different channel mix or whatnot. Can you just give us some more details on what your â kind of how youâre selling this used fleet? I mean thereâs obviously some concerns about used pricing starting kind of rolling over. And what your expectations are? Whatâs embedded in your expectations for used equipment pricing for 2023? Thanks. Sure. So, we feel good about the end market including pricing. Weâll fall off the historic eyes that weâve set over the last two years, maybe a little bit, but weâll find out. And I think one of the things weâre going see is that the increase of replacement capital costs could definitely have a halo effect on used pricing. But when we think about what channels weâre going to open up is what we were talking about, weâve been strictly or 90% retail all the way in the first three quarters of 2022. And then you saw we lose it up a little bit to get â to do some more volume in Q4. And that wasnât because there werenât options; it was to retain fleet to rent. Because we â the supply chain just wasnât getting fleet to us fast enough for our customers. Weâre hoping our expectation is that we can go back to a more normalized channel mix in 2023, and thatâs whatâs embedded in our guidance. So, weâll open up the broker chain. Weâll do some trades. We probably wonât do much auction unless you have something thatâs really in this repair. Weâre not really a big auction player. But just opening up that channel mix over and above the retail, and that will allow us to rotate out about $2 billion worth of hopefully. Got it. Okay. Thatâs helpful. Thanks. And then just on the strength in the specialty margin in particular was pretty notable is â I think it was 400 basis points year-to-year. Is there something â is there some step changes happened there? Is it the general finance business, itâs clicking or anything youâd call out that is supporting that big jump year-over-year? Thanks. Yes. I think there are a couple of things there, Seth. I mean certainly, growth has been good, so thatâs helped drive fixed cost absorption. But beyond that, you had really good cost control in the quarter. And you also had some beneficial mix both within the specialty segments and on a project basis that benefited that flow through. Thanks. Good morning. Just maybe group two together here. Matt, maybe the first is just on fleet productivity and just how you think about the components within that in 2023, just thinking of maybe time and rate given that you held on the fleet longer in this year to make sure you met the demand presuming youâre running pretty hot on time. So potentially, that starts to run against you, but maybe Iâm wrong on that. And then just kind of the interplay on rate. And then the second question, maybe for Ted, is just any help in terms of EBITDA to operating cash flows, how should we think about, say, cash interest and cash taxes. Any help you have on that? Thank you. Sure, Tim. On the fleet productivity, we still feel that the environment is going to be very constructive to drive positive fleet productivity. But you pointed out, the reality of our time may have been running so hot, but at some point, you have to look at it, are we running the appropriate level of time? Can we continue to raise it? Or does it become a bit of a headwind. With that being said, even if time becomes a headwind just because weâre running so hot in some key categories, and we need to make sure we have availability for our customers. We still have ample opportunity to drive positive fleet productivity. And we think the end market is constructive for that. Weâll feel comfortable that both in as reported and pro forma basis will exceed our hurdle rate that we talk about that 1.5% even if that goes up to 2%. So, we feel good about it. And Ted, you can take the EBITDA question. Yes. So Tim, just in the absolute, we would look for cash taxes in 2023 to be about $565 million. Thatâs an increase roughly of about $240 million. Cash interest at about $600 million, which would be an increase of $195 million or so. And so when you bridge kind of that $1.1 billion increase in EBITDA against a roughly $460 million increase in free cash flow, really that the delta is going to be the change in working capital. Got it. Thanks, Ted. And did you â usually you speak to a merit increase as we think about an SG&A kind of bridge year-over-year. Any â have you quantified that as to how we should think about that for this year? Yes. I donât know if weâre ready to quantify it. But certainly, weâve got that built into our guidance and built into our operating plan. We always talked about the importance of supporting our employees and taking care of them, and thatâs an important aspect of doing just that. So there is absolutely a merit increase built into this guidance. But in terms of quantifying it, itâs not something I think weâre prepared to do. Yes. Hi. Good morning, everyone. Iâm wondering if you could, just talk about the impact of the new higher pricing on new equipment on the marketplace. When we saw a Tier 4 higher pricing roll through that had a nice pricing umbrella on the rental industry for the entire fleet. And Iâm wondering, I know itâs early post the January price increases by the OEMs. But to what extent is that a pricing opportunity for the industry as you folks see it? How would you compare and contrast this transition versus the Tier 4 transition in terms of driving pricing upside? Thanks. Sure. Well, number one, this would be more across the board, and we feel comfortable, I talk about it in used pricing as replacement CapEx gets increased. Thatâs kind of an umbrella on the used pricing, residuals, which is a positive. And I think to your point about the whole industry having absorbed some inflation has been â has bolstered the discipline that weâve been seeing. But to be fair, we saw it even before the price increases, and I think this is just the maturity of the industry. Youâve heard us talking about the bigs â getting bigger and just more sophistication and information in the industry. I think all those are helping and certainly increased OEM pricing makes that even more important. And so I think your point is well taken. It will probably bolster some of the behavior in the industry. Super. And just curious, a lots of cross currency in the cycle, as weâve discussed, Iâm wondering if you look at the 2011 through 2015 environment, any analog that you would draw in terms of the industryâs ability to match supply and demand today versus that cycle where early on supply demand matched pretty well, but obviously 2015 touch of oversupply. Can you just talk about how you view the industryâs position today between availability and data, et cetera, and how youâre managing the supply/demand balance? Yes. So one of the biggest differences is the information that access â everybody has access to, right, whether itâs the route data, whether itâs now that over a third of the industry is covered by top three public companies, right? These type information gives everybody more understanding and visibility of the important metrics to focus on and the opportunities that exist in the industry. So â and the scale â so specifically for us, and letâs say, our next largest competitor, scale allows us to get through things in a different way. And so I donât really wouldnât draw a comparison. I think the industry changed significantly in my 32 years, but even in the last 10, we do things differently, and Iâm sure some of our peers do. And I think youâre seeing that manifest in better performance overall for the customer and for the shareholder. Super. And lastly, if I could just sneak one more in there. Ted, Iâm wondering if you could just talk about what level of inflation is embedded in guidance overall? And if you can just touch on transportation, specifically where it feels like there might be some tailwinds for you folks on third party? Thanks. Yes. In terms of the inflation thatâs built into our expectations, certainly probably elevated versus historical levels, probably not as significant as what we saw in 2022. And yet, weâve been able to manage it very effectively, right? So if you look at that flow through last year, as an example, when you back out use across the full year, flow-through would have been 56%, 57%. So clearly indicative of our ability to manage that inflation very effectively. And when you think about what weâre pointing towards in 2023, a similar level of flow-through on that pro forma basis. So â itâs not to say that weâre in a benign cost environment. Thereâs still elements of inflation that weâre managing and all companies are managing, but we feel very comfortable in our ability to manage it effectively. In terms of pickup and delivery, thatâs an area where, frankly, weâre not trying to make money. So as you see, the price of diesel, as an example, ebb and flow, the impact on our margins is relatively de minimis. So itâs something the team has done a great job managing through in 2022 when obviously, diesel prices were a substantial headwind to companies. But if you think about that dynamic in 2023, I donât think it will be very appreciable. Hey guys. Thanks for taking my question. Just we â I know thereâs been a lot of talk of mega projects. We see Tesla announcing a $3.6 billion of new investments in two battery plants in Nevada. Just â we think about the economically sensitive areas of non-res like office and retail. Can you just help us understand when we think of these mega projects, how much more fleet on rent for these projects versus your typical office or retail? Are the terms and structures different? Is it different in terms of the multiyear visibility there, the different type of fleet required. Just curious if we see that trade-off over the next 12 months, 18 months, how we should kind of view that? Yes. Michael, the type of projects vary so much that would be pretty hard to do. I mean outside if youâre thinking about towers, right, large towers, office building, which may be more limited in what type of fleet you would rent on it. All these projects have different needs. And the great thing about our product line is whether itâs early when theyâre scratching dirt, whether he needs trench places from creating the infrastructure to then creating the structure to then finishing off the building. Weâve got the opportunity to cross-sell into all those needs. But as far as the volume needs, we do attribute models, theyâre really hard to be predictive. I wouldnât really say that itâs something that you can rely on. I think the speed and the time to do the project and the sensitivity probably drives more variation of how much men, material and fleet theyâre going to put on there, right? And it seems like nowadays everything is a fast-track project. That used to be a term 10 years ago, that meant they were going to do something quicker now itâs every project is fast-track. So, I think that has implications of driving more rental than anything else. Thanks. And you guys highlighted all year that fleet productivity number was going to decelerate. I know you kind of gave us some puts and takes for 2023. But is the view that number continues to decelerate through 2023 or finds more stability at some point? Could you guys were kind of clear through the year how we should kind of prepare for that throughout the quarter? Just curious if thereâs anything we could kind of prepare as we go through 2023 there directionally? Yes, I mean, you see whatâs embedded in our guidance on as reported basis, right? And within that range would be a different number anywhere. I wonât even say the number. You could do the work. But I think really the most important thing is that the environmentâs good for us to continue to drive positive fleet productivity, even if time utilization doesnât go up. And thatâs really what matters. Thatâs the important part of it. And we will report this on a pro forma basis. Theyâll be a little bit as reported drag from the 800 â bringing in the 800 fleet, but weâll report that out and thatâll be a couple of points differentiation there, even between as reported and pro forma is what our expectation is. So, weâll â itâs an output that we really donât want to try to predict. But what our expectations are for [indiscernible] are all embedded within our guidance. Great. And just, Iâll sneak one last one. Just, I know we talked about power exposure, alternative energy, just on the traditional side, the upstream, midstream, downstream, just are you seeing more activity there? Is that actually accelerating? Iâm just curious if you kind of touch on the traditional side? Yes. Itâs bit pretty consistent in terms of that progression. Hold on, Iâm just turning something quickly, Mike. Give me one sec. So certainly continue to see strong momentum in upstream. I mentioned midstream has been kind of the one sector that has been a headwind for us this year. Theyâre â itâs relatively small, call it 2% of our total mix and downstream has been pretty steady as well. Chemical processing would be the same. So if we look at the business, itâs consistently been about 13% of our total business across the year. Good morning. Matt, I wanted to go back to a couple of your comments that you made. Obviously, you gave a lot of good color on infrastructure spend opportunities earlier in the call. I think the guide implies, call it a low double-digit organic growth after you strip out Ahern. But maybe, is there any way you can help us try to size what the midpoint of guide assumes are the benefits from the trends weâre seeing in industrial restoring or your visibility on infrastructure projects? I donât really have it broken out that way. We really look, frankly when weâre planning, but more by region versus the verticals and then we track the verticals as we assign capital after the fact. So I actually donât have that number for you, Ken. We can do a little work and get back to you on that. But just generally, right, without trying to get too pegged on numbers that I havenât vetted. Generally, itâs â we view infrastructure as something thatâs accelerating, right? We view that weâre seeing the beginnings of it â of the spend, and we think thatâll accelerate through 2023 and beyond into multi years. As far as the manufacturing, someone mentioned earlier, thereâs some big plants going on right now that have a lot of fleet on rent as we speak. But thereâs also some projects coming out of the ground that we think are multi-year mega projects. I donât really know how to lay those against each other. But Iâd say overall the mega projects work will certainly outpace infrastructure work in totality. But the acceleration infrastructure will continue throughout the year. Understood. For the follow-up, and you touched on this a little bit, but obviously weâve seen some cracks start to emerge for the broader industrial space, especially on the â you talked about PMI in your prepared remarks. I know thatâs a little less than 50% of your customer mix, the industrial MRO part of the business. Maybe talk to us a little bit about how much conservatism is built in to the bottom end of the guide range. Whatâs embedded there in the assumption if we really do see a sharper turn in the industrial MRO demand environment? Yes, Ken, Iâll take that one. As Matt mentioned, when we do our forecasting, itâs really built by the branches up to districts, regions, divisions, and corporate ultimately. So itâs really kind of set by the field. We donât look at it kind of top down looking by vertical. So as I mentioned, our industrial business has held in very well. Weâre not seeing any signs of cracks, and I know people have looked at whether itâs the PMI or other metrics and itâs raise concerns. Weâre not seeing signs of those. And as Matt mentioned in his prepared remarks, we also see a lot of these industrial projects kicking off this year. Weâve talked about autos and related stuff. Weâve talked about semis, but frankly, itâs even broader than that. And so if thereâs an offset from this â if there is a headwind on the MRO side, I think weâre very confident youâll see within industrial kind of offsets on the construction side. But just to answer the question pointedly, we donât forecast our business based on these industrial verticals. Got it. Maybe if I could just sneak one more in here. It doesnât sound like you guys expect any constraints certainly from a capital perspective, even with the new dividend and the share repo, but I am curious if you think thereâs enough management capacity to go after M&A here in the near term? Yes, Ken. So outside of anything that has a significant overlap with Ahern, right? So in those markets where theyâre integrating the teams together, right, getting the sales reps together, thatâs a lot of work on the ground. So weâre going to pause for a little bit on anything that would have a large overlap. But if we have opportunities and we continue to work the pipeline as we have for the past couple years that donât have a big overlap and we have capacity in the field. Weâre absolutely if they clear that final hurdle of the finance â makes financial sense. We have the dry powder, we have the capability and we certainly would consider M&A that whether it be a tuck-in gen rent deal in a market that Ahern wasnât in or a specialty product line where theyâre not dealing with any integration issues right now. So, our integration work rather than issues. So I would say absolutely we would. And just to touch on the capital allocation, one of the reasons why it was the right time for us to do a dividend now is because this is not at the expense of growth. When you look at the past two years and the kind of growth we drove, including significant M&A, we still have the capacity and free cash flow to give a dividend. So we had asked that question by someone earlier, are you given a dividend because of less growth prospects? No, quite contrary, itâs because even after supporting growth, we have excess cash to return and thatâs push points to the resiliency of our strong free cash flow through the cycle. Hey guys. Thank you guys for fitting me in. Matt, in the past you guys have talked about the big â getting bigger and in the K you mentioned 4% North American rental growth and youâre talking about 12% sort of growth right now. I mean, do you guys have consistently outgrown the broader industry? But are we seeing a step up now, an inflection point with the scale that you have, the specialty that now itâs reasonable to think that you guys might be able to put up 3x what the industryâs growing at? Well, certainly yes, because thatâs what our guidance implies. I think youâd have to think that that 4% number would be locked in as well. So, I donât know what the coming out number for ARA was last year, but I know they raised it throughout the year. But we donât focus on that as a barometer limiting ourself. We focus on what we see in front of us, what we do during our planning process and what we hear from our customers as well as our people in the field. But implied in this guide is 3x. And we do think we could do that. I think, Iâve talked about this before, how the top end of the business, the biggest getting bigger is a trend that we think is going to continue. And we think scale gives you some opportunities and options as well as adding additional product lines and cross selling that are â gives better service to the customers and gives you an opportunity to grow faster than the industry. And I think weâll see that continue. Thanks, guys. Good morning. My first question, in gen rent specifically, I guess, probably, Ted you may be the best to speak to this, but how is rental duration performed over the last few years? Have you seen an expansion of your equipment staying out on rent and with mega projects coming and infrastructure bill feels like 2023 is going to be a lot of that should, is it likely that we may see that expand? I know weâre talking a matter of days here. But might the length of period that assets are out on rent expand and could that have a positive margin benefit for the company? Thanks. Yes, so Iâll touch the first part of the question. Iâll start there. In terms of the mix between daily, weekly, monthly, which is really the way we would look at this. We donât kind of measure contract duration and maybe the way youâre asking Scott, but those numbers have not moved meaningfully. Youâve seen a very modest shift between daily and monthly to the point of â to the tune of about a point. So, weâd be kind of mid-single digits on a daily and weâd be about 80% on monthly. And those numbers have been remarkably consistent for a long time and it really hasnât been an appreciable change in terms of 2022 versus 2021 or prior years. In terms of the margin impact, certainly what weâre always trying to do is be mindful of getting more of your volume and serve you more efficiently. And so certainly, I donât know that thereâs a huge change there, but we do have that benefit as we do get larger projects that last longer and we get more fleet on this projects, weâre able to serve that customer more efficiently. And that certainly benefits margins to some degree and importantly returns. Great. Thanks. Appreciate that. And then, Ted still for you, kind of your thoughts and kind of how the Board is looking at with the new dividend program, should we anticipate United Rentals to be a dividend growth story? I think you referenced about an 18% payout. If you want to quantify this, but is there a comfort going higher on payout ratio? Is that kind of a direction weâd expect to take vis-a-vis share repurchase, just high level thoughts there? Thanks. Yes, absolutely. Donât want to get ahead of the Board, but absolutely, we have the intention of growing the dividend over time. In terms of what that relative growth looks like relative to net income because youâre asking about a payout ratio. I donât know that weâd get locked in there just yet, but absolutely the intent is to continue to grow the dividend over time. Itâs fully our expectation. Weâll continue to grow the company over time. Weâll continue to expand margins. Weâll continue to generate more cash. And so one of the things that dividend allows us to do is have another tool to return that excess cash to investors as we keep growing. So yes, I think itâs very fair to assume that we will grow the dividend over time and in terms of what that rate looks like, stay tuned. Thank you. That concludes our question-and-answer session. Iâll now turn the call back to Matt Flannery for any additional or closing remarks. Thanks, operator. And that wraps it up for today. And I want to say thank you to everyone for joining us as we kick off another year of growth for our shareholders. And we look forward to reporting a strong quarter for you in April. Until then, if you have any questions, please feel free to reach out to Ted. Have a great day. Operator, please go ahead and end the call.
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EarningCall_1203
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Good day, everyone, and welcome to the Lockheed Martin Fourth Quarter and Full Year 2022 Earnings Results Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Maria Ricciardone Lee, Vice President of Investor Relations. Please go ahead. Thank you, John, and good morning. I'd like to welcome everyone to our fourth quarter and full year 2022 earnings conference call. Joining me today on the call are Jim Taiclet, our Chairman, President and Chief Executive Officer; and Jay Malave, our Chief Financial Officer. Statements made in today's call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities laws. Actual results may differ materially from those projected in the forward-looking statements. Please see today's press release and our SEC filings for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements. We have posted charts on our website today that we plan to address during the call to supplement our comments. These charts also include information regarding non-GAAP measures that may be used in today's call. Please access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts. Thanks, Maria, and good morning, everyone. Hope you've all had a good start to the new year, and I thank you for joining us on our fourth quarter 2022 earnings call as we review our results, key business area accomplishments and our outlook for 2023. I'd like to begin with a few highlights from the quarter and from the year, and then Jay will review the financials in a more detailed manner. Lockheed Martin had a strong close to 2022. All of our business areas met or exceeded our prior expectations, resulting in a 2022 full year sales of $66 billion, segment operating profit of $7.2 billion and earnings per share of $21.66. Our free cash flow for the year of $6.1 billion also came in above our prior expectation, while backlog for the year increased to $150 billion, driven by all-time record orders for Lockheed Martin. Our financial results included more than $1.7 billion of independent research and development investments, or IRAD, a new high watermark for the company. We also continue to modernize and streamline our operations to increase efficiencies and reduce costs. Significant capital projects include our ongoing investment in what we call One Lockheed Martin transformation or 1LMX. This is our multiyear internal project to transform our business processes and systems from end-to-end. By implementing new digital tools in our operations and expanding our use of model-based engineering to enhance our speed to market and our cost competitiveness. In 2022, we completed a majority of the detail design for our new systems and business processes. And for 2023, we expect to complete the detailed design and implementation road maps that go with it, and then we'll transition to the system build and configuration phase over the next couple of years. These IRAD and capital investments accelerate the capabilities our customers need and for our operations to efficiently and effectively meet those needs. From a capital return perspective, we delivered approximately $11 billion to shareholders in 2022 via share repurchases of $7.9 billion and dividends of $3 billion. During the fourth quarter specifically, we entered into a $4 billion accelerated share repurchase program, and we've retired approximately 7 million shares under that agreement so far. We expect to complete our remaining repurchase authorization of $10 billion over the next few years, consistent with our focus to deliver free cash flow per share growth to you, the investor. These operational and financial results created significant value for our shareholders, ending the year with a total shareholder return of 40%. I will touch briefly now on the Department of Defense, or DoD, budget. In late December, Congress signed the FY '23 Omnibus spending bill into law, appropriating $858 billion for National Defense, including $817 billion for the DoD-based budget. This reflects approximately 10% growth year-over-year for both national defense and the DoD-based budget. These appropriations enabled us, along with the Joint Program Office, to finalize the contract for the production and delivery of up to 398 F-35s for $30 billion in Lots 15 and 16, including the option for Lot 17. Further, several other of Lockheed Martinâs programs received the funding levels necessary to drive the growth outlook we previously identified, including our combat rescue helicopter, the C-130J, Blackhawk, CH-53K and FAAD. We view this funding outcome as positive for the future, and our current expectation is that growth will materialize over the longer term, starting in 2024. Let's now turn to the four growth pillars: programs of record, hypersonics, classified activities and new awards. With regard to programs of record, there were several important developments in key signature programs in our fourth quarter. On the F-35, the definitization of Lots 15 through 17, as I mentioned a minute ago, included the first F-35 aircraft to be produced for Belgium, Finland and Poland. We received authorization to procure long lead items for Lot 18 F-35 aircraft for the U.S. Air Force, Marine Corps, Navy and U.S. allies as well. We also formally welcomed Germany, the ninth foreign military sales country, to the F-35 Lightning II program. And earlier in January, Canada officially became an F-35 operator as the country selected the aircraft to replace its aging fighter fleet. We continue to expect deliveries of the F-35 to ramp to 156 by 2025. Despite the temporary pause in flight operations and corresponding suspension of engine deliveries that began in December and resulted in the delivery of just 141 F-35s in 2022, seven shy of our expectation of 148 before the engine issue was discovered. Also in the quarter, the U.S. Navy authorized the CH-53K King Stallion heavy-lift helicopter to enter full rate production and then its deployment phase. This important milestone allows the program to proceed beyond low-rate initial production. And this achievement attests to our long-standing partnership with the U.S. Marine Corps and instills confidence and stability in Sikorsky's diverse domestic supply chain. In addition, at Sikorsky, international demand for the Black Hawk remains strong. Last week, the Australian Army announced it will acquire 40 UH-60M Black Hawk helicopters to replace its current multi-role helicopter fleet. Deliveries are expected to begin for Australia this year. Further, the Lockheed Martin built Orion exploration class spacecraft launched on NASA's ARTEMIS 1 and completed a 25-day flight test, slashing down off the coast of California. This successful mission takes us one step closer to the first woman and first person of color setting foot on the moon. On its journey, Orion traveled more than 1.4 million miles through deep space and surpassed records for total distance. It traveled 270,000 miles from home and the farthest distance from earth by a spacecraft designed to carry humans. We look forward to the next stages of the program with seven additional missions under contract. Turning to hypersonics. In December, Lockheed Martin Missiles and Fire Control and the U.S. Air Force successfully conducted a hypersonic-boosted flight test of the Air-Launched Rapid Response Weapon. This was the first launch of a full prototype operational missile, meeting all its objectives for the test, including reaching speeds of greater than 5 times the speed of sound. With regard to classified programs, we achieved successful milestones across multiple business areas in 2022 and grew 5% year-over-year. We continue to expect growth in classified that will outpace the rest of the portfolio over the next several years. And finally, at new awards, Lockheed Martin's Next-Generation Interceptor, or NGI, continues to make progress. In late October, we announced the delivery of the first NGI flight software package to the Missile Defense Agency, providing the framework of software development tools, process workflows, scripts and environments. The delivery was ahead of schedule and is a critical step on the path for flight testing and fielding. This program remains a focused competition for Lockheed Martin with the first NGI forecast for delivery in 2027. With regard to the Future Long Range Assault Aircraft, or FLRAA, competition, we were disappointed in the U.S. Army's decision. And upon review, we determined a formal protest by Sikorsky on behalf of Team Defiant to be the best course of action. We continue to believe that Defiant X with its increased speed, range, manoeuvrability and survivability is the transformational and most cost-effective aircraft that best meets the selection criteria for this competition. Sikorsky remains one of two competitors for the other component of the Future Vertical Lift initiative that's called the Future Attack Reconnaissance Aircraft, or FARA, which is currently expected to be awarded in 2025. The first RatorX-competitive prototype is over 90% complete and has more than 65% of its acceptance testers already done. Sikorsky is the only company with a representative FARA technology demonstrator aircraft. I saw it fly down at West Palm Beach a few months ago. It's amazing, the S97 RAIDER, which has completed more than 110 flight hours. In November, Norway became the first international customer for our new TPY-4 radar. It's the first software-defined radar that outperforms in target detection, mission diversity and transportability. Norway is going to receive eight of Lockheed Martin's TPY-4 radar with options for three additional radar. Finally, backlog ended 2022 at $150 billion with book-to-bill of 1.2 times and increases in every business area across Lockheed Martin. This strong demand signal bodes well for future growth over the longer term for our company. So, these four pillars will guide us as we face a challenging geopolitical environment and apply growth and integrated capabilities mindset to everything we do here. As conflict continues in Ukraine, unfortunately, and projected global threats require coordinated efforts to protect the U.S. and our allied territories, ongoing progress in our 21st Century Security vision will enable the acceleration of advanced capabilities to defer these threats and drive effective Joint All Domain Operations for our military service customers. In the fourth quarter, we continued to announce and expand strategic agreements with America's leading commercial digital companies, such as IBM's Red Hat, to advance artificial intelligence innovation on Lockheed Martin military platforms; and for Microsoft, with whom we're going to help power classified cloud advanced technologies for the Department of Defense. Microsoft's latest secure framework will make Lockheed Martin the first non-government entity to independently operate inside the Microsoft Azure Government Secret Cloud, ushering in a new era of cloud opportunities for the industry. As we look ahead, demand for Lockheed Martin platforms and systems is strong in the United States and abroad. We continue to expect 2023 sales about the same level as we discussed back in October. We also continue to expect a return to sustained top line growth in 2024 and beyond as headwinds diminish in our program mix, the supply chain continues to recover and our signature programs grow. Free cash flow per share will remain a key focus as we maximize returns for you, our shareholders. 2022 is a year of great accomplishments for our company in the face of a lot of dynamic challenges. The outstanding achievements of our teams resulted from real deep commitments across our business areas and better cooperation among them as well as our corporate functions to develop, produce and deliver world-class systems to our country and its allies. Our progress this year is a testament to the dedication of our 116,000 team members and the values we all share. So with that, let me hand it off to Jay to give more color on the financials, and we'll join you later to answer your questions. Jay? Thanks, Jim, and good morning, everyone. Today, I will walk you through our consolidated results for 2022, additional business area detail and offer a first full look at 2023 guidance. As I highlight our results, please follow along with the web charts we have posted with our earnings release today. Let's begin with Chart three, an overview of our consolidated 2022 financials. Lockheed Martin followed up a solid third quarter with a strong finish to 2022, highlighted by 7% year-over-year sales growth in the fourth quarter and effectively managed a turbulent year impacted by COVID and supply chain disruptions as well as inflation levels not seen in decades. Besides sales, we also exceeded our expectations for segment operating profit, earnings per share and free cash flow, all while absorbing incremental headwinds tied to restructuring activities within RMS and mark-to-market losses in our investment portfolios. We also booked record orders in 2022, resulting in 11% growth to an ending backlog of $150 billion. In addition to our orders on F-35, we experienced a surge in new interest for our industry-leading security solutions, such as in classified programs in Space and in Missiles and Fire Control, where we booked approximately $1.5 billion in orders, reflecting increased demand to replenish U.S. stocks and enhance security positions globally. And we delivered on our commitment to boost shareholder returns by deploying nearly $11 billion to shareholders through share repurchases and dividends while making significant investments in our businesses. Taken together, these results demonstrate the perseverance of our dedicated employees to perform in challenging environments and support our expectations for 2023 and beyond. Taking a closer look at full year results with consolidated sales and segment operating profit on Chart four. Sales came in higher than expected by nearly $750 million, limiting the decline to 2% year-over-year and essentially recovering to the sales guidance we had originally communicated last January. The stronger-than-expected performance was broad-based across all four business areas and reflects strong coordination with supplier partners to drive material throughput and program schedule performance as well as some favourable award timing, which drove additional revenue. Segment operating profit declined 2% year-over-year but also finished higher than expected by almost $50 million driven by the higher sales. Operating margins settled at 10.9%, slightly lower year-over-year and versus expectations based on lower net favourable profit adjustments. Moving to earnings per share on Chart five. Adjusted earnings per share grew 2% for the year as the benefit from share repurchases overcame headwinds from lower segment profit and FAS/CAS pension income. Moving to cash flow on Chart six. We delivered $6.1 billion of free cash flow for the year while investing almost $1.7 billion in CapEx at a ratio of 1.4 times depreciation. We also ended the year with nearly $1.5 billion of accelerated payments to our suppliers, maintaining our commitment to a resilient supply chain. As I noted earlier, 2022 represented a significant year of cash deployment. In total, we returned 178% of free cash flow to shareholders in 2022, leveraging our performance and strong balance sheet while still investing for our anticipated growth trajectory in 2024 and beyond. Okay. Moving to segment results and starting with Aeronautics on Chart seven. Full year sales grew 1% year-over-year primarily driven by increases in our classified programs, partially offset by lower F-35 production volume. Operating profit increased 2% driven by higher net favourable profit adjustments more than offsetting the impact of the lower volume. For the year, backlog at Aeronautics grew 15%. As mentioned, Aeronautics completed the F-35 Lot 15 through 17 negotiations and secured production volumes while providing the services with a value proposition that combines the highest performance at affordable cost. Looking at Missiles and Fire Control on Page eight. Sales decreased 3% driven primarily by lower volume on our special ops sustainment program following the Afghan withdrawal, along with lower volume on sensors programs. Segment operating profit was down 1% with lower favourable profit adjustments primarily on PAC-3. For the year, backlog increased 6% on the back of tactical missile strength. At Rotary and Mission Systems on Page nine, sales decreased year-over-year by 4% driven primarily by a non-recurring revenue event in our training business in 2021 along with lower C6ISR and Black Hawk volume at Sikorsky. Operating profit decreased 7%, following Sikorsky and C6ISR volume and lower favourable profit adjustments on the Black Hawk program. Backlog grew 4% in 2022, led by the Defense of Guam award, where RMS will be the lead integrator of the multi-domain air and missile defense system as well as stronger Sikorsky orders. Turning to Chart 10 in our Space business area. Sales decreased 2% due to the 2021 renationalization of the AWE program, partially offset by growth on a Next-Generation Interceptor program and national security space. Operating profit decreased 8% with lower net profit adjustments, partially offset by higher equity earnings from United Launch Alliance. Backlog grew 16% based on strong classified program captures and Orion orders. So all told, a strong finish to the year. So let's now shift to 2023 on Page 11. Before introducing our expectations, I'd like to inform you of a reporting change in segment operating profit starting in 2023. We will report purchased intangible asset amortization expense in unallocated corporate expense below segment operating profit. Previously, intangible amortization was included in segment operating profit. This change will not impact total earnings, and we believe the change provides a more accurate view of operating performance for each of our four business areas. The impact is approximately 40 basis points on our 2023 expectations, consistent with the impact in previous years. Our 2023 financial outlook includes the impact of this change, and you can find supporting data for these adjustments in the appendices of our web charts as well as in the earnings release. Okay, let's get into the outlook for 2023. We continue to expect sales to be in the range of $65 billion to $66 billion and the midpoint is slightly below 2022. Speaking to the timing of sales this year, we expect the first quarter to be our lowest quarter of the year, ramping up quarter-over-quarter as we did in 2022. Segment operating profit for 2023 normalized for intangible asset amortization has improved what we thought -- from what we thought in October. And we now estimate only 10 basis points of headwind from 2022 with segment operating margins at 11.1% under our new reporting. We currently expect $2.1 billion of FAS/CAS income in 2023. It's estimated to be roughly $100 million lower in '22, excluding the impact from our pension transfer transaction. Our earnings per share is expected to be between $26.60 and $26.90 for '23 with the year-over-year reduction to adjusted EPS primarily driven by lower segment operating profit in FAS/CAS income, partially offset by the benefit from a lower share count. Our free cash flow estimate for 2023 is greater to or equal than $6.2 billion and assumes continued enactment of the R&D tax capitalization. This increase of $100 million to cash generation, along with our share repurchase guide of another $4 billion, highlights our continued focus on increasing free cash flow per share for our shareholders. This projected combination of higher free cash flow and a lower share count lead to a mid-single-digit growth expectation in free cash flow per share in 2023. Okay. On Chart 20 -- on Chart 12, let's sum it all up. We closed out 2022 with a strong finish with operating momentum and a robust backlog, which have us well positioned to resume growth in 2024 and beyond. We also placed a premium on leveraging our strong cash generation and balance sheet to increase cash returns to our shareholders with a significant increase to share repurchases. Across all four business areas, our breadth of development, production and sustainment programs continue to drive a foundation of growth and sustained high performance. And we will work actively with our customers to meet their increasing demands and mission requirements looking ahead to the future. Our investments for growth, value and efficiency are aligned with our strategy for technology advancement and improved synergies across Lockheed Martin. So in closing, we believe the business is well positioned for long-term growth and value creation for our shareholders. Good morning, everyone. Thanks for taking the question. Jim, I wanted to ask you about, you highlighted the headwinds that you have in terms of your program mix in '23 is the reason for flattish sales. Could you quantify what that number is in terms of the headwind and what programs specifically you're looking at? And then as a quick follow-up, the FY '23 budget came in, I think, a fair amount better than you were anticipating plus ops on F-35 and C-130. How might that change what you've previously said with regard to the reacceleration in growth in 2024? Is it better than low single digit now? Thanks. So David, let me take the first one and then kick over the second part of your question to Jim and just really talk in the context of '23 and what's going to be different in 2024. In 2023, when you look at it, we've got continued growth in our four pillars, really the programs of record that Jim had mentioned. But we do have some specific unique items to 2023, and I'll give you an example. For example, in aero. On the F-35, we continue to expect mid-single-digit growth in sustainment on the program. But we are expecting also a mid-single-digit decline in production as deliveries catch up to the material that we had purchased in prior years. Similarly, on the F-16, we're going to see continued growth in production to roll out our backlog, but we are seeing a reduction in modernization and sustainment programs on the F-16. So as those -- both of those normalize in 2023 going into 2024, they will no longer be headwinds, which will continue to allow for growth in Aeronautics, particularly in the F-35 sustainment and on F-16 production. Similarly, like MFC, what we saw in 2022 and it carries over a little bit to 2023 is some of the areas where we see the higher demand from a production level, particularly in programs of record, things like PAC-3, it's taken us a little bit longer than we originally expected to ramp up. And so we're going to see gradual improvement in supply chain as well as our internal operations in '23 with stronger growth in 2024. At RMS, CH-53 will double deliveries in '24 versus '23. And '23 versus '22 is pretty much flat deliveries. We also see probably some Black Hawk growth in '24 as well. And what we're going through right now is the transition for multiyear 9 to multiyear 10 in RMS and Sikorsky specifically. So those are all things that we think will lift from '24 relative to '23, and those are headwinds that are really unique to 2023. Yes. And as far as where the defense budget came out, David, it really aligns with our view in our company about the nature of the geopolitical threat, the need to modernize U.S. and allied forces to continue to hopefully deter armed conflict beyond the sad and unfortunate situation in the Ukraine that's already happened and the fact that there's bipartisan support in Congress to do just that. So we've been expecting all along in our kind of long-range plan that the U.S. government and Congress would step up to meet the reality of the global geopolitical situation. And that's exactly what played out in the budget process for FY '23. We also expect that same reality to continue to sadly exist again in the next budget cycle, which is happening even now in -- for 2024. So we don't see the circumstances the fundamentals changing. Therefore, we also believe that the continued robustness of the defense budget is going to be a reality as well. Just let me follow up on your last question, David, whether or not there's upside. Where we see potential increases to where we were at baseline before really is in MFC. Over the next five years, we've got revenue potential. It's around $6 billion. And that would more than offset lost revenue associated with FLRAA should that decision hold. And so net-net, we see that there could be some upside over the next five years. Thanks, good morning. Jim, maybe one quick one and one sort of allow you to expand a little bit. When is your expected restart of deliveries in the F-35, as a quick one? And then, obviously, there's more of a debate going on in D.C. around fiscal restraint and has been in place in the last several years. And so I'm just curious where you think this ends up as one thing, but more importantly, what, if anything, do you do operationally to prepare yourself for whatever the outcomes are in terms of balance sheet holding back on repo or leaning forward, looking for areas where 2023 budget -- excuse me, 2024 budget might be in a continuing resolution for a full year. Anything on that perspective from an operational perspective? Sure, Myles. So as far as timing and resumption of deliveries on F-35, I think it's really important to differentiate between delivery and production, right? So we are continuing production in the final assembly factories at Fort Worth and Italy and in Japan at the same pace we expected to before the mishap occurred. We're also continuing to order and receive parts and materials from our supply chain as well. And so once an aircraft rolls out of the factory, our pilots and the DoD pilots conduct a handful of acceptance flights. That's what's kind of on hold right now is just that portion of the process. So the vast majority of our revenue, much greater than 90% is earned when the aircraft rolls out from the plant door. So Jay can add more color on the financial perspective, if you like, a little bit later, but that's really what happens. And so as far as the timing of resumption of deliveries, we'll be notified of that when the U.S. government and the propulsion supplier conclude their ongoing mishap investigation. Okay. And then secondly, we really can't predict the political dynamic in Congress and -- within and with the administration. So we're going to keep our head down, stay on our plan, do our job and expect that the right thing will occur at the other end of the 2024 budget process, which is fully funding and making available that funding to the department of defense, so we can deter conflict with them and that they can acquire what they need to do that. So that's our expectation. It's really difficult for us to lay out what we think the budget process will be given the nature of the House, Senate and the administration right now. But we expect that they are going to come together and do what's needed to defend the country and get the budget done. Hi, good morning. Jay, we've talked about this dynamic where the outlays are trailing the authorization and the possibility that supply chain is intertwined in that. And that was kind of tough in the first half of the year, look to be getting better in the third quarter, but then exited the year declining. Do you have any insight into incremental insight into what's going on there when that gets better? And to the extent that supply chain is related, your comments that you expect that to improve through '23, is that underway? You already see that happening? Or is that still just a logical anticipation of timing? Sure. Good question. Let me follow up. And we looked at this and tried to triangulate performance in a number of different ways. We looked at just straight piece part on-time delivery here in the fourth quarter relative to what we saw in the second and the third. We also looked at program performance, so earn value-type metrics, and we really didn't see a meaningful change in on-time delivery or schedule performance relative to our earned value systems. But what I will say is the fourth quarter had a significant step-up in requirements. And if you adjust for the number of weeks in the fourth quarter relative to the balance of the year and you also adjust for some of these benefits that we saw in terms of award timing, our requirements in the fourth quarter stepped up sequentially by about 5%. And I would say the entire value chain, whether it's our internal operations and the supply chain, was able to meet that increased level of requirements. So that, to me, bodes well to the future as well as expecting a gradual improvement in 2023. And I think that just provides a reasonable assumption and a reasonable basis for that assumption Yes, good morning. If you look at the F-35 program, like the incremental profit you reported was about a 16.4% rate, so I assume you stepped up the margin on the F-35. And going forward then, the slight decline that you're forecasting in the margin probably reflects sustainment growing versus production. And a quick follow-up, the $20 million charge that you took in a classified program in aero, was that the same program that you took large charges a couple of years ago? Thanks. Okay. So George, I can probably answer your questions with one yes, but maybe I'll provide a little bit of color there. I now take the -- you're correct, on the charge we took, that was related to the program. We continue to have some learnings there. But our team, I think, in Skunk Works is doing a great job managing that program. And this is a development program where you see and you continue to have learnings. But in the grand scheme of things, I think we've managed that quite well. And it really hasn't -- did not impact our results. And as far as the F-35 program, we did see some benefits there. And you're right, in the quarter, we were -- the results there were augmented not only by the volume but as well as the net profit adjustments at Aeronautics, and it was across the board. I think next year, as we think about the margin, yes, there's a little bit of a headwind there. I think mix does play a part in it as well as right now, we're planning a little bit lower favourable profit adjustments. But for the year, in the grand scheme of Lockheed Martin, this year, we did about 25% of profit in net profit adjustments, and we would expect that to be somewhat similar for the entire company for '23. Thanks for the question, George. Good morning. Jim, I think everyone would agree that Lockheed's got the pole position in offensive hypersonics. Strong program portfolio there and some recent successes. What I think people might be interested in are your efforts as well in counter hypersonics as we might expect that to be a growing portion of the budget. Can you talk about that a little bit? Sure. And it's largely classified, Rob. But what I can say is many of the elements of counter hypersonics, we also have a pole position in, right? So we've got existing products that we can take the lessons learned from and a lot of the engineering and apply them to just a faster incoming target, right? So we're working on NGI, as you already heard, which is a ballistic missile. It travels at similar speeds. We have the FAAD system, which is a sort of a high-altitude interceptor as well. And then we have PAC-3, which is a very accurate lower-level further in, if you will, defensive systems. So we've got the engineering talent. We've got the intellectual property. And we're developing these 21st Century Security concepts like applying artificial intelligence to network systems together and process data much more quickly, which, of course, you need that to process the information coming in on a Mach 5 missile, right? So I think we have a lot of the elements that will go into the eventual counter hypersonic solutions, and we are working on many of them right now in integrating what we have and developing what we need. So I wanted to ask you about the F-16 and maybe expand on the remarks you made just a few moments ago. I thought you might comment on things like U.S. and international opportunity set ahead, maybe update on the first delivery expected production rates. And if it's at all possible, maybe touch on like what margins you're expecting on the program right now. I'm just thinking that they should be pretty decent given the move to Greenville was done to improve the cost structure on the program. Rich, it's Jim. I'll start off quickly and hand it over to Jay for some of the background and data associated with the program. But the really great news is Block 70, which is the production article out of Greenville. The first Greenville Block 70 test flight was this morning was successful, really great milestone for the company and for that organization in South Carolina. But there's significant demand for this aircraft. A lot of coming organically, I guess, I'll call it, from allies around the world. Also, we're out actively marketing this jet to those countries that may not be authorized yet or maybe not have the infrastructure for F-35 at this moment but may in the future. India is one of those. I co-chair the U.S.-India CEO Forum with Secretary Raimondo. We're going to be going over there in a month or so with a team of CEOs from across our industry and meet with theirs and try to get collaboration going. And one of the, I would say, primary opportunities in that endeavour is the F-21, which is F-16 variant specifically designed for India, for example. So we haven't made that sale yet, but I can tell you all the way up to my level, we are out marketing F-16, and we have a lot of organic demand coming in from either existing, order customers or new ones. Jay, anything you want to add? Sure. Just maybe a little bit more color. Just on top of the first flight that we had today the successful first flight, congratulations to our Aeronautics team there. We have over 20 aircraft that are currently in process in the production phase. We will deliver anywhere between, say, 78 aircraft this year, and then that will step up significantly in 2024. And so we're on a good path that we recognize the opportunities that are in front of us. There are a few countries that have been announced there that we're eagerly awaiting contract finalization, hopefully this year, with Jordan and Bulgaria. That's about combined about 20 aircraft. And so the demand, as Jim mentioned, is pretty significant. And we're ramping up as we speak to be able to deliver the customer requirements. Thanks very much. Good morning, everyone. Jay, I'm sorry to waste a question on pension. But if we look at the CAS recoveries, it was about 30% of this year's cash flow. And I know there's discount rates and returns and all that stuff, but CAS tends to be much more visible than FAS on the income statement. So can you give us a multiyear outlook for the CAS recoveries over the next few years and where the balance stood at year-end? Yes. I mean -- so for cash this year, as we mentioned, that will decline this year. I said about $100 million. Specifically, the CAS element will decline by about -- the recoveries by about $75 million. We'll see that decline a little bit more over the next few years as well. And so it will come down in the range, I think, around $1.5 billion, $1.6 billion over the next few years. And so that's the best outlook we have today. As you know, these things are -- they do fluctuate and a little volatile. So we'll update that accordingly as we go and think about next year and what that means for 2025, Seth. Yes, thanks. Good morning, Jim, Jay. Jay, I wanted to just focus on Missiles and Fire Control. Just kind of obviously a little transition in growth this year, but profitability going to be down also looks like close to 90 basis points. Just maybe walk us through a little bit kind of some of the puts and takes there and just thoughts about kind of margin recovery as we think about the next couple of years where we've got all this growth inflected? Thanks. Yes. No, good question. This is something we talked a little bit on the third quarter call. We've got some new program awards, particularly in classified, that are going to put margin pressure not just next year but a few years beyond that as well. And it's really just on the early phase of these programs as we head into production. It's just low margin, and it will take time to have those restore to margins that we've seen in the past. What I will say is that we do have the benefit of some offsetting mix with the upside that we're seeing in this business. I mentioned before a potential $6 billion over the next five years. Those will come with more solid margins will help mitigate the reduction that we're seeing on these new programs. But there will be some pressure there that we have to deal with. And look, the MFC team has a good track record of driving out cost, driving margins. I'm confident they'll be able to do that in the future as well, but it will take a few years to get there. Good morning, everyone. Maybe switching gears to a different topic. With tighter cost of capital, we've seen valuations come down in high-growth investments. Is this a better time for corporate VC to enter into deals on attractive terms? I mean just looking at the limitations on M&As from the FTC stance that we saw with Aerojet Rocketdyne, I mean how should we think about the importance of Lockheed Martin Ventures to access these new technologies? And could we see ventures double from here? Kristine, this is Jim. One of the first things I did when I came from the Board to active management was to double, as you said, to double the venture fund, right? So, it was $200 million, now it's $400 million. We're actively -- actually, very actively looking to invest that additional funding. In the great scheme of the company, though, it's really designed to discover emerging technology that might be applicable to our strategy and to our products and systems and help kind of develop that technology in a way that it can have utilization earlier than perhaps otherwise for our industry. So, we get the most benefit out of our venture fund in actual operations, production and development of platforms and systems. We have had a nice upturn in the valuations of those investments as well, but they're not necessarily driving the ultimate results or the ultimate growth prospect of the company, but they're indirectly doing just that. I'll just add, Kristine, I mean it's a great point. I mean we've got a pretty tight alignment on the targets that we pursue to our technology road maps. And these are examples like Joint All Domain Operations interoperability, autonomy, artificial intelligence and other areas that will help us drive and accelerate our internal organic capability with these new emerging technologies. And so it's a great point. There's certainly opportunity there. As Jim mentioned, we've increased our availability of funding for that, and we're excited about those opportunities. Hey, good morning. Jay, you guys have taken a bit of a different approach on this R&D tax issue than some of your peers. And I know this subject has been beaten to death already, but I'm just curious if you've had any recent conversations with the government on whether they're going to agree with the approach you've taken. And then I guess just stepping back more broadly, you had this uncertain tax position disclosed in the 10-Q. Just kind of give us a sense for when you think that might get resolved? Thank you so much. Sure. Good question. We remain confident in the position that we've taken. We've had really no dialogue. We are awaiting guidance from the IRS on what contracts specifically would be covered. You're right that different players have taken different positions. We remain confident in our position. We believe that the risk is a factor. And when you are under particularly cost-type contracts, there is no risk taken by the provider of those services. Secondly, we believe the benefit is marginal because the owner or the contractor of that work is really the one that takes over that technology and can transfer it to others at any point in time. And so we think that those are sound base and sound arguments supported by legal teams that we have in a position that we've taken. But again, it's uncertain -- and our uncertain tax position really reflects that uncertainty. So, I can't give you specific one way or the other in terms of IRS positions because we just don't know as of yet. But I can tell you, we spent a lot of time researching this, a lot of time discussing it, deliberating it internally, and we think the position that we've come out is the right position. Thanks so much. Good morning. Jay, a boring inflation question for you. Are you seeing any signs that inflation is starting to ease as it works itself through your system? Or was there any mitigation for this cost inflation that is going to be flowing through from the final FY '23 budget resolution? Yes. Rob, inflation is something that we evaluate all the time. In many of our existing contracts, we have not really seen a significant impact, only because I mean our fixed price contracts -- our suppliers are under fixed price contracts with us. Where we have seen is really on new proposals is where we've seen some impacts, where you've got suppliers unwilling to provide longer-term price commitments requesting what we refer to in the industry as economic price adjustments, which are escalation clauses, inflation clauses. And those are ongoing dialogues that we have with our customers as well. And so it's still an ongoing issue. To be honest with you, on the proposal side, we really haven't seen any type of reduction there in the pressure. It's something that we review quite often on these new proposals, and it's something that we grapple with because either you have to price in some type of inflation assumption into your proposal or you have to have some type of back-to-back agreement where you're going to have an inflation clause. And we're getting squeezed with our customer as well as with our suppliers, and we're trying to make sure that we can accommodate both requirements here. Hi, good morning, Jim and Jay. Just wanted to ask a question here on the new award outlook. Putting FARA aside, if you look at NGI, maybe NGAD and other opportunities, what's the current expectations for timing around some awards, specifically around NGI? And are there other programs out there on the new award side that could significantly move the needle as we think about sort of the potential impact into '24? You think about a few of these, it's something that we have -- I mean you know that the F-35, so we've got waiting for the -- we're expecting the production order on Lot 17 in 2023. We do have a large missile -- air and missile defense program -- international program. It's an important program for us this year. And so it's probably back half of the year type of decision. That is included in our four pillars of growth when we talk about new awards. There are other programs here that are classified, really can't get into kind of the detail of those, but we expect some of those awards to be made either at the tail end of this year or into next year as well. And in NGI, we would expect to down-select around 2025. And so there's a fair amount of markers out there in some of these programs that I just spoke between now, really in 2025, that certainly are important to us. Jim mentioned FARA. That's probably a 2025 decision as well. Good morning. Thank you for the time, Jim and Jay. Jay, I think your margins came in a little bit better for 2023 than anticipated your guidance of about 10 bps higher. When we think about your profitability going forward, is this sort of the expected range we should expect? And of your segments, which do you think is the biggest variable? You talked about MFC and some of the challenges there. So maybe if you could talk about that. Yes. Let me maybe talk a bit in the kind of longer-term outlook. And you look at the history of Lockheed Martin over the last probably five to 10 years, and we've reached margins in the range of 12%. I do believe we have the potential to get back to those, but that will take time. In the short term, really, I would say, over the next three years or so, our objective will be just to hold the margins where they are because some of these pressures that we see on these new programs, particularly at MFC, when you've got a 90 basis point reduction in one year from -- in one BA, that's a lot to really overcome. We've worked things internally as far as both product cost reductions, overhead cost reductions to really try to drive and maintain our margin profile. But that's where we're really going to be over the next few years is really trying to maintain where we are as we re-crank the growth cycle. And I think that's the key message that we have had internally: let's re-crank the growth cycle, get ourselves in 2024 on track to deliver the growth. As we get that flywheel turning, then we'll be able to focus and turn back around on margins and start improving margins. Good morning. Thank you. On F-35, so when you get ready to restart here, you've also though now flown the F-35 with tech refresh upgrade -- or Tech Refresh 3 upgrade. Can you talk about how that's progressing, how Tech Refresh 3 is progressing? And how does the progress there play into your delivery plans for Lots 15 through 17? And perhaps you might also comment on, when you get the restart, you've got these airplanes that have already been produced. Should we see those as really add-ons to 2023 deliveries? So Doug, let me take the first portion of your question, it's Jim, and then turn it over to Jay for the second piece on delivery numbers, et cetera. So Tech Refresh 3 is really important in a couple of dimensions. And you're accurate in mentioning and thank you for the first flight with the TR3 upgraded hardware and software was literally just a few weeks ago. We've got more software releases to go. We're going to add capability over the next couple of months. But we expect production of TR3-capable aircraft hopefully in this -- during the course of this year. That's our expectation. Now what that does for the customer and for us and our strategy is really kind of two major dimensions. One is for the capability of the aircraft itself. It will be able to handle more weapons. It will be able to upgrade electronic warfare capabilities. It will be able to accomplish more missions. So the basic functionality of the aircraft alone by itself is going to be elevated significantly by the insertion of this technology. And what is this technology? It's an updated core processor. So the -- basically the server for the airplane that it carries with it is going to the next-generation upgrade. The data storage is going to be vastly improved. And then the display is going to be modernized for the pilot, so what they see, how they interact with the jet and with other aircraft and systems around it. So those three things, right, data processing capability and speeds, data storage capacity, and the ability to interconnect with basically a modernized interface for the pilot along with the better capabilities they're going to have to interact with other aircraft to other systems because of TR3 are all of the characteristics that you need for an edge compute node in a modern 5G Internet of Things system and architecture, right? The three things are data storage, multi-cloud connection and processing power and speed. So we've actually killed two birds with one stone with TR3 here. On one hand, the aircraft is going to be much more capable in the kind of its traditional role. On the second hand, it's going to be way more capable, perhaps uniquely capable, in sort of the network Internet of Things or Joint All-Domain Operations of the future, right? That's what our customer calls that. So we have now the computing power and the capacity to serve as sort of the central aerial component of our 21st Century Security open architecture concept. And that's really the two pieces of F-35, TR3. They're super important. One is the airplane itself; and second, its ability to network with other systems and aircraft in an IoT-based architecture open architecture. Sure. To answer the question on add-ons, that is -- will be -- that will occur but not necessarily in 2023. If you think about it right now, we're going to be introducing and cutting in new production, hardware and software on a full rate production program, which is a pretty aggressive schedule. And so what I would expect -- and this is included in our sustainment revenue growth projections, we'll see the retrofits on the existing fleet over time. And that will probably start beginning maybe sometime in 2024 and beyond, and its part of our mid-single-digit sustainment growth on the F-35. Good morning. Thanks for squeezing me in. I wanted to ask, I think you had mentioned some of the restocking of stuff Ukraine and you've got some orders there. How big is that for Lockheed Martin? And how should we think about sort of the timing? And how accretive that might be the growth maybe in '24 and beyond? Yes. So as I mentioned in my prepared remarks, we've got about -- we had orders of about $1.5 billion. We'll start delivering on some of that in 2023, and that will carry over into 2024. We've got a line of sight to significantly more orders beyond that, that we'll see again in the outer years. And so it's still to be determined. But what I can say is that we have had contract funding and internally funded projects to make sure we can meet higher ramp rates, whether it's HIMARS, GMLRS, PAC-3, all of those, all are opportunities from where we are today and part of the investment that our customer is making and that we are making to drive the higher ramp rates. Yes. And Matt, it's Jim. One of the issues that this situation has illuminated with is that when you need to accelerate production in the defense enterprise for national defense, we would have liked to have been able to A, ramp up the production faster and B, bringing the revenue sooner. So it just highlights the need, I think, and it's an urgent one, to work together with government and industry to quickly evolve the relationship between the two so that we can maintain an effective deterrent conflict as we've talked about. So what I'm discussing with some of our senior government officials who are receptive, and there are several thought leaders in government on this now, is apply the concept of anti-fragility to the relationship between government and industry, meaning things like ensure that we have multiple reliable sources of key materials and components, right? So we have a lot of single-source components that we have to go back down into our supply chain and find out who and if they can double or triple their production of the components so we can double or triple the output of the system. Another piece of this anti-fragility concept is to have the government invest in production capacity with us, call it, 2 standard deviations above the mean peace time production rates. So if you need to accelerate, you can quickly and start up the line or speed up the line much faster. Another one is significant, expansion of the use of long-term and multiyear contracts so that we don't have to have a fluctuation in demand year-to-year, which sets our supply base back, again, less willing to invest because they can't predict the future. And then finally, especially for those small and medium businesses, we're suggesting that government really take an overview of a broad overview of the oversight and compliance burdens that are on companies that participate in the defense industrial base from an audit and compliance and certified cost perspective, truth and negotiation act, things like that, while we at Lockheed Martin and other major defense funds would like to see that burden ease, it's a burden that can really prohibit other medium and small companies from working with us or working with the government to provide what it needs. So there's a great dialogue beginning. I'm sure other companies are raising these issues too. But this issue of restocking raised an important industry issue that we're going to try to work with government to solve. Great. John, this is Maria. I think we've come to the top of the hour here, so I'll turn it back to Jim for any last thoughts. Great. Thanks, Maria. I'd like to conclude our call today by thanking the entire Lockheed Martin community for everything they've done in 2022 and they'll do this year and beyond. Together, we positioned our company to continue to push the edge of the technology and advance scientific discovery to ensure our customers remain what we call ahead of ready and keep people safe around the globe. So thanks again for joining us on the call today. We look forward to speaking with you on our next call in April. John, that concludes the call. Thanks, everybody. Have a great day.
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EarningCall_1204
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[Call Starts Abruptly] [Operator Instructions] And finally, I would like to advise all participants that this call is being recorded. Thank you. Thanks, Pauli. And good morning everyone and thank you all for joining us on the Regis Resources December 2022 quarter update. Joining me this morning is Anthony Rechichi, our CFO; and Stuart Gula, our COO; and Ben Goldbloom is sitting with us as well. The December quarter was another one of reliable delivery to plan for Regis. First on safety, our LTIFR, Lost Time Injury Frequency Rate, was steady and well below the industry average sitting at 0.6. As we always say, the health and well-being of our people continues to be a focus of the company. And I would say that in this period where we're certainly seeing elevated levels of turnover that the challenge continues to be in front of us is to making sure we can maintain that safety performance. We are very pleased to release â also during the quarter we were very pleased to release the 2022 sustainability report, we saw another year of improvements. And while on sustainability progress, the installation of our 9-megawatt solar farm at Duketon South is on track and we're expecting it to be commissioned in the June quarter. This will be very beneficial initiative as that both reduces our carbon emissions and also results in direct power cost savings through the reduction of fuel consumed per ton processed at the DSO mills. Across the business, we saw gold production delivered a plan as the transition of our assets into their production stages, some of our assets into their production stages. We're very pleased with the progress, which we've now delivered three quarters in a row of reliable production. Pardon me. For the December quarter overall, we produced 117,316 ounces of gold for an all-in sustaining cost of $1,760 an ounce â and is Aussie Dollars. The elevated cost environment continued in the quarter, however, we have seen some recent easing of this pressures in the area of cost of diesel, pleasingly. With the planned increase in production and a continued effort on cost management, we remain on track to deliver production guidance, but we are seeing â are expecting that our AISC will be at the top end of our guidance range. With the approval of Garden Well mine exploration decline, which we announced earlier, and some short-term delays in declaring commercial production at Garden Well Underground and also at Havana, we have increased our growth capital guidance up to a range of $180 million to $190 million for this year. In line with the outlook of increasing production and reducing AISC and CapEx overall, cash â in the second half â cash generations' forecast in the second half â improved in the second half of this year, FY2023. Look, I'd now like to hand over to Stuart Gula, our CEO, who I introduced earlier, who will briefly cover the operational performance. Over to you Stuart. But I appreciate that. I guess, looking more closely at the operations, Duketon lifted to 82,000 ounces at an AISC of $2,000 an ounce during the quarter, while Tropicana remained steady at 35,000 ounces at an AISC of $1,119. Duketon North had lower production at 17,000 ounces which was at $2,959 due to high strip ratios and waste movements associated with bringing forward Stage 3 at Gloster, which we had to do more aggressively than what was originally planned due to some ground conditions. Cash margins at Duketon North will improve in the second half of the year as strip ratios decrease, overall material movement will drop and ore production is expected to increase as well. Duketon South increased to 65,000 ounces at an AISC of $1,757 an ounce, as ore presentation improved in the open pits and grades in the underground returned close to reserve grades, which is as per the schedule. At Garden Well South we had our first production start firing and it was delivered to the mill, and we are expecting underground ore time to increase as the year progresses. The team continues to work through the typical challenges associated with starting up a new mine and we expect the commercial production will be achieved in the second half of this year. While on Garden Well underground, during the quarter we released our bi-annual exploration update, and you'll note that the results we're seeing in the Duketon South underground mines continue to reinforce the consistency of both ore bodies and our belief that these mines will grow both laterally and at depth. The underground operations at Duketon South remain a key focus and are expected to deliver significant value as they continue to grow. Across the Tropicana we delivered a steady quarter at 35,000 ounces for an AISC of $1,119 an ounce. The underground mine provided a reliable gold production during the quarter, and as we extended deeper, all indications are that the ore bodies continue down plunge and in a consistent manner. Open pit mining activity was completed in the Boston Shaker pit during December, so going forward we expect open pit feasible will be from Havana pit and supplemented from stockpiles. So this achievement of commercial production, will see growth capital drop away and a commensurate change in AISC. Thanks, Stuart. Bad news, you're back to COO. Look, just before I pass on to Anthony I just wanted to make a comment on Tropicana. We were very pleased with the building cash flow generating capacity at Trop. It is delivering and performing as we had anticipated when we purchased it back in the middle of 2021. Tropicana has returned now in the last quarter at its annualized production rate of 480,000 and in fact it's been sitting there for the last six months. And I will just point out that while it's sitting at that level, when we first picked it up it was operating over the first three or four quarters that we had at circa a little bit over 400,000 ounces per annum. So Tropicana is doing exactly what we anticipated it would do and build its production rate up to that, back up to that 450,000 to 500,000, obviously that's all at 100%. The phrase gets thrown around a lot in our game in our industry, but Tropicana truly is a long-life, Tier 1 asset in a Tier 1 location and sits, we are pleased to say, very nicely in our portfolio. Thanks, Jim. Onto the financials for the quarter, we sold 121,000 ounces of gold at an average price of $2,412 an ounce, and that's after the effects of the hedges. This generated a total of $93 million in operating cash flow with approximately $36 million from Duketon, and $57 million from Tropicana. Operating cash flows from the operations does remain strong. Capital expenditure payments during the quarter were $77 million. We saw about $61 million of growth capital, of which the majority of this expenditure related to the development of the Garden Well Underground and the Havana Cutback. As both of these projects reach commercial production in the second half of the year, growth CapEx reduces, similar to what Stuart was talking about earlier. In other significant transactions, referring back to the quarterly report, if you take a look at figure three, the company's paid $15 million in dividends and also received $20 million for the sale of a rural property in New South Wales related to McPhillamys. Now, I want to cover the tax refund opportunity we've noted in that quarterly report, where there's clearly an opportunity for us to return more cash to our balance sheet. As a bit of background information, one of the government's economic incentives in response to COVID was to allow companies to use a loss carry back tax offset arrangement whereby tax losses can be used to offset taxable income in recent financial years. The losses applied against that previous taxable income effectively reduces the tax required to have been paid in those years and hence, a cash refund is paid back to the company for the difference. Now, having said that, during the year ended 30 June 2022, Regis incurred $52 million of tax losses, that's at the 30% company tax rate. Applying those losses back to taxes we paid for the 2019 and 2020 year, we are eligible for a refund under these pronouncements. The final amount of the tax losses we can retrospectively apply and the election to trigger a refund under the temporary provisions will be finalized with the lodgement of the company's 30 June 2022 tax return in the March 2023 quarter. We're nearing the completion of that work and looking to identify any more expenditure that will further bolster the available refund amount. So, in summary, weâre increasing gold production, decreasing all-in sustaining costs and CapEx in the second half of the year, we expect a significant improvement in cash generation compared to the first half. Thanks, Anthony. Look, Iâll touch on growth â our growth projects have made some good progress during the quarter. Stuartâs already covered the progress at Garden Well South Underground, which is very pleasing to see. The Garden Well Main Underground exploration decline, which we mentioned earlier as well. Weâve now completed a bit over 240 meters heading towards the North. And weâre expecting that the first diamond drilling program [indiscernible] will be kicked off during the March quarter. So with some results expected a month or so after that. We remain very excited about the potential growth of Garden Well Underground and are expecting this to deliver some significant value for the company. Weâre also seeing some very pleasing potential at South Rosemont or the â what we call the south end of the Rosemont Underground. And if you have a look at Figure 5 in the release, you can see the area weâre talking about, and some of the â I wonât go through the intersects that weâve highlighted there but clearly thereâs great potential for a new production area at the south end of Rosemont. And the underground story at Tropicana is very similar to that at Duketon. If you see Figure 6 in the release, you can see the latest new potential area that we see down plunge of the already existing Tropicana mining area the underground Tropicana. Thatâs also of course, in addition to the potential that weâre seeing at Boston Shaker. The results outlined in our Bi-Annual Exploration Update released back in November further reinforced the potential to grow on the existing plans both laterally and down plunge at really, at all our underground operations. At McPhillamys, we achieved a major approvals milestone with the New South Wales Department of Planning and Environment, the DPE referring the project to the Independent Planning Commission of New South Wales for final determination. The DPE did in a statement consider the project was approvable subject to conditions. And these conditions are in line with our expectations and not expected to material impact the project although we do note that they are still subject to finalization by the IPC in the event that it finds a positive â makes a positive decision. Now, the next stage in the IPC process, because it already has kicked off is the public submissions are currently underway. Thereâs a â in fact, thereâs a portal where you can go and register your support for the project. Itâs either at the IPC website or if you go to the Regis Resources homepage, there is a link there that will take you to a place where you can make a positive submission if you like and read some more about the project. Now the public hearings, which were originally scheduled for early December, which got delayed due to tragic circumstances with one of the IPC members passing away unexpectedly. It has been rescheduled for early Feb. In fact, itâs about two weeksâ time. I think its kicks off about February 6. And that will run for three days. That will be starting to see the wrap up of the submissions. And then somewhere within three months of those hearings, weâre expecting a final IPC recommended decision. Now, this is a very exciting phase for the project and a very quite, a material one. Itâs been a long time where thereâs going to be â itâs going to happen. Thereâs a decision soon and weâve seen that stretch, but weâve actually got the recommendation by to go forward from DPE was quite a significant step, which Iâm sure, anybody on this line thatâs been listening to the story for the last few years realizes and recognizes. So wrapping up, what did the December quarter brought us was another reliable quarter of production at both Duketon and Tropicana. Costs are elevated in the quarter, and we are continuing our efforts and we are not Robinson Crusoe they are clearly the environment, the general economic environments putting a lot of pressure on all miners. And we are continuing our efforts on cost management. We are maintaining our full year production guidance for the reasons that we outlined. However, we do expect, as I said, that our all-in sustaining costs will fall at the very top end of our guidance range. We saw significant milestones at Garden Well South Underground, and as I just went through at McPhillamys, and weâve made some very good progress at the Garden Well exploration decline. The cost environment does remain elevated, but with our planned higher production reducing our AIC and our planned lower CapEx in the second half of the year. Weâre looking forward to some more free cash flow generation as the year progresses. Thanks, Jim. [Operator Instructions] And your first question comes from the line of David Coates from Bell Potter Securities. Your line is open. Good morning, and thanks, Jim. Thanks, Stu for the opportunity to ask the question this morning and good work on the quarterly. A couple of questions. So letâs see at Tropicana, good steady performance costs coming down. Duketon sort of stay again, but across thereâs still particularly due to North, youâve run us through a couple of the issues there. But Iâm just wondering if what you are thinking is on Duketon North? Are you prioritizing production at Duketon South to kind of keep the wheels on it, sort of the more important operation, sort of other factors theyâre driving the costs higher at Duketon North. Yes. Thanks, David. Yes, look, just touching first on Duketon North, and we do â they are two really â those two sites North and South are quite separate. The only real connection between the two is a shared airport. And also we have a line running between them to send water in either direction depending on which area needs it. So I wouldnât say that we would be prioritizing the South against North or vice versa. Our philosophy and our drive with Duketon North is, clearly the reserves there are starting to â currently are starting to run down at current reserve base. We will finish mining of open cut, direct feed material this time next year possibly even a little bit earlier than that. And then we run onto low grade stockpiles for at least two to three years. So what we are seeing at Duketon North at the moment, right now, itâs almost on a month by month or quarter by quarter basis. The all in sustaining costs are right up through the roof, as you can see. And thatâs because we are doing a lot of waste mining. Production levels are a little bit off, but itâs the waste mining thatâs really pulling that all in sustaining cost up to nearly $3,000 an ounce. What we are and weâre already seeing is that the total material movement up at if Duketon North starts to drop away, that immediately starts to â weâve demobilized â I think weâve already demobilized a digger up there and so weâll see the gross spend drop off. Weâll see the AISC start to lift as well. And then actually for some of the pits right in the final quarter in the June quarter, we actually start to overproduce or, and put it on the stockpile, which is something we havenât done up there for quite some time. So I think itâs certainly â Duketon is â Duketon North really is a story of weâre working at the moment barely, well, arguably itâs not, but barely to wash its face keeping it running. Itâll do well â itâll do okay on cash flow when itâs running through those lower grade stockpiles. And really itâs to hold that â hold it in an operational state, not â itâs not expected to make enormous amounts of cash flow, but it keeps it running. Last thing we want to do is unnecessarily close it and then reopen it again in a yearâs time because weâve proven up some more reserves. So, weâre sort of holding that, weâre trying to follow that pattern of keeping it running while we exploration continues to look for something material. But weâre not doing that in a way that means we lose money other â but itâs just â itâs quite variable from quarter-to-quarter just because itâs sort of, I guess itâs in the tail end of its business if you like. I hope that makes sense? Yes, Duketon South is quite a different story. We â itâs improvements and lifting of its production come from the underground. Garden Well â Garden Well South, sorry, is just starting to â itâs quite exciting there actually. We are doing a bit of stoping on the 8 Level and 9 Level where 8 Level and 9 Level is that, that ore bodies, like a lot of our ore bodies up in that area, they tend to pinch and swell as they go down in depth. And the 8 Level and 9 Level, which are the first area of the underground are right where it was pinching. So there werenât a lot of stopes there. And a couple of the ones we thought we were going to get it just didnât carry. But we are down, weâre now mining on the 10 Level, 11 Level, and 12 Level. And weâve been â weâve drilled that out all to gray control and weâre very pleased with what weâve seen there. Itâs really stacked up well. Weâve got multiple development headings in there because that weâre now, that area is down into the thick part of the ore body. Weâre not narrow vein sort of benching. Weâre actually transverse stoping just as an indication of just how much how media these stopes are. And weâve got a lot more headings in ore as well. So, we are just getting into that now and obviously thatâs where a fair chunk of the extra ounces for the second half come from. And Tropicana; look, Tropicana is in an interesting space at the moment. Itâs all-in sustaining is certainly looking good, but as Stuart said, we are shifting and moving as Havana comes online, weâll see the, it will declare commercial production. We are expecting that sometime in the next couple of months. As we do that, the expenditure that weâre putting into the waste mining, which has defined as growth capital, will basically shipped across into AISC and weâll see a commensurate lift in the AISC. The key thing to note about Tropicana is that itâs probably in the heaviest part at the moment of its waste, whether itâs defined as growth or sustaining material movement, itâs kind of irrelevant. And we like to think that we make it how thatâs defined as less relevant, because we just make our numbers transparent. We donât â if itâs not in growth, itâs in sustaining. If itâs not in sustaining, itâs in growth. Itâs pretty easy to figure that out. But what we do see at Trop [ph] is, as we head into next year, the amount of material moved associated with Havana starts to drop away, not by a huge amount next year, but maybe 10% or 15%, something like that. But then it really starts to drop off as you know, the pit gets all its waste, breaks the back of all the waste mining and just starts to become more the strip ratio, instantaneous strip ratio drops. So, we see Trop will continue along its path. The production levels will increase a bit. The cash costs â the overall costs probably stay similar, itâll just shift. But over the coming next year or so, weâll see every â all the unit costs start to drop, which is really great because thatâs where we â thatâs what we were planning. Thanks, Jim. You just answered my other questions. I did have one other. You have touched on it in the call just around the cost environment. COVID disruptions and labor availability have been and that disrupting production has seems to have been a big driver of high costs across the sector. You mentioned diesel costs easing, but are you starting to see those sort of COVID disruptions and labor availability and all that sort of stuff also starting to ease as well and helping the cost outlook? Look, itâs a mixed bag, Dave. The â we are not seeing some of the direct costs that we saw of COVID where we were testing and time loss for all of that. But we are still seeing absenteeism, people are still getting COVID. Theyâre still, as a result, getting crooked. Theyâre not coming to work. We are seeing empty seats and that is having an impact on production, itâs technical side of things. Itâs okay. Or in the office environment, itâs â people can still work from home and you can sort of roll with that punch. But if you donât have an operator on site to drive a truck, it just doesnât happen. So yes, we are â itâs not as bad as what it was. Yes, you got that for that. Yes. Yes. Yes. Not yet. So it is â that continues to be, as I said, probably not as bad as it was, but itâs still there and having an impact, agree with that. The other question was generally whatâs happening with inflationary is another, the pressure is there, right? Itâs certainly not as bad as it was probably four months ago, and fuel by far was the biggest impact because of the flow on that has on our rise and fall [ph] contracts. And probably just about everybody else, I would imagine. But pleasingly, we have seen â we were probably in the first half of this year, we were paying bit over; I think, it was $1.56, $1.57 on average for the first six months. And we're already, this month we're seeing it down to about $1.30. So it's softening, which is pleasing to see, but we've still got to â we're not out of the woods by any stretch, and I'm talking about the industries. But maybe just changing to Havana Link drive, but maybe just a timeline on that development so when we start getting some expiration updates, firstly? Look, Havana Link will be quite a while yet. I wouldn't be expecting too much coming from that this year. I think it's there and it's something that we and Anglo are certainly excited about, but it's in actual fact some of the, the priorities have shifted back to the areas that I mentioned before because it, it looks to be a bit more perspective. That's not to say that the Havana Link has fallen off the, the edge of the earth. It's just little bit lower down on the priorities at the moment. So we'll keep you informed with the progress there, but I'm not â certainly not expecting to see anything material in this year â this financial year. Yes. Okay, awesome. Thanks Jim. And just there as well on Tropicana, the full asset potential project. And I know you guys spoke to productivity and cost improvements but is there anything you can talk to a bit more detail there and how we should look at that going forward? Is there any even potential to look into other strategies to bring down cost to Duketon similar to how Anglo looked at trops? Yes. Look, I think there certainly are some takeaways for us that we're thinking about. We could and I know that Stuart's been sort of giving that some thought as to what we could do to take the methodology and apply some of the concepts to Duketon. We've got, at the moment there's a lot of focus quite frankly on making sure that we're getting our under grounds up and running and that's the best thing that can add value and continue to add value to our business. The full asset potential at Tropicana I think was quite a successful process. It identified a couple of things. It probably identified, that there wasnât a huge amount of low-hanging fruit. The guys, that the team up there had already done a pretty good job of that, but it did result in a, rethink of the overall strategy of the place which also didnât come up with anything I think substantially out of whack. But itâs a process that sort of forces you to go back and make sure that what you think is actually the right way to think. And we are having a look at that and as we head into it, pardon me, as we head into our reserves and resources underestimation period in the, over the next few months, weâll be looking to see what lessons of that assessment and whatâs the right word? The scenario planning that we can look at in that area as well. And basically make sure weâre still running on the right overall strategy. Yes. Awesome. Thanks Jim. So Garden Well updates coming in the March quarter. Will we get a resource reserve update for all assets then too? Well, I think what I heard, the update, the drilling that weâre going to be doing at Garden Well Mine will be occurring during the March quarter. Iâm not sure when weâll get the results for it. I doubt whether itâll be in the March quarter and thatâll only be, core results. It wonât be any modeling or anything like that because itâs pretty early, very early in the process. Our resource and reserves process is something that, we sort of kicking off now, but we donât normally put our resource and a reserve update out until sometime in the June quarter, usually towards the back end of it. But so thatâs the timing that we follow there. Iâm not sure if I answered your question, George I⦠No, thatâs it sounds like back half the year weâll get a bit more color there on Garden Well and resource, reserves coming through, so awesome. Thanks for that. Yes, the two, they wonât be connected, as we get information and updates on Garden Well Mine weâll let the market now, it wonât be tied-in with the R&R [ph] release sooner, the better as far as Iâm concerned on that we get the info from Garden Well Mine. There are no further questions at this time. I would like to turn the call back over to Jim for closing remarks. All right. Thanks everybody for joining us. We know that itâs a, been a pretty busy morning this morning with a few releases no doubt a result of having Australia Day tomorrow. But look, we thank everyone for joining us. As always, if youâve got any follow-up questions please drop us a line, get in touch with Ben and weâll do our best to help you out. All right, thanks everybody. Have a good day.
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EarningCall_1205
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Good afternoon, ladies and gentlemen. Thank you for standing by. And welcome to the Central Pacific Financial Corp. Fourth Quarter 2022 Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. This call is being recorded and will be available for replay shortly after its completion on the company's website at www.cpb.bank. I'd like to turn the call over to Mr. David Morimoto, Senior Executive Vice President, Chief Financial Officer. Please go ahead, sir. Thank you, Hannah and thank you all for joining us as we review the financial results for the fourth quarter of 2022 for Central Pacific Financial Corp. With me this morning, our Arnold Martines, our new President and Chief Executive Officer, and Anna Hu, Executive Vice President and Chief Credit Officer. We have prepared a supplemental slide presentation that provides additional details on our release and is available in the investor relations section of our website at cpb.bank. During the course of today's call, management may make forward-looking statements. While we believe these statements are based on reasonable assumptions, they involve risks that may cause actual results to differ materially from those projectors. For a complete discussion of the risks related to our forward-looking statements, please refer to slide two of our presentation. Thank you, David. Aloha, and good morning everyone. We appreciate your interest in Central Pacific Financial Crop. As we normally do, I'll start with an update on the Hawaii market and a summary of our strong fourth quarter results. Then I'll turn it over to the team to provide additional detail and insights on our financial and credit metrics, as well as other key updates. The Hawaii tourism sector continues to perform well with visitor arrivals holding at about 90% of pre-pandemic levels. The majority of visitors are from the U.S. Mainland. Visitors from Japan are about 20% of pre-pandemic levels, and we are optimistic that the Japan counts will continue to trend up as a country is now fully reopened and the yen value has improved recently. The Japan government also upgraded its 2023 growth projections in December based on expectations for higher business expenditure, substantial wage hikes, and robust domestic demand. Japan may avoid the global growth slowdown, which will translate to greater visitors to Hawaii, helping offset a potential slowdown in domestic visitors. Hawaii visitors spending is strong, totaling 1.5 billion in November, an increase of 13.7% compared to the same month in 2019. Hotels in Hawaii continue to perform well with total statewide hotel occupancy at 71% and an average daily rate of $440 in December, up 4% from a year ago. Hawaii's employment and housing sectors remain solid. Our statewide seasonally adjusted unemployment rate was at 3.3% in November, 2022, and is forecasted by the University of Hawaii Economic Research Organization to be fairly stable in 2023. Housing prices in Hawaii remains very strong with a total Oahu median single family home price at 1.1 million in 2022, which is up 11.6% from the previous year. Reflecting a national trend, home sales have cooled in 2022 due to rising mortgage rates. The number of single family home sales was down 23% in 2022 compared to a year ago. We view this as more of a moderation in the market and believe the Hawaii housing market remains healthy with continued strong demand and low inventory. This combined with the fact that tourism is expected to remain strong and the Hawaii economy is also supported in a big way by a huge and growing military presence, it is our strong belief that Hawaii is less likely to experience a material downturn compared to most other U.S. markets. Overall, we remain optimistic about the Hawaii market and believe CPF will continue to be successful as we remain focused on our strategic pillars, including home ownership, small business, digital adoption, and Japan market development. Moving to our financial results. We ended 2022 with solid loan and deposit growth, an increase in net interest income, and strong expense management, which resulted in an improved bottom line. Our total loan portfolio increased by $133 million or 2.5% sequential quarter. For the full year 2022, the loan portfolio grew by $454 million or 8.9%. The growth was diversified across all loan types as we continue to focus on prudent and appropriately priced asset growth. We have a healthy loan pipeline and anticipate continued strong loan growth in 2023 in all loan categories except Mainland, unsecured consumer. In Q4, we began to let our Mainland unsecured consumer loan portfolio runoff until the national economic outlook improves. With that said, we expect runoff in our unsecured consumer book will moderate overall loan growth in 2023, which we expect to be in the mid single digit percent range. During the fourth quarter, total deposits increased by $180 million or 2.7% from the private quarter as we were successful in acquiring significant time deposits, which enabled us to reduce our borrowings and manage our funding costs. While deposit rates have increased somewhat, the Hawaiian market continues to be rational on deposit pricing. CPB strong and stable core deposit base enables us to keep deposit repricing betas low, consistent with past tightening cycle. Going into 2023, we have already started to implement strategies to not only retain deposits, but to garner a larger share of core deposits to fund our future asset needs. Finally, I'm personally very excited to start 2023 in my new role as President and CEO. I anticipate a smooth transition with our talented and experienced leadership team. Lastly, I could not be more proud of our exceptional group of employees who remain steadfast in our mission to help meet the needs of our customers and the broader community. Thank you, Arnold. Turning to our earnings results. Net income for the fourth quarter was $20.2 million or $0.74 per diluted share. Return on average assets was 1.09%. Return on average equity was 18.3%, and our efficiency ratio was 59.56% in the fourth quarter. For the full 2022 year, net income was $73.9 million or EPS of $2.68. Importantly, full year 2022 pretax, pre-provision income excluding PPP income increased by $29.1 million or 45% year-over-year. Net interest income for the fourth quarter was $56.3 million and increased by $0.9 million from the prior quarter as our increase in loan balances and yields outpaced the increase in our funding costs. The reported net interest margin remained flat at 3.17%. When excluding the impact from PPP, the net interest margin increased by three basis points sequential quarter. Our total cost of deposits was 41 basis points in the fourth quarter. We continued to manage deposit repricing to product segmentation, and thus far our interest bearing deposit repricing beta has been approximately 15%. Fourth quarter other operating income was $11.6 million, which increased by $2 million from the prior quarter, primarily due to higher BOLI income. This included certain non-recurring death [ph] benefits totally $0.6 million, as well as the higher income driven by equity market gain. Other operating expenses totaled $40.4 million in the fourth quarter down $1.6 million from the prior quarter. The decrease was primarily driven by one-time lower occupancy and advertising cost totaling approximately $1 million. Our expense run rate will increase modestly in 2023 to the range of $40.5 million -- $42.5 million per quarter as we continue to invest in our people, facilities and technology. Despite that, we expect positive operating leverage, which will drive a lower efficiency ratio over time. Our effective tax rate declined to 24.9% in the fourth quarter as a result of higher tax exempt fully income. Going forward, we expect the effective tax rate to be in the 25% to 26% range. Our capital position remains strong and during the fourth quarter, we repurchase 241,000 shares at a total cost of $4.9 million for an average cost per share of $20.41. The Board of Directors approved a new annual share purchase authorization of up to $25 million for 2023. Additionally, our Board of Directors declared a quarterly cash dividend of $0.26 per share, which will be payable on March 15th to shareholders of record on February 28th. Thank you, David. Our asset quality remains solid in the fourth quarter. Our loan portfolio is strong and well diversified with over 75% real estate secured with a weighted average LTV of 63%. We continue with our conservative underwriting policies, including tight LTV and concentration standards, and 83% of our loan portfolio is in Hawaii. For the lending we do on the U.S. Mainland, loans are typically commercial and commercial real estate participation with larger banks and markets we are familiar with, and our consumer purchases are from established lending partners. All Mainland loans meet our credit underwriting guidelines. We believe we have minimal exposure to sectors that could be impacted by an economic downturn. Our construction portfolio is just 3% of total loans, and our Mainland consumer unsecured portfolio is 3% of total loans. At December 31st, non-performing assets to total assets were 7 basis points, or $5.3 million. Total criticized loans were just 1.4% of total loans. Our net charge-offs were $1.7 million for the fourth quarter, which equates to 12 basis points annualized as a percent of average loans. Our allowance for credit losses was $63.7 million or 1.15% of outstanding loans. In the fourth quarter, we recorded a $0.6 million provision for credit losses due to loan portfolio growth and net charge-off. Thank you, Anna. Central Pacific Bank had a great year in 2022, and we continue to be well-positioned to continue deliver strong performance in 2023. We have prudent and disciplined risk management and the right leadership team to move us forward as we continue to create shareholder value for our investors. Thank you for your continued support and confidence in our organization. At this time, we will be happy to address any questions you may have. Maybe just maybe starting on the funding side and talking about some of the competitive dynamics in -- that you're seeing in Hawaii. You talked about it being a more rational market, and that's what we've seen historically. Just curious, how you think about deposit growth and the competitive dynamics there? And any other updates on your -- the other deposit initiatives that you've been working on, both from the Japanese and the tech side. And just any thoughts on deposit growth to fund the loan growth that you talked about? Yeah. Thanks David. This is Arnold and I'll start and then I'll -- if David wants to add comments as well. But as I mentioned in the earlier comments, we were successful in bringing in about $180 million. Mostly it was from our time deposit campaigns that we ran in Q4. The way we look at this is that, while deposit rates have increased, we're looking at funding costs in general. And the time deposit rates that we offered in the Q4 were better alternatives to the -- to more wholesale borrowings costs that we were looking at. As far as the market itself, I mean, further impact of continued Fed tightening and yield curve movements on deposit bonds is yet to be seen. So, obviously, we're actively managing our funding sources and ensuring that we're optimizing performance to this operating environment. And with regard to where we're focusing, of course, we're focused in garnering more core deposits. Our Japan development is going well. We had -- we're about a $1 billion now in Japan deposits, and that was up about $22 million quarter-over-quarter. So, we feel good about that. Japan is opening up as I mentioned earlier, and we feel good about the opportunities that we have in -- bringing in deposits from Japan. So, generally, kind of challenging environment, but, teams doing a good job in managing funding costs overall near term. And I think, longer term, obviously, we're well very well positioned in the marketplace. Yeah. Maybe just a couple points. Yeah. We're fortunate obviously to have a strong core deposit franchise that provides over $6 billion in stable, relatively low cost funding. As Arnold mentioned in the current rate cycle, we are proactive in using CD specials to retain some more rate sensitive balances with CPB, while also attracting new deposit balances at reasonable cost. Our deposit pricing strategies that we're implementing in this rate cycle are very similar to what we used in the 2015, 2018 rising rate cycle. Those strategies were successful then, and we expect similar results. And then, I think finally, if you exclude government deposits from the sequential quarter growth, customer deposits grew $85 million or 5.3% linked-quarter annualized, and I think that's pretty good performance in this operating environment. No, absolutely. And maybe just kind of taking this into context with kind of the loan growth and the improved pricing side, I guess, how do you think about rate sensitivity and maybe the NIM trajectory as we look forward, just -- as we talk about a discipline on the deposit side, beta are accelerating, but more rational market and then, assets continue to reprice higher. I'm just curious how you think about your ability to defend the margin and maybe the NIM trajectory as we go out throughout the year and over the course of the year, yeah. Yeah. Hey, David. It's David again. Yeah. We did achieve 3 basis points of core sequential quarter NIM expansion. Obviously, the velocity of the NIM expansion has been slowing as we've been seeing throughout the industry. The guidance for net interest margin right now is 310 to 320, so it's kind of guiding to a flattish NIM going forward. Okay. That makes sense. And then, just wanted to get your updated thoughts on the Swell banking and the service initiative and where we are there. Your thoughts on expansion at this point and whether Elevate sale impacts that partnership at all? Sure. Good question, David. Swell is currently an pilot testing. It's -- like, it's an invitation only, so the app is available, it's operating, but we're only inviting customers from the Swell waitlist to join. And it's in beta testing. There's about a hundred customers that are currently on the platform. And we're actually preparing to do a little bit of a wider launch in the first half of 2023. We're going to do a lot of test marketing, and customer acquisition beginning in the first half of this year. But it â we -- as we've talked about over the last several quarters, we've really -- we've slowed down the rollout of Swell as a result of what we've been seeing in the broader FinTech market. Obviously, there's been a lot of turmoil in the market. The operating environment is not the greatest for launching new FinTech initiatives. So, we've decided to slowdown and we're observing what's happening in the FinTech marketplace. The Swell strategy has pivoted slightly, rather than just broad customer acquisition. We're now focused on looking for profitable customers. So, rather than millions of unprofitable customers, we're looking for a smaller amount, a hundred thousand or profitable customers. And we think that's a better business model than what we've been seeing more broadly in the FinTech space. Yeah. I think that makes complete sense. But does the sale of Elevate impact that partnership at all, or is it kind of a non-event? Yeah. Sorry. I forgot about that part of, Dave. So, as you know, Elevate is looking to be sold to Park Cities Asset Management. Park Cities Asset Management is the private equity money behind Swell. So, Park Cities has a long history of working with Elevate prior to the Swell initiative. And then Park Cities was the largest outside money that invested in the Series A round of Swell. So, Park Cities is a very familiar entity to Elevate, Swell, and CPB. So, it does not affect the plans for Swell going forward. I just want to talk about the -- hi -- the deposit mix here. A lot of it was from -- the increase was from the successful CD campaign. How should we look at deposits going forward? So that match loan growth as it did this quarter, and you think it's going to be more weighted towards CDs? And then, I guess, over time, do you think the mix of CDs and non-interest bearing get back to like where they were pre-COVID? I'm just kind of curious how you think the funding mix is going to change? Yeah. Andrew, this is Arnold. I'll start by just saying that I think, near term, we're probably going to see a 50/50 mix time deposits and core. Core coming mainly from new acquisitions, new customer acquisitions, top market right now. As I mentioned earlier, I don't see it -- this is a near term dynamic that us and every other bank has to manage through. I don't see this as a longer term issue. I think, we're going to get back as Fed's start to ease rates in the future. We'll get back to kind of where we were pre-pandemic. But it's going to be a little bit of a journey. And we're just going to manage that effectively in the near term. Just maybe one additional point, Andrew. On DDA, there's obviously a lot of interest in DDA. DDA as a percent are total deposits at the end of 2019. So, pre-pandemic, it was 28% of total deposits. At the end of last year, it was 31%. So, there's 3% differential to pre-pandemic, that's about $200 million, roughly $200 million in the in deposits. We think our baseline DDA ratio should be higher than pre-pandemic due to our outperformance on PPP lending. So, we're thinking maybe we have $50 million or $100 million more normalization on DDA balances, and obviously we're doing everything we can to keep that to the lower end of that range. Gotcha. That's really helpful color. Thank you. And then, just related to that your margin guide, is that for the quarter or for the next several quarters or for the year? Just curious what that 310 to 320 range is good for? Yeah. Generally, it's for the next couple quarters. That's what we're looking at. Obviously, an operating environment is very volatile and a lot of things can change, but that's what we're guiding for the next couple quarters, Andrew. Certainly that makes sense. And then good to see the new buyback. I guess, how active do you intend to be, been pretty active the last couple quarters? Is a similar pace of repurchases reasonable, or I guess kind of how you're looking at that? Yeah. I would say similar. We've been repurchasing about 200 to 252 -- 200 to 250,000 shares per quarter. Spending roughly about $5 million on repurchases combined with $7 million in orderly cash dividends. So that's roughly the 60% return of net income that we've been targeting. Yeah. Hi. Good morning. Just maybe circling back to where David was asking on Swell, can you quantify a little bit more where your Swell balances are as of December 31st? It sounds like they're not a lot there. But when you talk about ramping it up in 2023, what does that look like? And then, I guess off of that, I thought you were ceasing Mainland unsecured consumer. So, is this pilot testing then just in Hawaii, or help us think about that. Thanks. So, Laurie, this is Arnold. Good morning. I'll start on the Mainland unsecured consumer, and then I'll turn it over to David and he can speak to Swell. But yeah, we -- as I mentioned earlier in my comments, we are suspending Mainland consumer unsecured purchases until such time that we believe the outlook, the national outlook, economic outlook is improving. So, near term, pretty much full suspension of the Mainland consumer unsecured. Okay. So -- but as far as, Hawaii, we're continuing to be very active there on consumer, and in our whole market. And also we're still looking at auto, auto loans as an area where we believe it's acceptable risk given the -- what we saw in the past, in the last recession, it actually performed pretty well as far as the data points that we're looking at. So, generally speaking, we're open to auto, but in any event, on mainly unsecured consumer, we're just basically suspending for now until the national outlook improves. Yeah. And just a clarification, when Arnold's talking about suspending Mainland unsecured, that's on the purchase side, Laurie. So, we're not suspending Swell, but we're continuing the very deliberate and gradual rollout of Swell. So, at year-end -- to give you an idea, we have about less than a hundred customers on the platform. The deposit balances are probably less in the aggregate are less than 20,000. The loan balances are less than 5,000. And so, it's very nominal balances at this point. We are planning to do some test marketing in the first half of 2023, but we don't anticipate the balances to be meaningful at all. And so, that's where we are. We're not suspending Swell. Yeah. So, in other words, I guess as we think looking out to 2023, and you said you would ramp it up, that you're obviously not going to stay at 5,000 in loans. I guess, the question is, what are you taking that to? Are you taking it to $5 million? Are you taking it to $25 million? How are you thinking about that? Okay. Sorry. We had a technical glitch on our end, but we thought we lost you. No. I would say that Swell balances are not going to exceed $10 million in any time soon. Perfect. Perfect. That's what I was looking for. Okay. That's helpful. And then, just on the unsecured Mainland consumer book that I have that at $310 million at September, what is that as of December 31st? And then, can you help us think about, I mean, your credit is pristine outside of consumer. The consumer piece, it looks like you had $1.07 million of charge-offs. $1.03 million of it came from consumer. Can you help us think about, of that $1.03 million, how much came from the Mainland piece? So just what is your Mainland unsecured consumer at December 31st and then in the quarter, how much of the Mainland charge-offs were in total? Thanks. Hi, Laurie. Good morning. So, for our consumer unsecured book at the end of fourth quarter, it was just about $316 million. So, we did increase slightly from the 310 we talked about at the end of third quarter, and that was because we had a couple of orders in place that we did need to fulfill. But we did go ahead and really suspend any additional purchases for the rest of the quarter. With regards to the charge-offs, about $900,000 is from the Mainland consumer book. The breakdown was about $200 in auto, about $280 in our home improvement and about $450 in our unsecured consumer. And that's all related to Mainland consumer. Perfect. That's great. Thank you. And then just going back to margin, David, do you have a spot margin for December? Yes. So, December spot was 317, which is flat to the full quarter. And then just to give you a little more color, spot interest bearing deposit costs in December was 73 basis points, which increased 10 basis points month-over-month, while December loan yields was -- were 420, which in increased 12 basis points month-over-month. So, I think that -- all of that data is supportive of the flattish and guide that we provided. Thank you Ms. Hunsicker. There are no additional questions waiting at this time. So, I will turn the call over to Arnold Martines for any further remarks. Thanks a lot. Thank you very much for participating in our earnings call for the fourth quarter of 2022. We look forward to future opportunities to update you on our progress.
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EarningCall_1206
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Kimberly-Clark de México, S. A. B. de C. V. [KCDMY] Q4 2022 Earnings Conference Call January 20, 2023 9:30 AM ET Good day, everyone, and welcome to todayâs Kimberly-Clark de Méxicoâs 4Qâ22 earnings conference call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please note this call is being recorded. I will be standing by, if you should need any assistance. Good morning, everyone. Thanks for participating on the call. Our very best wishes for all of you and your families in 2023. I'll start by making some brief comments on our results. We had a good fourth quarter, and an active continuous sequential improvement throughout the year. We posted strong sales growth, driven by pricing, but volumes improved sequentially behind consumer-led innovations and effective commercial execution. The record raw materials and commodities inflation continue to be a headwind, but the combination of pricing, greater efficiencies, and a strong end of year on our cost reduction efforts, allowed us to significantly increase our profitability, as well as our margins. We've come a long way compared to the fourth quarter of last year, and still have some room to improve. Our strategies and execution are rendering better results, and we are poised to build on them. Thank you. Good morning. During the quarter, our sales were 12.8 billion pesos, a 9.2% increase versus the fourth quarter of 2021. Net sales were boosted by consumer products and away from home, which grew 11.7% and 13.3%, respectively. Exports were down 14.3%. We will continue monitoring prices and volumes to find the best combination going forward. Cost of goods sold increased 1.4%. Against last year, every commodity and raw material category compared negatively, except for SAM and resins. Both imported and domestic recycled fibers compared negatively. On the personal care side, fluff also compared negatively, while SAM was slightly down, and resins were lower. Finally, energy compared negatively. The FX was lower, averaging 6% less. Our cost reduction program once again had very good results and yielded approximately 500 million pesos of savings in the quarter. The savings are mainly at the cost of goods sold level and are generated by sourcing, materials improvements, and process efficiencies. Gross profit increased to 27.5%, and margin was 34.7% for the quarter. SG&A expenses were 3.7% higher year-over-year, and as a percentage of sales, were 80 basis points lower. We continued to look for additional opportunities to streamline our operations, while strengthening the investment behind our brands. Operating profit increased to 54.1%, and the operating margin was 19.7%. We generated 3 billion pesos of EBITDA, a 41.5% increase. EBITDA margin was 23.1%, a 160 basis point sequential improvement, and a 530 basis point improvement versus the fourth quarter of 2021, underscoring our focus towards margin and profit. Cost of financing was 419 million pesos in the fourth quarter, compared to 420 million in the same period last year. Net interest expense was lower despite our incremental gross debt because we earned more on our cash investments. During the quarter, we had a 26 million peso foreign exchange loss, which compares to a 13 million peso gain last year. Net income for the quarter was 1.4 billion pesos, with earnings per share of 0.46. For the whole year, our sales were 51.1 billion pesos, an 8.9% increase, and an all-time record. EBITDA was 10.9 billion pesos, a higher overall number despite the strong cost increases, and was 21.4% of sales. Our margin increased sequentially every quarter, and we are on the right track and closer to our long-term target. Net income was 4.9 billion pesos, and represented 9.7% of sales. We have record savings from the cost reduction program amounting to 1.7 billion pesos. During the year, we invested 2.1 billion pesos in CapEx, in line with our program, as we focus towards technology improvements, cost reductions, and efficiencies and capacity additions. We maintain a very strong and healthy balance sheet. Our total cash position at the end of the year was 16.9 billion pesos. Our net debt to EBITDA ratio was 1.5 times, with an EBITDA to interest coverage of seven times. Thanks. Back to Pablo. Thanks, Xavier. The past couple of years have been challenging on many fronts, particularly the unprecedented cost environment. 2023 will not be an exception. Economies are expected to slow down, if not go into recession, and consumers will be stretched. For the most part, raw materials are expected to trend down, but many are at historically high levels, and the speed of the amount of the adjustments is not clear, as the impact of China's reopening is uncertain, and suppliers act to protect their pricing. However, we expect domestic consumption to be resilient, particularly in our categories, and raw material prices to come down as the year progresses. This, together with a robust innovation pipeline and strong support behind our brands, the investments we're making to optimize our footprint and strengthen our execution, as well as our consistent and effective focus on cost reductions, should allow us to achieve good results in 2023 and reach our target margins by the end of the year. Finally, our February board meeting and March shareholders meeting, we will be proposing a dividend that will be in line with last year's. We are pleased, although never satisfied with our progress, and excited with our opportunities. We're committed and will be relentless in achieving our goals. Hello, Pablo, Xavier. Happy 2023, and thank you for taking my questions and congrats on the results. I just wanted to ask on the - on costs, how they have evolved sequentially. What do you expect in coming quarters? We have seen pulp prices starting to decrease, and also in the US, recycled fibers some of them decreasing quite substantially. So, do you expect to see more tailwinds in that regard? And also, if you could maybe give some color in the CapEx you expect for 2023, for this year. Thank you. Sure, Jens. Thanks for the for the question. First, on the costs, as we mentioned, we expect of the year to end - to start, sorry, with pulp still in a very high note. They should correct as the year progresses, but the speed and amount of correction is still not very, very clear. But again, as the year progresses, pulp should certainly trend down. Fibers are starting to turn around, and hopefully the amount and the speed at which they turn around will accelerate, but we are starting to see a little bit of turnaround in fibers, although, again, we're starting the year at a very high level. Fluff will be higher than last year, significantly higher as there is less capacity out there in the market and more demand. What we - where we see some improvement is in resins and super absorbent materials already in the first quarter, and that should be stable throughout the year. At least, that's how we see things currently. So, again, key thing is how fast and when and by what and by how much pulp starts to turn around here, hopefully in the second quarter and beyond. When it comes to our CapEx, it'll be pretty much in line with this year's, which was higher than prior years because we're making important investments in capacity and innovation and in our footprint. Itâs - as you know, the way we see CapEx usually is not very much what we assign directly to sustain, because we usually take advantage of the process of the - of what normally would could be called sustained projects to improve efficiencies, to add some capacity. So, it's really hard to separate it. Most of it will have some - will come with some - sorry about that, will come with some benefits in terms of a flexibility, cost savings, or capacity. Yes. Hi. Good morning, Pablo and Xavier. Happy new Year, and thank you for taking my question. My question is on the margin recovery that you're seeing and just having an eye on the 25% to 27% range, the median term. How do you feel about the outcome? Is it like an easy one because of comparison, or do you see potential obstacles? And what do you think of the timeframe to achieve that? Thank you. Thanks, Sergio, and also have a terrific 2023. Look, as I mentioned, we expect the first quarter to be a challenge as some raw materials continue to be at historical highs. And - but we expect them to start to come down, although we have not seen some important moves, particularly in pulp, but they will trend down during the year. So, as we move into the second and third quarters, as it stands now, we should see sequential improvement, and we believe that by the end of the year, we should reach our long-term target. Again, as things stand now, but it's very, very volatile, but we expect to reach our target by the end of the year. Hey, good morning, Pablo, Xavier. Congratulations on the quarter, and thanks for taking my questions. Pablo, how are you thinking about innovation and pricing over the coming year, as well as competitor discipline and the consumer's ability to accept further price increases? And then I was also hoping you might be able to touch on exports given the contraction in the fourth quarter. And I'll just lay out a couple more questions right away. Outside of the dollar debt or near-term supply contracts that you might have hedged, do you have any other long-term hedges on, and how are you thinking about the FX and - given the strength of the MXN in the last couple of months? And then last year - or the last question was, you had a record year for cost savings. Can you discuss what's been mapped out so far for this year and maybe some general indications of where you're finding those incremental costs and expense opportunities? Thank you very much. Thank you, Bob. Thanks for participating on the call, and that's quite a few questions. Let me take them one at a time. First, on innovation, very, very excited with our pipeline on innovation and what we've done in the fourth quarter, what we're doing this first quarter, and for the next couple of years. Just to give you an example, in the fourth quarter, we introduced Kotex Zero, which is, we believe, the first flushable, biodegradable pad panty in - pretty much in the world. I know thereâs another effort going on in Great Britain on this, but this is the first one to market. And that's the kind of innovation we're pushing forth. And in this quarter, we're improving our products in all of the tissue categories and all of the tissue tiers. So, very excited about what that will bring in terms of opportunities for growing in the market. And then we will see important innovation in all of our categories throughout the year. And again, a very robust plan for the next coming years. In terms of pricing and discipline, I mean, we've - as you know, over the past year, we've implemented a few increases, and that, together with our price realization efforts, compounded the effect and certainly helped our results. As we move forward, we will be very careful to monitor which categories are still facing intense cost pressures and what we need to do with them, and decide when and by how much we should move forward. But what we've seen so far is, for the most part, competitors lagging, but following. So, they lag in timing, but they eventually follow. And as that has happened in the couple of categories where we have lost a couple of share points, we've been able to start to get that back. So, pretty much in line to what happens when we lead, and then they follow. And for pricing, again, we'll take a look at how the raw material environment continues to evolve and which categories are still under pressure, and then what it is we need to do moving forward, but we do expect for this year to be - show a more balanced growth between volume and pricing. On the expert side, which is really what brought down our volumes for this quarter because we saw good performance on consumer products, good performance on our professional business, even with sequential volume improvements, but experts was a headwind, and it was a headwind, not only sale of parent rolls. That went very well. It was really on our sales of expert finished product to our partner. As they've seen some of the categories over the past quarters decelerate a little bit on volume, we were required to provide less to them over these past quarters. And it seems it will be the case for first quarter. We are hoping that things will accelerate over there, and we'll be able to get a little bit more volume starting in second and certainly third and fourth quarters of these years. On the cost saving side, then I'll ask Xavier to comment on the FX, but on the cost saving side, we are - we had a very - another very good year. As you know, this is not just a process that we follow every year. It's just a part of our culture. It's a relentless focus on our part to find savings, to be more efficient, and to be as frugal, fit, and agile as we can. And we're excited because at this point in time, we have identified a higher number or a better number in savings for this year versus where we were last year, again, at this point in time. Still got a lot of work to do to ensure we get to at least the number we achieved this year, but given the way we're starting, we feel pretty confident that we should be at least at 1.5 billion pesos, hopefully higher than that. Hi, Bob. On the FX, we have some partial hedges that will only go for next two or three months, I think. We don't - and the pricing that we have of the spot peso right now, our comp will be very positive on these at least first two quarters. Going forward, we'll have to wait and see. You ask for a view. I really - I don't think that we can answer much on that, except that, hopefully - that hope that it stays at the low level to where it is. And Xavier, just to make sure I understood, on your FX positions for the next couple of months, is that something thatâs rolling? And when would you expect to start to cycle into an MXN thatâs stronger than â19? Yes. There's something we did, both in terms of hedging that will be a little bit higher than the best stance at this point, still at much, much better levels than where we were at this point last year. And by second quarter, we should be able to start seeing the - reflecting the prices that you're seeing in the market currently. Hi, good morning. Thanks for taking my question. Congrats on the results. My question is regarding MSP. Group pricing of course has helped quite a lot, and you mentioned that you've seen a little bit more of a balanced structure in terms of pricing and volumes. For these vehicles, what are the strengths in efficiency that you've seen lately? Anything worth highlighting there? Thanks Antonio, I'm going to try and answer the question as best I understood it, because you're not coming out too clearly. But if I understand correctly, you want to understand a little bit better about the balance of volume and pricing. But I can tell you, for the fourth quarter, particularly on consumer products and our professional business, really the growth came from pricing still, but as you look at it sequentially, fourth quarter versus third quarter, we did see improvements in our volumes. So, they were quite a bit in better shape by the fourth quarter. Coming into the year, we expect, again, this to be a little bit more balanced. We will be very careful in analyzing where we need further pricing, given the cost pressures that we're seeing. But there are certain categories where we will really focus on just being a little bit more aggressive in terms of volume and getting back some of the share that we lost as we pushed pricing forth. And understanding that consumers will be stretched this year as inflation continues to bite their budget, we will be, again, managing a strategy that will try and balance - better balance both volume and pricing going forward. Hope that answers the question. Yes. Thanks for that. And I just wanted to know a little more about elasticity. Are there certain categories for these market share losses that you're gaining back took place, or for the different categories, whatâs worth highlighting there in terms of elasticity and competitive pressure, and youâre gaining back. In terms of categories, what are you seeing? Thanks. Right. Look, in terms of the categories where we've lost share, when I take a look at the different categories, we're really talking about three or four where we saw some slight decreases in share. Most of our categories are either flat or increasing for the year. So, that's a really, really good sign, particularly after a year where we needed to push pricing a little harder. On the categories, where we've seen some share decline, again, we led price increases, but we've seen competitors follow. And as they've done that, now with our innovations and our commercial execution, we're starting to see our shares come back. So, itâs a dynamic that usually happens when we put price into the market. And - but we will monitor very closely this year what's in the best - what's best for each category, and then decide how to move forward as hopefully some of the volatility that we're seeing in raw materials subsides. Hi, guys. Good morning. Thanks for taking my question, and again, this is a great year for you and your families. So, I just wanted to pick your brain, Pablo, and Xavier, about how - what do you think about capital allocation in coming years? I mean, you touched about increasing capacity and some CapEx related to innovation, but I wanted to get down a bit more on dividends. I mean, the last couple of years have been rough in terms of the environment, but free cash flow has been really great. So, how do you think about your policy, I don't know, say, the coming couple of years? Thank you. Hi, Luis. As you know, we have the dividends we have to pay them from retained earnings. That's the reason why the last couple of years, we have not increased the dividend. The dividend that we will be paying this year will come from previous yearsâ retained earnings. We will be using most of our bullets to make sure that we keep it pretty much in line or very close to what we paid last year. Going forward, it's going to depend. If things continue to improve, we will definitely consider increasing it again, and maybe and hopefully taking, again, the share buyback program. But again, it all comes down to net earnings, not necessarily cash. And so, itâs a little bit independent of CapEx and that cash, we will have to - we will have and we need to work to make sure that we have those net - that net income and those earnings to increase it again and get back to that policy. Hi, Pablo, Xavier. Congrats on the results, and great to see that sequential improvement, and all the best for the year. So, I just had one follow up on Jensâs earlier question around the expectations there on the prices of partner. So, there is a lot of news flow there on some capacity coming in line in the year and et cetera, and I just wanted to know if this is considered in your base case, and maybe we could see better trends there if the capacity does come in line at the expected rate. I know there have been some delays there, so I just wanted to see what's kind of been baked in your base case. Thank you. Thanks, Ulises, for the question and yes, absolutely. As that capacity comes in, that should allow or put a little bit of pressure on pricing on pulp. Unfortunately, as you mentioned, that has been delayed somewhat, but as it comes into the market, it will have its effect, and that's why what experts are calling for right now is that this should turn around and it should gain some speed in second, third quarters of this year. That's the current expectation. And then in the coming years with that capacity, the cost should be pretty much flat going forward. So, it's really just a matter of when it happens and how fast it happens. So far, we haven't seen any important moves. Again, hopefully, we'll start to see them in the coming quarters. And yes, definitely as capacity comes in, that should be very, very helpful for the market. It appears that we have no further questions at this time. I will now turn the program back over to Pablo Gonzalez for any additional or closing remarks. Nothing much more to say. Just again, thanks so much for participating on the call and our best, best wishes for you and your families in 2023. Look forward to being in contact with you. Thanks so much.
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EarningCall_1207
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Good day. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to SVB Financial Group Q4 2022 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. Thank you, Emma, and thank you, everyone, for joining us today. Our President and CEO, Greg Becker; and our CFO, Dan Beck are here to talk about our fourth quarter and full year 2022 financial results, and our 2023 outlook and will be joined by other members of our management team for the Q&A. Our current earnings release, highlight slides, and CEO letter have been filed with the SEC and are available on the Investor Relations section of our website. We will be making forward-looking statements during this call and actual results may differ materially. We encourage you to review the disclaimer in our earnings release dealing with forward-looking information, which applies equally to statements made in this call. In addition, some of our discussion may include references to non-GAAP financial measures. Information about those measures, including reconciliation to GAAP measures may be found in our SEC filings and in our earnings release. Before we go into questions, I just want to briefly comment on kind of our business and the market environment. First, I think it's important to set kind of context. When we continue to see strength and momentum in our business despite the broader market backdrop, which I'll talk about in a minute. We had healthy loan growth across the board driven by global funds, banking technology, and private banking, mortgage lending, we had record core fee income from improved client investment fee margins, we saw healthy investment banking revenue driven by a foreign pharma deal activity, which was great to see. And we had more balanced in client fund flows as client cash burn in the pace of VC investment declined showed signs of moderation, which was obviously very important and welcomed. And we saw continued strong new client acquisition of approximately 1600 clients in the quarter, which is higher than pre-COVID levels, which is notable. And credit remains solid, although our provision reflects higher net charge-offs and non-performing loans as well as our expectations for deteriorating economic conditions. Now, the markets are still challenging, we admit that and they're likely to remain so throughout 2023. We don't expect any dramatic change from where we are right now. And in fact, even a little bit more pressure in the first couple quarters. So in other words, again, not expecting a dramatic improvement. Global market volatility is significantly reduced private and public investment. In public there's almost, there's a longest time that window has been effectively shut. And we don't really expect that to change until maybe put a big maybe in the latter half of the year. And there's still a lot of uncertainty over the direction of rates and inflation in the broader economy. And we hear about it pretty much every day in the news and on media. So, what does it mean for us for 23? We expect these conditions we'll continue to put pressure on our growth in the first half of 23 with net interest income pressure, somewhat higher provision, although we still expect credit performance will remain good overall, and other headwinds that are kind of come on a daily basis. But in the second half, we expect continued momentum and balance between venture investment and cash burn. And it doesn't â as we reported, and it doesn't take much of improvement, in fact, no real improvement from where we are. On the deployment of dollars, itâs more about the cash burn which we again continue to believe is going to be a pullback. We expect the shift towards interest bearing deposits to stabilize and could see an inflection point in net interest income and NIM in the second half of the year. We believe that shift combined with progressive pay downs in our investment securities portfolio again roughly 3 billion a quarter, will provide meaningful revenue tailwinds that build throughout the year. And we have enough visibility at this point to provide full year 2023 outlook despite the market uncertainty and those details during our Q4 '22 earnings deck filed earlier today. We're prepared if those things don't improve, again, which is important. And even if the market challenges are prolonged or get worse, it's important to note we have a high quality, very liquid balance sheet, which I know there'll be lots of questions, about strong capital levels, a seasoned management team which we experienced navigating challenging markets, and adding a lot of new people with deep experience as well. And a consistent focus on our long-term business strategy. So, when you put all that together, we feel clearly better about the outlook than we did last quarter where there was more uncertainty. And we certainly believe that the innovation economy is the best place to be. And even if we're in this prolonged period of time, for longer, or even a little bit deeper and deeper, we know we're going to weather that fine. Thank you. [Operator Instructions]. Your first question today comes from the line of Ebrahim Poonawala with Bank of America. Your line is now open. So, I guess, I mean, think it was good to see the 2023 guidance and just wanted to follow up on what you just mentioned around having enough visibility to provide that guidance. It sounds like you're feeling better today. And you look at the slide 10 in terms of the client fund, outflows obviously, cut in half quarter-over-quarter. If you don't mind, just give us a sense of this customer conversations that you are having with clients. What's added to that visibility today versus three months ago? And I understand all the things that can go wrong, I think, but what are you seeing in terms of green shoots of improvement? Would love to start there. Yes, I'll start. And I'm sure that Mike will want to add even more color to my comments. Ebrahim, here's how I think about where the clarity is coming from is a couple places. One is, I would say, we were hoping we would have had seen more of this in the third quarter. And that's where I would say we're disappointed. And that's why we didn't give guidance, because it kind of didn't fit with what our expectations were and what we were hearing, which was the following. Companies realized that it's hard to raise money, the level of venture capital deployment is coming down. And we expected a more dramatic decrease in burn rates, that really didn't happen in Q3. We saw clearly much more of that in Q4. And I think you're going to see more of it in Q1 and you hear about it, because when you're having conversations with companies, they're talking about, gosh, we hired a bunch in the last couple years. And now we're going to pull back on some of that. So, we're going to cut back 10%, 15%, 20%, or whatever that is. And we're going to look to cut costs in other areas. And the only reason I don't think it happened as quickly as we thought it was going to, is that companies had a lot more cash than they had in other cycles. And so that was just a prolonged period. So, we know that venture capital declined pretty significantly in the third quarter continued in the fourth quarter. But again, what our expectations are, is that you're actually going to see a little bit more of a decline in the first two quarters, and then start to see a little bit of improvement in the second half of the year. So, our forecast isn't a rosier Q1 and Q2 with higher levels of venture capital deployment, in fact, it's the opposite, a little bit more of a decline. And then you're going to see, again, this continuation of client burn, or cash burn pullback. So that's the narrative that all -- when we talk to clients, and again, not all clients are the same, as you know, we have some that are still spending more money. They're raising money still. And that's going to happen, but that narrative is shaping our outlook in the first kind of two periods, first half versus the second half. So Mike, turn it over to you to add any color to them. Sure. Great. Thanks a lot Greg. Ebrahim, there's a few data points, I think were investors are going to start to get even more clarity, right. When we think about inflation reports and whether or not the rising rates are having an impact on inflation. We just had a January 12 report, and we had the February 14 inflation report coming up. So, we're starting to see that rates are starting to have an impact on inflation. I think that's really important for investors looking for clarity, what's happening, the COVID impact of the zero COVID policy in China. We're starting to see that go through China and we'll know here end of January, February about whether or not that actually is gone through and then supply chains can start to come out again, having impact on inflation. The energy impact in Europe, we're going to get to that and see some more data points about the impact of inflation. But perhaps most importantly is the valuations, right? I think you have the auditors that are in at the various companies here that are looking at the valuations. And you're going to start with these audit reports that start to come up. And there'll be some valuation adjustments between the companies who have been holding off in terms of readjusting the valuation. So, I think that's really helpful. And so right now, obviously, the investors are still holding off on investments. They're slowing the pace but there's still a lot of good companies out there. There's still a lot of opportunities. They're still investing in early stage. But they have to prioritize their investments here. And they know they're probably going to have to hold on to these investments a little bit longer than anticipated, because there's just not a whole lot of exits as you know. There's just no IPOs, there's not a whole lot going on out there. But again, I think, there's obviously a lot of dry powder, I think that's very helpful. Now, when you shift to the lens of the entrepreneur, as Greg mentioned, they have had a lot of cash. They've been sitting on that, but we are starting to see where they are resetting their spin levels, right. The layoffs, you're starting to see that in news, which there's the good news and the bad news. Obviously, the bad news is the layoff. But the good news is, they're really starting to focus on their cash burn, because they know they need to hold on to their cash for a lot longer. Advertising spends have been coming down over the last several months. And so that's been a big thing that we're seeing here. So they're all getting back to focusing on client acquisition costs and profitability. So again, growth or just for growth sake is no longer the thing to do. So economics do absolutely matter. So they've been very, I would say, very focused on valuations, they've been holding off in terms of taking more investments, but eventually the cash starts to run out, eventually, they start to reset their expectations on valuations. And so we believe we're starting to see some of that breaks through. And again, I think over the next couple of months, I think that's when you would start to see as Greg describing a little bit more stabilization there, and perhaps as a platform here for the second half of the year to start to see some of those shoots that you were talking about. Understood. And I guess maybe a separate question for Dan. When we think about, from a balance sheet management perspective, on the asset side, available for sale securities, about $25 billion, $26 billion. Give us a sense, is there any view of like pulling forward some of those maturities and locking in higher interest rates today, given one, the COVID is already inverted? Who knows where it might be six months from now? Just give us a thought process around any piecemeal restructuring of the AFS book that we should think about? Yes, Abraham. Good question. In the quarter, for example, we did billion dollars sale out of the Treasury portfolio for AFS to be very clear. And the rationale behind that is, we look at the payback period on that sale was roughly nine months. So that's really the way for us to look at, from a tangible book value perspective, that payback period and opportunity. So I wouldn't say there's any desire for a wholesale change in the available for sale portfolio. But periodically with an opportunistic lens on payback period, we can do these small sales that -- to some degree can be offset by warrant gains and things along those lines. So thinking about it from a tangible book value perspective, but at the same time, looking opportunistically at payback period. Couple of questions on Slide 12. First off, so the non-interest-bearing mix, high 30s by fourth quarter '23. That's obviously very difficult to sort of handicap. Just what's giving you confidence around that number. Yes, Casey, it's Dan, I'll start. Mike wants to add as well. There are two things that we're looking at that give us a little bit more confidence on where that non-interest-bearing mix is going to bottom-out. First and foremost, the teams have spent a lot more time getting into the detail across our different segments on where operating dollars lie versus excess dollars in these deposit accounts. So exactly how much from a deposit perspective is available to be transferred. Now that analysis is never perfect but allows to start to get a sense of where we think that non-interest-bearing piece is going to lie. And then secondly, when we take a big step back, we've talked about this before. And when you look at the total client funds of the company, and you start to think about non-interest-bearing bottoming out in the high 30% range. And looking at the fact that total client funds is close to the $340 billion range, that high 30s is really when you compare it to other banks that don't have off balance sheet in that, mid-teens to high-teens range, which we think no route relative to our historical experience is a bottom and is a low. So we've got the individual assessment that we've done plus just our historical experience, on where that would bottom-out, in comparison to peer banks. Now, it's not perfect for sure. And we're encouraged by the slowdown and the pace of that change here in the fourth quarter. And we expect that to continue throughout 2023. Very good, thank you. And then in the letter you guys talk about, you don't need to see VC deployment returned to 2021 levels, which were obviously very strong. Can you provide some color as to why that is? Because that comes up a lot, because that was such obviously a monster year for deposits. And it's obviously flowing out now. And so it makes sense, the push back that it's going to be very hard to replace what was a banner year? Yes, Casey. I'll just go to the results of the fourth quarter as an indicator of why that statement makes sense. We're looking at venture deployment in the quarter, 35 billion or so think of that is kind of an annualized run with 120 billion to 140 billion venture deployment in the quarter, from a balance sheet perspective on balance sheet. While we did see the decline in deposits, it was much lower than what we saw in the third quarter. And the reason for that gets to what Greg mentioned, as well as Mike, where we're seeing that lower level of cash burn. So even on a much slower venture deployment number, call it in the mid $30 billion range, we started to see that on balance sheet deposit when we look at cash burn versus the inflows get to a much more normalized level. So that I think is an indicator with cash burn continuing to slow based on what Mike and Greg just said, that we can get back without going to the 2021 deployment level, to not just deposit of being at the same level, but the potential for deposit growth. Got you. Okay. Just last one for me, the premium amortization that you guys talked about for the first quarter here, you have it down a little bit. But it's predicated on a 375 tenure, which is, tenure, obviously a little bit lower today. With incremental pressure on that number, if the tenure finishes 50 bp lower, can you just provide some color on the premium memorization because this does create a lot of, I think confusion. Yes. So we would still anticipate the premium amortization to decline here in the first quarter. And the reason for that is that mortgage spreads continue to come in. Now, after the first quarter, to the extent that we continue to see the 10-year come down, we do have the sensitivity to an increase in premium amortization from that quarter, but just from the fourth quarter to the first quarter, consider that it's going to continue to come down just because of the decrease in mortgage spreads in the quarter. So to follow up with the pace of cash burn now slowing, has the amount of cash on hand and the burn levels are those both [the words] [ph] what you guys would consider a normal level right now or those each still elevated? Yes. It's Greg. I'll start. Trying to say what normal is, is really difficult for a variety of different ways. When you go back and the one thing you go back, five or six, seven years and try to say well, is that more of a normal period? Our portfolio, we have a lot more mature companies in the portfolio. So you going to think about they tend to keep a lot more cash. And so we don't have quite the same level of experience. I think towards the end of this year, my sense is like, we're going to get more to what I'll call more of a normal cash balance level, because you're going to see the cash burn rates are still be elevated from the first half, they're going to be reducing, but they'll still be higher. And so we'll get to this more I'll call normal level. And I think, again, when you get to 24, we expect a modest increase in venture capital deployment. But one more thing that gets factored in is, which has been zero for almost all at '22 and it's first part of '23. And most of '23 have been unexpected big impact is private market or public markets. And, again, this for the longest time that they have hadn't really been any IPOs. And as we spend more time with our late-stage clients, there's many of them that are doing really well. And when that market opens up, that we certainly believe that we're going to be in a really good position to do two things, one, help them go public, number one, and number two, be the beneficiaries of that cash when it comes in. And so all those things are factored in, which makes it, it's just hard to predict exactly how it will, âsettle out to a normal levelâ. Okay. That's fair. And I know it's not one-for-one, but very roughly, what type of year would you need from a VC investment level? To get to this 2023 guidance? Like what is this roughly based on? Yes. I'll start and Dan or Mike may want to add. I tried to kind of give a little bit of color in my opening comments, but the way to think about it is that we still expect in the first half of '23, that you're going to see kind of a 10% to 20%, roughly decline in venture capital. And then, you're going to kind of pick back up in the -- from those low points in the first half. And pick up that not a lot. So you're probably looking at, again, if you annualize the fourth quarter, you're at about 144 billion, I think we're in that, roughly 130 billion-ish for the year. Again, rough estimates, because you factor everything in, you got to think about burn rates and everything else. But the point is that the run rate for the fourth quarter, our forecast for '23 is actually slightly lower than that, when you aggregate it, it's just more front end loaded the negative. And we'll see a little bit of a benefit in the second half. Yes. Steve just add to what Greg is saying it doesn't increase very much in the back half. So we're in no way shape, or form being aggressive, thinking that the market is going to come back with significant amounts of deployment, the back half of the year. So you're not talking about material shift in Q3 and Q4 in investment levels. But what we do see in Q3 and Q4, with the guidance that we're going to see the slowdown in the decline in non-interest bearing deposits, plus the securities pay down each quarter that you kind of -- you get to a normalization of net interest income and margin, right around the midpoint of the year, And then can start to see some growth into the fourth quarter, just with those factors alone. So small increase in venture deployment, a stabilization in the non-interest-bearing levels that happened towards the back of 2023 plus the securities pay down starts to build momentum for net interest income. Got it. Okay. Finally, just to clarify, you mentioned high 30%. As the bottom, you said this a couple of times the bottom in the non-interest-bearing mix, but then I thought you said that deposits might bottom the midpoint of the year and then grow in the second half. So if you actually expect that interest bearing deposits to bottom below the high 30s in the first half of the year and then grow to the high 30% level? Thanks. No, Steve. The expectation is that we're going to continue to see some mix shift, non-interest bearing into interest bearing really throughout all of 2023. And we would expect as we get into the fourth quarter that's where we're really going to see that bottom out from a non-interest bearing to total deposit perspective. At the same time, what we can see in the back half of 2023 is with a small increase in venture deployment and the slowdown in cash burn that we expect to continue and small improvement in the overall deposit bubble. So they are really two different things. I just wanted to maybe just follow up in a line of questioning on the non-interest bearing. I just wanted to get a sense for, is there like a natural kind of level of non-interest-bearing deposits, from an account level perspective that need to be -- these companies need to keep on hand. I just asked just because you guys have actually done a pretty good job of actually maintaining account growth over the last couple of quarters. And so I just wanted to get a sense for, if non-interest-bearing account levels, if there's an average account level where these things kind of naturally bottom out. Yes. Brody, it's Greg, I'm going to start at a high level, and Dan, or Mike may want to add some color commentary to it. The challenge of the answer your question is that there is not any more an average client, because it really depends upon early stage, mid stage, late stage, publicly traded, all those things. Here's one way to think about it again, why, again, Dan made the comment about kind of this bottoming out. It was said, but I'll repeat. When you look at that high 30s, kind of bottoming out of the non-interest-bearing accounts, you have to think about it and look at the totality of all the total client funds. Right now we're at about a 24% of all total client funds. But if you factor in this high 30s, as a bottom, you're going to be in that mid to high teens against that total client funds. We believe historically, that would be low. And when you factor in all the types of clients, that that seems with all the data and information, we have to be where we'd be bottoming out. Obviously, it can change, our assumptions can be wrong, but that's the analysis that we've done. So think about it in the mid to high teens of total client funds, not just this 23%, 24% kind of at the end of the year. I don't know, Dan, or Mike, if you guys would add anything to that? Yes., Greg, it really gets back to the same thing. If you look at most commercial banks, you think of total non-interest-bearing deposits, even in these rates, cycles being in the high teens, become a low watermark on non-interest bearing. And that's effectively where that on balance sheet, high 30% non-interest-bearing range turns out to be if you consider the totality of client funds. So that's one marker plus, like Greg said, the analysis that we do internally. So I think when we look at those things, yes, it's subject to change that at the same time, it gives us confidence in the outlook. You're [restricting] [ph] just a little bit over to the loan side and the growth you saw in, and they are going to be talking about clients favoring debt over capital here. Have you changed underwriting? Or have you seen any better terms on loans that are being originated now versus earlier in the cycle for these early and mid-stage companies? Yes. This is Greg. I'll start and Marc and Mike probably both will want to share a perspective on that. It's the growth has been, again, in the three years that we talked about, it's the technology side of the portfolio. It's been in the global funds banking, and then a little bit with the mortgages as well. And on the technology side, we've seen price some of the best growth we've had in many, many, many years, clearly on an absolute dollar volume basis, and even on a percentage basis. And that's one, it's just kind of a simple discussion. We were competing, and we've said this on many conference calls. We're competing as much with equity dollars and anything else. These companies you'd sit back and go, we would love to lend money to you because of all the great fundamentals you have, but they just raised $200 million. So why would they want to borrow $20 million, $30 million. And so obviously, it's gotten harder. Not that they couldn't raise money, it's that they're choosing not to because of the valuation, that they would like to see, those are great opportunities for us. So the team is doing a great job of winning, really some great, great business on the technology side. In the global funds banking, you've got, again, we've been doing this longer than anybody else. So we've got a great experience. That's the term sheets, and the new business is still in very, very strong demand and we've seen some people pull out of the market. And so that allows us to, in some cases get a little bit higher margin. But I'd say it's as much getting -- making sure we have the highest quality clients that we're bringing on board to the platform. So it's still competitive. But we're able to bring in some great clients, and we're able to see some nice outstandings in this environment. So I don't know, Marc or Mike? So I'll just comment, specifically on underwriting that was part of your question. Generally speaking, we try to keep our underwriting standards consistent. And what that will mean generally, in times when the environment is getting worse is fewer clients clearing the bar. At the same time, as Greg mentioned, that has been offset by more demand. And so we are continuing to see some great opportunities to grow loans, really across the segments, including the core tech and healthcare. Mike anything you want to add. Yes. The only thing I would add is, I mean, clearly, we're very cognizant of the economic environment that we're operating in. So when we're looking at underwriting, we're very conscientious of business models that are relying on the consumer as the consumer might be hit with inflation, starting to think about interest rates and how they might impact the business models as well, or their amount of financing. So all these things are coming into factor. But as Marc said, right, we're very consistent or underwriting standards, which has served us well for many, many years. Okay, thanks. And then, I guess a corollary of that you look at the credit, expectations and the growth in the allowance looks like, inside 30 of -- you're nearly at peak stage losses are very close to it for coverage. How much higher do you think we can see the allowances or ratio go with sort of your broader credit expectation backdrop for normalizing losses? That's Mark, I'll start, Dan or others may wish to chime in. So certainly, there's a fair bit of reserve build, as you pointed out in '22, because the reserves go higher in '23. As I think you probably know, economic forecasts can drive the reserve as it did for us, this particular quarter. So that's one factor. We could, as we've noted, see higher levels of non-performing loans that could drive higher specific reserves. And so there is that potential for the reserves to go higher, again, recognizing that we have a fair bit of reserve built behind us in 2022. I wanted to follow up on the reopening of IPO markets being a clear positive for the business. From a timing perspective, would you expect that reopening to coincide with a Fed pause? Are we more likely to need to see rate cuts? Just curious for your high-level thoughts there? Yes. I wish I had our SVB Securities team on the line right now. They're close to [indiscernible]. But as we talked about it, I think we don't have a lot of expectations for things, in '23, with a few exceptions, right. I think my view when you start to see the top off of rates, and so I don't think they need to go down. I think they need to be stable at whatever level they're at. And I think just some confidence that's where we're going to hold and we're not going to see a potential for another spike. So that's one data point. Second data point is, as I mentioned this earlier, I've been spending more time with some of our later stage clients that are -- they have a lot of the metrics that we would say they are in a position when the market opens up to go public. And I think there's when that stability happens, you're going to see some go out and test the waters. We need them to test the waters. And so I think could that happen in late Q3, Q4, the answer is yes. So I think if we see maybe a couple more rate hikes at 25 basis points and a quarter a little more than a quarter of flattening. Do I think that the market could open up for a few IPOs, the answer's yes. Again, make one more point, even when it opens up, it's not going to be a flood, it'll be a trickle. Because it'll be the ones that have the highest potential to go public, and people are going to wait to see how they perform. So I would say, yes, maybe in the late third quarter and fourth quarter, you'll see an opening, but it's going to be a slow-paced opening when that happens. The only thing I'd add to it, Greg is, and we saw it in the fourth quarter on the biopharma side, in particular, good deal flow, good deal activity there, has that if you think about that business, that's the normal flow of fund-raising activity for those types of clients. So we're not expecting, a substantially strong year on the biopharma side. But I think that can become more constant. And as embedded within our guidance expectations for 2023. That's helpful. Thank you. Separately, how would you characterize the current willingness of companies to take down funding rounds? And how would you say that compares to the appetite for dry powder deployment? Just curious, if you think we're in any way getting closer to those two sides coming together? Yes, it's Greg. I'll start. It's exactly what you'd expect. We've seen this movie before. And you've got companies that are, and you can see this in the venture capital data that was released in the fourth quarter. Late-stage rounds, there were a lot fewer of them, but the valuation actually didn't drop a whole lot. And the reason for that is that investors looked at this as an opportunity to go in on a flat round, and some of the highest profile companies that had actually done really well since their last round, but they can still get in at it, what they would say is a decent valuation. And you have another group of companies that are there -- they're basically saying, hey, I'm going to take the lower valuation, I'm going to get it over with, those are fewer. But we're going to see more of it over the course of '23. And then the final one is, what I'll call the in between, it's the structure deal where it is, it looks like it's the same round valuation as the last round, but they have preferences and things like that, that you would say, when you really look through it isn't keeping it at the same valuation, there's structure involved. All those things are happening but you're going to see more my view, more down rounds occur in '23, you'll see some more structured deals. So all three of those scenarios are played out, you're just going to see more activity happening. And again, as we talked about earlier, more in the second half of the year, than the first half of the year. That's very helpful. Thank you. If I could squeeze in one last one. Really wanted to follow up on your commentary around the non-interest-bearing deposit mix. I'm sorry to keep coming to that question about stabilizing the high 30% range. But the question is sort of around this broad concern around the banking system in general that we're hearing from a lot of investors that we could see the mix of non-interest-bearing deposits revert to pre GFC levels. But when we look to the pre-GST era, your mix of non-interest-bearing deposits was in the mid to high 60% range, which is around where you were pre-COVID. So I appreciate your commentary around looking at non-interest bearing in relation to total client funds. But maybe like a broader question is, do you envision a scenario where we can sort of get back to that mid to high 60% non-interest-bearing mix as we look beyond some of these more near-term liquidity pressures that you're dealing with? Yes. As people would say, hope is not a strategy. So while it would be great to be there. There certainly is nothing in our forecasts that would say we're getting back to that at all. And so, do we -- is there a scenario that we would see an uptick from the bottom that we think will happen later this year? The answer is yes. And we haven't come out with a guidance on what that would look like. But it's going to be well below our historical level of non-interest deposits. I know, Dan what you add to it. Yes. The other way to think about it is, when you go back to the history of pre-global financial crisis, just the size of the overall balance sheet, the types of companies that we bank are very, very different. And I think as a result of that change in client mix, we're not going to get back to those levels of non-interest-bearing deposits. That doesn't mean that we don't have the quality of the deposit franchise, it's just a different mix of clients, now versus then with close to $215 billion balance sheet. And maybe the only thing I would add on to what Dan said, thinking more about it is, there's, kind of -- the way you're describing, it's either -- its market interest bearing, or it's zero. And I think you can see scenarios. And Mike and team have done a great job, this is looking at different products and solutions. So you're going to see a whole different level on the interest-bearing deposits of different yields based on the profile of clients. So I think you have to understand that that, yes. interest bearing is going to be a higher percentage, but the spread of yields on that will be varied. On the off-balance sheet funds balance, I think it's about 168 billion, as of the end of the year. Can you just update us again, how much of that is available? Or you're able to bring on balance sheet and how much of that you expect to be used under your -- that's baked into your guidance here. And any other dynamics in terms of that could be impacting that balance? Thanks. John, it's Dan. And we have talked about it in the past, that we believe that there's still access, obviously doing the right things for clients, to roughly half of that off balance sheet balance, so, sitting where we are, that still leaves, a sizable opportunity across what's classified as sweep. And what's classified as repo. So that's a substantial opportunity for us. In terms of how much we're including in the forecast, we're still expecting to see some of that move on to the balance sheet, but the pace of that is expected to continue to slow into 2023. And that's all included in our net interest income guidance and the interest-bearing deposit beta guidance. Yes, John. It's Dan again. Very clear that we're only talking about available for sale. In the quarter, we did opportunistically sell a billion worth of Treasury securities at a very short payback period with limited impacts to tangible book value considering that we also had some warrant gains in the quarter. So, I think what you're going to see from us is less of a broad review across available for sale and actions there. But you'll see us opportunistically where the rate environment, the payback period makes sense. And also protecting tangible book value, we take some of those actions to effectively accelerate the pay downs of that book. Again, that's opportunistic, that's for net interest income generation purposes, more than anything else. And again, we did a billion of that in the quarter. No, and again, anything we're talking about is within available for sale, and it's opportunistic, and protective of tangible book value. Got it. Okay. Thanks. And then, separately, on the credit front, just because they'll feel the fair amount of incoming from investors regarding potentially under appreciating credit risk in your story. Is there -- where are you seeing stress in materializing that growth learning where you expect some losses materialize and go against some of the reserve buildings that you've already put up. What are the most noteworthy areas where you're beginning to see some of that stress? Yes. It's Marc. I'll start. Dan or Mike may wish to contribute. But it is consistent with our historical experience. It's the early-stage venture backed investor dependent cohort where we have and would expect to continue to see the most stressed. Okay, thanks. And then, lastly, for me, it's just the capital markets investment banking pipeline. If you could maybe just comment there what you are saying, sorry, if you've already touched on it. But just wondering if you can talk a little bit about what you're seeing here in terms of deal opportunities, as you look out into 2023? Yes. It's Greg. We don't -- we haven't talked about pipelines. We did give guidance on what we expect the outlook to be from a revenue perspective, which is an uptick from where we saw it in '22. And maybe just to kind of walk you like, why would we show an improvement. If you're called back, you've got, there's kind of three parts -- actually four parts of the business. You got the biopharma business, which is really what we brought on board, an incredible franchise with limited partners. When we added healthcare services, we added technology. And they had -- the team had sales and trading and they had research. But now then, with the addition of MoffettNathanson, you have to look at the entire platform. So now you've got M&A capability, full ECM capability across all three verticals, you have strong sales and trading. And you have actually, I would say incredible research when you look across the entire platform, so you have a full stack platform. And it's actually, people are in the saddles and they're productive. And so even though the market is going to be a challenge, we look across that whole portfolio of opportunities and actually feel very good. I feel very good about the team, the strategy and their ability to execute. This is going to be a tough year, our outlook shows, it's going to be a tough year. But I'm actually really excited about '24 and '25. And having that team be on the platform longer and really take advantage of an improving market at some point. But it's going to be a tough market, but still an uptick in revenue from what we saw in '22. Question on credit quality. I know you have a very small commercial real estate portfolio. But I wonder if you could just kind of give us a characterization of what's in there. And if you have any concerns about any piece of it. I know it's really small. But a lot of banks have been talking about concern about commercial real estate in a tougher environment? Hi, it's Marc. And that is a segment certainly bears watching, particularly if there is a recession in the offing. But generally speaking, as you pointed out, it's 3% of total loan, it's reasonably well diversified across several different categories. And probably what's most important, is that it's on average, well margins, relative to the underlying real estate collateral. So that was certainly going back to the Boston Private acquisition. It was a portfolio we were more concerned about, in part because it was -- we were in the depths of COVID at the time, and it has continued to really outperform my expectations. There is some office exposure, it is not an enormous part of that 3% but significant again, so far has continued to outperform expectations. Yes. Good evening. Thank you. It's a question, I guess, mainly for Dan. And I hear you and I understand exactly why you're saying the only securities restructuring would be in the available for sale portfolio. But I wonder as you're looking at that held to maturities portfolio, I'm looking at your average balance sheet, there's like the $85 billion taxable hold to maturities portfolio. I wonder, just if you can highlight a few of the dynamics of the run-off there. And the first thing I'd say is, I noticed like the yield went down from, like 192 to 172 from the third quarter to the fourth quarter. Presumably that's the $50 million of amortization. But I'm wondering, what's the go forward? I mean, was the third quarter a $50 million, good guy or is the fourth quarter $50 million bad guy, I guess? That's the first thing, you know, should we expect something like with a 170 handle or a 190 handle? And then, secondly, I guess I'm wondering, I mean, from the disclosures in the 10-Q, it looks like that had has a very long maturities profile. Is there like any significant runoff that would kind of on a natural basis, take that portfolio over, say, 3% yield handle anytime in the next, 12 to 24 months? Yes. It's Dan. I think, first and foremost, the payoff profile there, we're getting off that book, anywhere between $2 billion to $3 billion, a quarter. So think $12 billion, annualized, run down in that portfolio. And those assumptions were where 10-year rates were just a couple of weeks ago. So we now think about tenure, 330, 340, you can pick up some pay down acceleration associated with that. We'll see how material that becomes and where the 10-year ultimately land. So I think you're going to continue to see some improvement. But in this kind of $2 billion to $3 billion, quarter like a clock just continues to pay down with the opportunity to accelerate if 10-year rates come down from there. We think about yields themselves, I think, as we look at Q1, we're still talking about in the high 170s to the mid-180 range, in that book, and a lot of that really comes down to where premium amortization comes in for the portfolio. So, those are really the factors, watch the 10-year yield, to the extent that that continues to come down, you could see an acceleration of payments on that book, which obviously, just make things go faster, faster there and get us closer to that inflection point of NII and NIM sooner, if that were to occur. Just curious if you'd look at the investor dependent cohort right now, how much cash runway do they have? Obviously, they've been trying to sell their cash burn. And that sounds like they've been successful at doing that. But how does their cash position stand looking out for the next year or so? Yes. So we track remaining months of liquidity we call it otherwise referred to as runway, and the majority of that portfolio at last check, still had over a year's worth of cash on hand. Got it. All right. That's helpful. And then just shifting gears. On the funding side, when investment activity does come back, and client funds come in. How do you expect the mix to trend with respect to deposits versus off balance sheet funds? Yes. This is Dan. I think, based on a potential recovery and venture deployment, again, we don't have a substantial pickup at all in the earnings guidance for 2023. But imagining that we do start to see a pickup there, I think we're going to continue to direct those funds on the balance sheet. We think about the composition of those funds as they come in, they'll likely be less expensive than what we've got from the off-balance sheet to on balance sheet product. So over time, to the extent that that accumulates, we'll look at over time, shifting more of those expensive deposits. That's one of the benefits of that product is that it's not a one-way door, we have the ability to shift that off balance sheet to accelerate the improvement in net interest income and net interest margin. So I think we'll for -- if you think of the switch and how we toggle the switch, the switch will be continued toggled on the balance sheet. As we drive some of those higher costing deposits off the balance sheet. And to be very clear, we don't expect this to come in is all non-interest bearing it'll certainly be more heavily weighted to interest bearing in this higher for longer environment, but still be cheaper than those off-balance sheet client funds. On the capital call lending and global fund banking, could you just say a little bit about how much of the growth was driven by new lines of commitments versus any change in utilization? So, as far as the new client business, I mean, most of it was from utilization, the change from an outstanding perspective. So we did have some new, obviously new client fundings. But so, I'd say it varies from quarter-to-quarter. So it's probably not anything to make a -- have a dramatic change. So, Dan, if you would add anything to it? Yes. I think when we look at the quarter from a funded perspective, we did have growth in capital call. And at the same time, that was off of lower utilization. So you've got some net new clients in there. I think more notable is the increase in the amount of term sheets and net new unfunded commitments, which over the next six to nine to 12 months, are really going to be a tailwind for us from a loan growth perspective. I think that's most notable also drove an element of the provision increase in the quarter. Okay. So just to be clear, lines were up but utilization was down slightly, but on net to outstandings were higher? Okay. And just unpacking the SVB Securities outlook a little bit more. It was largely biopharma driven in the fourth quarter, as I understand it. What kind of tech recovery is contemplated in the guide for 2023? Very little, very little. Again, as I said, now, having the full platform and people in the saddle for longer and deeper relationships being built, it's really just -- able to pick up some market share. We just don't have a lot of new activity in there. No. I think it's clearly going to see more of a mix. Biopharm will do fine, but it's M&A in technology. It's M&A in healthcare services. So M&A is going to be the bigger part. So I here's how to describe it. Biopharm is probably going to be still be a mix of ECM in M&A. Technology and healthcare services is going to be more driven for the year with M&A. And maybe towards the end of the year, you start to see a little bit of a pickup in ECM in the technology side. Greg, your balance sheet historically has been one of the more asset sensitive, we're going through a period of really big rate increases. So you've moved to the other side. If we look at the forward curve, which begins the pricing cuts, and I know your guidance doesn't factor in cuts. How do we think the margin will perform if the Fed funds rate gets cut? As we look into next year, should the balance sheet flipped to being liability sensitive in that respect? Yes, Chris. This is Dan. I think if you look at our disclosure of what we're talking about for potential rate increases, you start to see that that which is factored at least the next couple increases are factored into our guidance, you start to see that we could be liability sensitive associated with that. So in the case that the Fed starts to decrease rates, and again, we don't have any of that baked into our estimates, that could start to be a bit more of a tailwind from an NII perspective, reducing the overall pricing on some of those more expensive deposits faster than what we have incorporated in our model. So I think you can look to the asset sensitivity disclosure and look to the same potential for a reduction to the extent that rates come down. And maybe Chris just to add-on, because I think you've kind of had two questions. One is maybe short-term and long-term. And I think, when we settle out to find out kind of that kind of normalization. And then when you see, let's say, you got back to whatever that normal floor is, or flattening of rates at some points and lower level. And then at that point, I think if you saw some rate increases, modest ones, I think we'd be back into the more assets sensitive side. I think it's just right now, and you said it, we saw such a rapid increase in rates, which we've never seen before. And that's what kind of made the biggest change, in addition to this kind of construction of the balance sheet. Those two things, cause it to be kind of out of historical norm. And it's going to take a little while for us to get back to that place where we can eventually get back to a base level, although less level of asset sensitivity. That's great. Thank you for that. If I could just follow it up. One of your competitors. Last week talked about deferring costs into the out year, given the environment, appreciating the low single digit guide for expense this year. Were certain projects just pushed to next year, or is there, I know you talked about hiring slowing, but is there a natural ramp that comes back into the expense growth rate once environments get a little better? Yes. I'll talk about Chris philosophically how we've operated from an expense perspective over years and cycles. And then, more specifically about the guidance that you gave, and then Dan can add comments to it. And we've said this, when you go back and look at the pace of investment we made in digital infrastructure, and a whole variety of risk management, a lot of different things. We looked at it and said, look, when [indiscernible] times are better, we are earning more money. We're going to we're going to kind of accelerate that investment level. Because we have an insatiable appetite for investment, because of our target market and the market overall, and where it's growing and how large it is. And so when you have times like this, that's just a more challenging, more uncertain market are more headwinds, you're going to take a look, and you're going to say, you're going to basically prioritize, and you're going to kind of optimize what you have. So does that mean slowing down some projects? Yes, it does. Does it mean potentially pushing things out into future years? It does. But we have that prioritized list. And as things start to improve, we're going to start to put more money behind those projects. We have in the deck where we're making the investment focus, our prioritized list. So it's more in the private banking, wealth management going to go-to-market strategy. Secondly, in the commercial bank, kind of focus there and digital enhancements. Third is this one SVB collaboration, just making sure that we're working across the entire platform. And that's just really important to make sure that we leverage our investments, leverage our acquisitions, and really take care of our clients deliver for our clients in a meaningful way. And then the last one is risk management, which again, we continue to enhance, as we are in this LFI status, and both expectations, and just our own needs are increased. And so that's how we think about prioritization and so forth. So Dan, what would you add to that? Yes. I think as long as it's clear, we're going to continue to invest here, even in a more challenged 2023, across the elements that Greg mentioned that's key, I think, for us to emphasize, we're able to optimize that spend also, as we're looking at changing the mix between professional services, and cheaper, full-time employees. That's just another way for us to get optimization from a cost perspective. And we're doing that and that also helps us from a sustainability perspective. And then I think the last part of your question is, to the extent that the environment improves, are we going to go back, to that more traditional higher expense run rate. And I think that's going to be a balance. And I think for us the overall return, the profitability of the franchise is continuously important. So we'll have to continue to balance those investments, as our profitability returns to more normal levels. That's great color. Thanks. And maybe just the last one, I know the environment is uncertain, but thoughts on a buyback over time given the valuation. Yes, Chris. I think we've said this in the past, we're always going to remain open to looking at our options from a capital perspective. Now, obviously 2023, we're not expecting a lot in terms of new major acceleration in deployment. But to the extent that deployment does come back and does come back quickly, you can start to see the balance sheet increase. And again, no more pressure from a Tier-1 leverage perspective. So we certainly don't have that now, but it's something that we need to continue to be cognizant of. So I think as we look ahead, we're just going to continue to keep our options open. But again, no, I think growth over the medium and long-term is the thing that we need to prepare for. Great, thanks. Thanks, everyone, for joining us today. We tried to give as much detail, and again, I give a huge amount of credit to our IR team to put together a lot of information, a lot of detail on kind of what we're seeing the outlook, what are the key drivers. And so I think that's really helpful. And I think, again, just to reiterate, when you go back and look at fourth quarter, there's a lot of really healthy signs, whether it's loan growth, core fee income growth, nice growth in investment banking. And probably, maybe most importantly, this kind of stabilization of this inflow of venture with a pulling back or slowing down of cash burn. So that was great to see. That being said, look the market is still very, very choppy, there's still a lot of uncertainty out there, which is why we gave guidance in two ways. One is the annual guidance and the second one is the quarterly guidance to make sure that you kind of really have a good sense of how we're feeling about the quarter. We talked about what it means for SVB. And again, just to go back, we think the first half is going to be -- it's going to be bumpy. We expect that you're going to see venture capital decline in the first half of '22, and then kind of '23 and then stabilized and start to improve. So our expectations are not for a big improvement from where we are right now. And that's just the outlook we think is realistic. And could there be some upside, certainly there could be some upside, but that's not what we have in our plan. And especially if it gets worse, as we went through and you can see in the deck, we have ample resources of liquidity and other ways to make sure we're taking care of our clients and still being there for them when they need us. So that's kind of our view. Again, thanks, you guys for joining. As always, I want to thank our clients. It's one of my favorite parts of what I get to do is spending time with our clients and just hearing their stories about what they're doing. And they're still excited. And yes, they're making hard decisions. But they are well positioned. And quite honestly, I think markets like this, in many ways, as much as we don't like it, we don't enjoy it. It's actually healthy because it allows those companies to run more efficiently, run more effective and position themselves for growth. And then, finally, thanks to all of our employees, I can't thank them enough for what they have been doing to support our clients, what they're doing to support each other and look at the tough market. And so keeping that positive attitude and client-centric mentality is super important. So we appreciate that. So thanks, everybody. Thanks for joining us and have a great day. Thank you.
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EarningCall_1208
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All participants will be in listen-only mode. [Operator instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. This call may include forward-looking statements and the companyâs actual results may differ materially from those indicated in any forward-looking statements. Important factors that could cause actual results to differ materially from those indicated in the forward-looking statements are listed in the earnings release and the companyâs SEC filings. I would now like to turn the conference over to Alerus Financial Corporation, President and CEO, Katie Lorenson. Please go ahead. Thank you, Emily and thank you, everyone for joining our call this morning. 2022 was the year of significant transitions in our company as I moved into my current role and spent a better part of the year building the executive leadership team, including our new Chief Financial Officer, Al Villalon, who joined me on the call today along with Karin Taylor, our Chief Risk Officer. In June we recruited a new chief banking and revenue officer who is also here with me today in the Twin Cities and in July we promoted from within two long tenured employees to round out the new executive team of Alerus. I am so proud of the professionals across the company who I get to work with every day as we take Alerus to new heights. Recruiting and retaining talent beyond the executive leadership team is a key strategic initiative we remain committed to as we build our commercial, treasury and private banking franchise to support our historical strong client growth, scale and brand, we have already established in our wealth management, retirement and mortgage division. On Monday, we announced another win on the talent side with the addition of three high-performing commercial bankers to the Alerus team. And this week, we also welcomed our new Head of Treasury Management and deposit strategy to our company. Consistent with the rest of the industry, 2022 was full of unpredictable and unprecedented headwinds to our company. The power of the Alerus diversified business model, our collaborative on Alerus culture and our hard-working team members continued to focus on what we could control, attracting talent, acquiring new clients, expanding relationships with existing clients, managing expenses and constantly improving the client experience. The results of these efforts across the company are creating embedded tailwinds for the coming years when the pressure points on the balance sheet and in the markets subside. Specific strategic highlights for 2022 included the acquisition and closing of Metro Phoenix Bank, our largest acquisition in company history and a transformational deal for our Arizona franchise. Another successful lift out of a team of bankers who exceeded our expectations and closed over $200 million in high-quality loans in 2022, less than a year with Alerus. In 2022, we surpassed the sales milestone with another record year of record levels of new business growth in wealth management and retirement while constantly building on the synergies from the businesses, including synergistic deposit balances reaching nearly $700 million at the end of 2022. We remain committed to exceptional asset quality. And in 2022, we continued building on our strong foundation of credit and risk management to support our future growth, including the additions of regional credit officers, additional technology, enhanced administration and monitoring, robust stress testing and reporting as well as changes to loan policy. We strategically exited the payroll business, a small and no margin product, which we replaced with formal referral partnerships with other payroll providers, allowing us to focus on our core retirement and benefit product offering. We've done a good job in managing expenses while thoughtfully improving the processes and the client experience. Despite the inflationary headwinds, we continue to make progress in building efficiencies and scale in our company. The company and the client rates have grown while expenses in the number of employees continue to trend downwards. Looking ahead to 2023, we have put the pieces together, and this team is focused on the fundamentals that drive sustainable long-term outperformance. We remain committed to the work of rightsizing our structure, investing in experienced talent entrenched in our markets and building our business. We remain committed to exceptional asset quality and are laser-focused on client selection as we grow. We will take the positive lending market share and grow our company through new client acquisitions, expanding and deepening relationships with current clients and reducing attrition by taking our service levels and the client experience to new heights, all while making the company more efficient and improving long-term shareholder returns. Thanks, Katie. I'll start my commentary on Page 14 of our investor deck that is posted in the Investor Relations part of our website. For the fourth quarter of 2022, reported average loans increased 4.3% on a linked-quarter basis. The increase in core average loans was driven by a 6.4% growth in commercial real estate and commercial construction. Average deposits declined 1.1% on a linked quarter basis as clients continue to put liquidity to work. Due to decline in deposits, we had to increase our short-term borrowings over $124 million, a 49% increase to fund continued loan growth and especially with the addition of Metro Phoenix Bank as we continue to expand in Arizona. I will discuss later the impact of these increased borrowings. Turning to Page 15; credit continues to remain very strong. We had net recoveries of three basis points in the fourth quarter. Our nonperforming assets percentage was 10 basis points compared to 17 basis points in the prior quarter. Our allowance is 1.27% of period-end loans, which includes our recent acquisition of Metro Phoenix Bank. We will be transitioning to CECL in 2023. We are currently expecting a $5 million to $7 million day 1 allowance increase. This will impact our CET1 capital ratio by 20 to 25 basis points based on risk-weighted asset levels for the fourth quarter. Turning to Page 16; our core funding mix remains very strong. We saw an increase in our cost of funds due to rising interest rates. Given the further rise in interest rates and a highly competitive deposit environment, we have responded by increasing our deposit rates. At the end of the third quarter, our deposit beta was only 3.510 which is one of the lowest in the industry as we lagged deposit pricing through the first nine months of the year. However, competitive pressures escalated as many banks in our footprint saw their loan-to-deposit ratio exceed 100%. Due to escalated competition for deposits, we raised pricing several times, which increased our overall deposit beta tenfold to 36%, which is in line with our historical experience. Despite the competitive pressures, and deposits declined slightly, our funding base remains very strong and sticky as our loan-to-deposit ratio was at 83.8% with no broker deposits. On Page 17, our capital base remains very strong as our common equity Tier 1 ratio is at 13.4%. As a frame of reference, the medium common equity Tier 1 for the largest financial institution subjected to the Dodd-Frank stress test was around 8%. On this slide, you'll also notice that we have over $2 billion in potential liquidity, given increasing concerns of potential economic uncertainty, we are well positioned from both a capital and liquidity standpoint. Turning to Page 18, are key revenue metrics. On a reported basis, net interest income declined 4.8% on a linked quarter basis. The decline was driven primarily by increased funding costs as deposit pricing rose and as borrowings increased to support loan growth and our Arizona market, as previously discussed. Noninterest income declined 5.5% on a linked-quarter basis, mainly due to a decrease in mortgage I will go into detail about our fee income segments in later slides. Turning to Page 19; net interest margin was 3.09% in the fourth quarter a decrease of 12 basis points from the prior quarter, which is lower than expected, primarily due to a rising cost of funds. As you'll see in the last page of our earnings release, we saw our cost of funds rise across the board. Interest-bearing deposit costs increased 284% to 50 basis points. Money more market and savings deposit costs increased 248% to 139 basis points and short-term borrowings increased 59% to 382 basis points. Overall, the cost of our interest-bearing liabilities increased 120% to 145 basis points. We expected our liability costs to rise given our sensitivity, but the magnitude and speed were more dramatic given the competitive environment. Offsetting this increase purchase accounting accretion for the Metro deal impacted net interest margin positively by 10 basis points. Turning to Page 20. Over $1 billion or over 30% -- 37% of our loans are floating, as you can see at the top left of the slide. As you see, almost all of our variable loans are above their stated floors or have no floors. Now on the bottom left, you can see a waterfall for our net interest income and net interest margin. You'll see that impact of our liability sensitivity in the waterfall table. The net effect of asset and liability rate changes negatively impacted net interest income by 4.7%. As we disclosed in our last -- latest 10-Q, we are liability sensitive in the near term. In a plus 100 to 400 basis point scenario, we would expect our net interest income to be down 10% to 13% in the upcoming 12 months. Taking a step further, that means we have approximately a $12 million headwind embedded in our current balance sheet for 2023. However, due to recent balance sheet strategies and remixing we should see our net income growth resume after one year even when assuming no loan growth. While net interest income will contract in 2023 under a static balance sheet basis, I expect this coiled spring and net interest income to bounce back in 2024. On Page 21, I'll provide some highlights on our retirement business. AUM increased 5.1% due mainly to higher domestic bond and equity markets in the fourth quarter. Revenues were stable on a reported basis, but up 4.6% if you exclude onetime restatement fees, of $721,000 in the third quarter. This increase was in line with our expectations. Turning to Page 22, you can see highlights for our Wealth Management business. Revenues increased here by 6%, which was better than our expectations. AUM increased 4.2% from the prior quarter, mainly due to improved equity and bond markets again and also strong production. Turning to Page 23, I'll talk about our mortgage business. Mortgage revenues declined $1.6 million from the prior quarter due to lower originations as the environment remained challenged. Mortgage originations decreased approximately 45% from the prior quarter, while originations of $812 million for 2022 came in in line with our lowered expectations. As a reminder, the first quarter and fourth quarters of a calendar year are typically the weakest quarter for originations for us due to seasonality. Lastly, turning to Page 24 is an overview of our noninterest expense. During the quarter, noninterest expense decreased 11.3%, which was better than our original expectations of a mid-single-digit decline. Compensation expense declined mainly due to lower mortgage compensation from a decrease in mortgage originations. Our tech expense declined due to timing of new contracts, and we do not expect that benefit to occur again. Our efficiency ratio improved over 500 basis points to 69.6% and we achieved a positive operating leverage that was previously guided to. Before I provide guidance, I want to highlight again that due to our near-term liability sensitivity, we have some strong headwinds in 2023 for net interest income. We are making changes to reposition and remix the balance sheet. That will take some time, but the coiled spring that I referred to earlier will take shape in 2024 and beyond. When interest rates eventually stop rising and actually declined that coiled spring will only become more powerful given our current positioning. Now I'll provide some guidance for the first quarter and for 2023. For the first quarter, we expect the following: we expect net interest income to be done -- to be down high single digits. Our net interest margin should decline further as we expect the cost of funds increase led by the repricing of our index liabilities. Some of the increased interest expense will be offset by modest loan growth. On the fee income side, all segments will be heavily influenced by the macroeconomic landscape. While new business production has been strong in both wealth and retirement, revenues will be influenced by market conditions. More mortgage revenues will continue to be challenged as interest rates remain high and we are in a seasonally weaker quarter for originations. On a reported basis, we expect noninterest expenses to be stable relative to the fourth quarter. We have begun rightsizing our infrastructure while also adding some talent that Kate referred to help drive future revenue growth and deposit growth. We expect credit to remain benign in the first quarter. Now I will comment on some metrics for the full year 2023. As discussed previously, net interest income will be challenged due to our liability sensitivity where most of the challenge will come in the first half of the year. To offset some of the 10% to 13% decline or approximately $12 million pre-tax headwind embedded in our current balance sheet, we expect some modest loan growth and deposit growth. We continue to expect the mortgage business to be challenged as the Mortgage Bankers Association purchase index is forecasted to be down 8% to 9% in 2023. Excluding market impact, we do expect retirement fee income on a reported basis to be down a little due to the exiting of payroll, which had reported revenues of $1.4 million. As we reposition, remix, rightsize and add talent, we are focused on controlling expenses in 2023. 2023 will be a year when spring coils back but we remain confident that we will -- with all the strategic initiatives being put into place during the year that we will spring forward noticeably in 2024 and beyond. As that coiled spring jumps forward after the challenge had been absorbed in 2023, we will return to our strategic goals of achieving EPS growth of 10% or more and a 12% -- and an ROE of 12% or more. In 2024 and beyond, we expect continuous improvement in our efficiency ratio as we are laser-focused on investing in talent and infrastructure to make us more efficient in the way we operate, while continuing to offer a high-level service for our clients. Katy, you alluded to the number of hires that you've made in the last year have been significant. And just trying to get a sense for if growth slows in '23 and as roles have been filled is the hiring pace slow down? And I guess as that -- the second question of that is how that translates to the expense growth in '23. Maybe a question for Al on the second one. . Sure. Thanks, Jeff. In regards to the talent adds, we will continue to add professionals with expertise in our markets. We will balance that level of investment as we work through and reposition talent throughout the company in regards to the support side. And so from a -- Al can give guidance in regards to the expenses, but that's how we look at the talent additions. And in regards to growth, I will hand that off to... Thanks, Kate. This is Jim Collins. I will say that as we look at that talent that Katie just talked about, we're looking at focused talent and specialized verticals to bring that value add to our customer base. We will consistently look for adding that talent in all of our markets, but we're going to be a little picky, right? We're going to make sure we're adding the right team to us. We will offset that expense with expense saves or repositioning of different expenses already in the bank, but the intent is to harvest talent during this time when we can. Jeff, it's Al. So on the noninterest expense side, we are -- as I alluded to in our call, laser focused on continuous improvement on our infrastructure. We are looking on trying to achieve some expense saves this year, and we are looking to have that reported noninterest expense to be down slightly on a year-over-year basis, but a lot of that will be determined on the timing of those expense saves. As we also do trying to add town to, and that's going to be [indiscernible] as well. Yes. Just trying to -- I know that you kind of alluded to some Q4 maybe incrementally lower, but do we look at kind of full year close to $1.59, you're down slightly as -- is that a good number to think about for the full year, something inside of that number, absent maybe getting opportunistic hires in there? Okay. And then, Al, while I got you, the margin, just thinking about where that may trough. It sounds like further pressure in Q1, and you talked about the coiled spring thereafter. But trying to get a read on where that -- where you think that bellies out. Yes. That's a good question there, Jeff. So I said it's going to be in the first half. I'd say a good brunt of it will be felt in the first quarter, a little bit more in the second quarter, and then we're hoping to rebound from there. But again, a lot of the timing is going to come from the interest rate environment. So I feel comfortable saying that in the first half of the year and maybe the first quarter, we'll feel brunt of it and then a little bit less in the second quarter and then probably starting to rebound in the last -- in the second half of the year. Again, timing will be determined in the mid- midpoint of the year based on what the curve does. Appreciate it. One last one, just on the -- if it was modest, but I wanted to look at the nonaccrual drop anything of specific there? Was that just a miscellaneous, or was there one large loan that came back on accrual? Yes. Thank you. Good morning, everyone. Thank you for taking the questions. Just wanted to drill down into the outlook for this year. I appreciate your comments on is decline in the first quarter. I guess just kind of thinking further out, if we just get two more Fed hikes in the first half of this year, do you see kind of flattish growth after a presumable trough in the second quarter? Or are you guys kind of think about just NII growth prospects in the back of the year on pickup after being somewhat seasonally soft in the first quarter. Yes. So Jeff -- sorry, Nate, this is -- the timing of the -- we kind of gave the guidance already on the previous question in terms of our margin, and I'd say our NII is going to follow somewhat a similar cadence to a lot of that, though, too, will be influenced by the talent adds we've had and also the loan growth we're doing from our current team. So I would say right now, a good portion of that sensitivity, liability sensitivity will be felt in the first half of the year, which will impact that NII and then kind of gradually dissipate as we get through the year. So as we get through the first six months, I think you'll see those storm clouds on that liability sensitivity kind of starting to dissipate and then start turning to more bluebird guys, I would say, for us in the back half of the year. Okay. Great. And then just within that context, curious how you guys just kind of think about the overall balance sheet at from here. With some of the deposit runoff that we saw over the course of last year. Do you think that's largely brought us sports at this point and we can anticipate a more kind of stable average earning asset base relative to the level in 4Q? Nate, that's a question that's going to have -- we're going to have to see how the year goes because right now, the deposit environment is very competitive. I mean we've added talent right now and where we're very positive about right now and very excited about is that on the treasury management side. We're bringing its very experienced capabilities in our footprint. Maybe I'll switch it here to Jim in a second. But as we build out that treasury management and also our HLA capabilities, we think we can take market share out there because this is a -- they're bringing in a level of experience that is very high for us, and I'll switch over to Jim here. Thanks, Al. I'd make the comment that else right, the deposits, it's going to be hard to see what happens to our current deposits. We have a lot of commercial customers that are just going to use their deposits instead of taking on debt. But we are building out and continue to build out our team and bringing in experts in other verticals, such as repositioning one of our commercial executives into building out professional services, right? We'll focus -- have more focus on commercial deposit-focused bankers/wholesale deposit group. And we have the HOA group that we acquired in Arizona, middle of last year and looking at ways to leverage that to garnish more deposits and of course, building out and enhancing our private banking group, which harvests a lot of deposits. So it's a hard question to answer, but I think we're doing all the right things in order to build up our deposit base. And Nate, just to kind of clarify one last thing here in terms of our NII, if you think about the cadence here, hopefully, it troughed somewhere midyear, but we do expect our NII to start growing again in the back half of the year, especially in the fourth quarter. And I would say the same thing about our margin as well. And in the back half of this year, does that contemplate just a bit on pause you actually see some growth lift potential to Fed test rates just given the index deposits repricing lower? Maybe quicker than loans are pricing lower. . Okay. Helpful. And then maybe just turning to the income outside of mortgage. I would love to get your guys' updated thoughts on just kind of expectations for 2023 in terms of just overall kind of wealth management, RBMS revenue growth, assuming equity markets kind of stabilized, and we don't see much more valuation pressures from here with some of the initiatives that you guys are you're taking in terms of driving more durable kind of less market sensitivity within the business. Are you guys in growth in the segment year, again, assuming more stable equity markets this year? . I'll take that one, Nathan. Yes. The simple answer is yes. If everything stabilizes going forward with the additional focus that we've done with line of business in that group, along with our current product set and our long-standing initiatives that we have put in place with the wealth group, we plan for additional growth. 'm just going to also piggyback off of that to we did see record production in both our wealth and retirement business in 2022. And we expect those tailwinds from all the strong efforts from the teams in those segments to continue forward into 2023 as well. Okay. Great. And then maybe one last one for Katie. I would be curious to kind of get your updated thoughts on the acquisition landscape going forward. I mean at your lessons to bank deals to some at this point and maybe there's more of a focus on impairment platform augmentation, or just kind of any thoughts on what you're seeing in the landscape in those arenas. . Sure. Yes. So retirement benefits, fee income acquisition is always a high priority for us, consistently building the pipeline, networking, building relationships across those landscapes. On the banking side, we're obviously having great success in lifting out talent. And so that's where we're focused. But working on building partnerships and relationships across that network also. Okay. Great. And I'm sorry, if I could just ask one more just on kind of reserve outlook from here. I appreciate the guidance in terms of the CECL impact in the first quarter, but perhaps absent that -- is it fair to expect provisioning can be pretty negligible, just given you're still a fairly robust reserve level as a percent of loans and obviously a great coverage on NPLs as well. So just any kind of thoughts on reserve apart from just some impact in the first quarter from here? Sure, Nate. This is Karen. Yes, I think that characterization is accurate. Of course, with the switch to CECL, what's happening in the macro environment matters now that we're somewhat forecast dependent. So -- but certainly, we don't see anything early in the year that would cause me to think we're going to have volatility outside of those macroeconomic factors. Yes. That increase was the result of a downgrade of one commercial relationship. That client is experiencing some stress, which we believe to be temporary, and we are working with them as they improve their results in 2023. I have a few things for you. First thing is I want a little bit of clarification. You're kind of describing 2023 as maybe a bit of a write-off, nothing great is going to happen. It's all a year out from now. So with the margin, Were you saying that the margin -- so let's just focus on where you are at the end of the quarter at $309 okay. Is your margin going to trend much lower from here? Is it going to break 3%? And are your dollars of NII? I thought you said the dollars of NII are going to be lower in 2023 than 2022. Did I understand that correctly? Yes. So what we gave on the call, we said that using -- looking at a static balance sheet right now, embedded in that is a $12 million headwind. So if you take that into -- on a static balance sheet basis, you could probably calculate out the pressure on the margin there. The $12 million is based on our -- if you look at our ALM modeling that's disclosed on Page 62 of our 10-Q, you'll see that up 300 to 400 basis point scenario, it does decrease our NII, mainly due to repricing of our liabilities, which is going to be mainly our money market and interest-bearing deposits. Now also, too, what's impacting that now because of our increased borrowings to support our increased loan growth in our Arizona market, we have also increased borrowings, too. Okay. So you obviously like a number of banks. The core deposits were not exactly as maybe core deposits as everybody thought, given the big increase in the rate that you provided customers at least in the last quarter. So when I'm looking at your money market, primarily, that's the big chunk of it at the end of the day, is there much more? Is that number going to be hitting 2% next quarter? And I'm just trying to understand -- I understand the $12 million you're pointing to the 10-Q, that's fine, but there's a practical side of what really happens? And maybe you can talk a little bit about what is in your market. Who's been gaming the deposit side that's caused this kind of a headache for you. Maybe maybe you could talk a little bit about that and where you expect those deposit costs to go? Sure. I'll start. Thank you for the question. In regards to our core deposit franchise, exceptionally strong. Now they are long tenured relationships and they are also significant balances. So they absolutely have pricing -- some pricing power. And we are not going to lose core deposit clients. We've been very focused on building our core deposit franchise for decades. In regards to the money markets, certainly a portion of those relates to our synergistic deposits. They are indexed, they do reprice quarterly. As in regards to the total cost of funds for those, they knew servicing costs, of course, and they have no acquisition costs. So overall, although the rate is high, the total all-in cost of those deposits is fairly slow. Al, do you want to... Yes. And I'd just like to say, when you ask about where is it coming from the pressure, I'd like to just highlight when we look at community banks within our footprint, we have approximately 30 banks that have loan-to-deposit ratios in excess of 100-plus percent. So that's where the pricing pressure is coming from is those banks need liquidity in our deposit ratio -- loan-to-deposit ratio remains well below 100%, they're coming after our deposit base as well. So that's where the pressure has been coming from. Okay. So let me ask question, if I went on your website or walked into a branch right now, what would I be offered on a money market deposit account rate wise? . Yes. But that -- those are synergistic deposits that do not come out at the branch level. So they're coming from our retirement services side. Okay. Okay. So that's where you're having to pay up more for the deposits. Yes. Do you expect the NIB, the noninterest-bearing to you expect to continue to lose volume there? You made that comment about some of your commercial customers are drawing down their own liquidity as opposed to taking loans. Do you see more of a dent on that coming? I think that generally is a trend in the fourth quarter for all commercial clients as they're paying dividends or getting money out of the entities. I think it's Safe to say line utilization is a big question mark on what will happen in the rest of this year. It has creeped up towards the end of last year. But we have seen a lot of customers instead of taking a term note for a piece of equipment just using cash. So I think it could come down a little bit, but I don't think that's enough at this point that's going to be impactful. Okay. Let me just switch gears for a second. The mortgage banking business, obviously, unless something drastic happens in rates, it's not going to come back online anytime soon. The way you're operating that business now given where the revenue volume is it fair to say it is breakeven? Or are you losing money on it all in? . You are. Okay. That's good. And then last thing on the expense side, you talk about cuts and things like that. But if this revenue environment stays subdued for you or there's maybe more of a surprise with the margin, the model is what the model is, but the rubber hits the road with what your competitors do, right? You can't control that. To what extent do you see your comp line coming down at the operating level and at the executive management level this year. From an expense standpoint, we're doing the right things. We just completed a restructure. We eliminated several positions in the company. And -- but we're thoughtful, right? This company has run for the long term, and we are going to be opportunistic in adding talent where we can while thoughtfully repositioning the support to make sure that talent has even more capacity in the company. How -- Katy, how much -- or I guess, how far are you through that sort of plan to streamline more, maybe that's my own word, not yours in 2023. Are you right at the beginning of doing it? Are you mostly through it? I realize with Metro Phoenix, there was a lot of churn there and things you had to get through to the positive. But I assume you're talking more about the core bank outside of what happened with Metro Phoenix, the acquisition. So are you -- is this sort of a new step or are you halfway through it, do you think? A new step -- first step was here just a couple of weeks ago. And it really was restructuring the team to formalize the structure around our go-to-market strategy and so as we bring in experienced producers in their verticals. We have realigned the support side and dedicated support side to those team members so that our speed to market can improve as well as the client experience and again, just the overall capacity of those team members. Okay. And then just one last thing. The stock had a premium valuation on it for quite some time. That premium has come off quite a bit. And again, this is sort of like a financial metric, but is there anything you would consider on the stock buyback side if the stock stays weaker or not, repurchasing shares. We do have a current authorization out there, but we've been also watching making sure our capital levels are adequate because we also are aware that the investor base and stakeholders out there are very closely watching TCE. Yes. I would just add. I mean, everything we're -- all the steps we're taking are what fundamentally build value and creates value. So our balance sheet is not in the is in the position it's in, but we're doing the right things and taking the right steps, and I expect we'll return to that valuation. Just to make a last question around valuation. I mean the stock is down plus the 1.5 and book with where it's trading today. How are you guys thinking about buyback within the context of what I'll describe in terms of how your capital ratios are well both peers and so forth today? Right. So made. We do have an authorization out there. We are watching closely because we want to make sure that we manage that authorization to make sure that we don't also put us in a TCE position that people will be concerned about us. So we're carefully watching. But our stock is very cheap right now, and I'd love to be active in the market. But also, too, with the acquisitions we've done on the retirement side, we also have to make sure that our TCE doesn't cause concern as well. Right. Understood. And then can you just remind us in terms of how much of your deposit base effect to short-term rates. I don't think that's something we've talked a lot about in the past. . Nate, let me get back to you offline on that one. I just want to make sure I got the exact numbers for you on that one. Yes. Our tax rate has been on the lower side, we're expecting somewhere in the low 20s still. I think that's pretty fair to go forward. Quite a bit of fire in Broomstone in the tenor today. I get the modeling question, and I try to bring a little bit of levity to hear, but I'm just kind of thinking just I don't know, 10,000 or 100,000 foot view with the recent hires, which all have pretty solid pedigrees. And if you look at what you guys have done on the core bank, it seems like growth is solid or should be solid. You should not really have a credit risk. If you think philosophically, you could ever see spread revenue above fee income in terms of revenue generation. I think longer term, you guys have a charter clearly, and you're focusing on being a bank because of the lead for all your kind of flywheel type businesses across the income. Can I get the fee income kind of a market that gives you the results, i.e., mortgage and retirement to some degree. But when you just think bigger picture, a lot of the marquee hires have been in the bank, and that's clearly the focus. But is that just because that's the lowest hanging fruit? Or is that the easiest change? I'm just trying to figure out for the next two or three steps here in turn the ship around. Yes, sure, I'll take that. So strategically, as we've talked about, our wealth management, our retirement, our mortgage division has historically had strong performance. Within our Banking division, we know that scale is important and moving upmarket is important. We're in great markets. And so what we bring in terms of an opportunity for talented producers really resonates. They see a very -- an opportunity to be part of a very special growth story and do more with their client base. And so we have had great success in building the expertise within the banking franchise so far. We intend to keep going. And I do anticipate that you will see our mix of revenue start to trend towards the banking and side, but we will always be focused on being a diversified company with high levels of fee income. Okay. Fair enough. And then being that your fee income strategies are more diversified than your branch footprint, I guess, you could say about like kind of the Denver area. When you think on production? Do you think there's LPO opportunities that don't necessarily carry the overall cost of a branch network extension. [Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Katie Lorenson for any closing remarks. . Before we go closing remarks, I just want to provide one answer that Nate adds on the call. About 15% of our total deposit base is directly indexed to short-term money from market rates. So with that, I'd like to turn it over now to Katie. All right. Thank you, Al. Thank you for joining the call today. Thank you for the question. 2023 is a pivotal year for Alerus. The work we are doing this year will set the stage for Alerus to return to high-performing return ratios in 2024 and beyond. Our enviable diversified business model with industry-leading recurring fee income, strong core deposit franchise with access to synergistic deposits robust reserves and regulatory capital and historically strong asset quality position our company well for attracting and retaining talent and growing our client base. We are committed to constant improvement throughout our company and expect to see continuous improvement in our efficiency ratio and return metrics. As the balance sheet headwinds subside in 2024 and beyond, we believe the work we are doing on the fundamentals and the power health of professionals of experienced bankers and producers. We are bringing into the company will be catalysts for the long-term value we are creating for our shareholders. I want to thank our Alerus team members for all they do, and thank you all of our shareholders for your investment in our company. Thank you all for joining our call today.
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EarningCall_1209
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Ladies and gentlemen, thank you for standing by. Welcome to Qualtrics Fourth Quarter and Fiscal Year 2022 Earnings Call. [Operator Instructions]. Please be advised that today's conference is being recorded. Thank you, operator. Welcome to Qualtrics fourth quarter and fiscal 2022 earnings conference call. On the call, we have Zig Serafin, CEO; Chris Beckstead, President; and Rob Bachman, CFO. Following prepared remarks, we will open the line up to answer your questions. Our results, press release and a replay of today's call can be found in the Qualtrics Investor Relations website. During today's call, we will make statements that represent our expectations and beliefs concerning future events that may be considered forward-looking under federal securities laws. These statements reflect our views only as of today and should not be relied upon as representative of our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations. For a further discussion of the material risks and other important factors that could affect our financial results, please refer to our filing with the SEC including our annual report on Form 10-K for the quarter and fiscal year ended December 31, 2022, that will be filed with the SEC. Thank you, Rodney, and thank you all for joining. Q4 was a solid quarter, capping off a very strong year of growth and operating margin improvement. Revenue in the quarter was $389.1 million, up 23% year-over-year. And subscription revenue was $327.6 million up 26% year-over-year. 2022 annual revenue was $1.46 billion, which represents 36% annual growth. Our current remaining performance obligations grew to $1.2 billion at the close of the quarter and total remaining performance obligations grew to $2.17 billion. As customers around the world continue to grow their investments in Qualtrics and commit to multiyear deals. I've mentioned before that we're building a generational business, focused both on growth and profitability. And I'm pleased that we delivered Q4 non-GAAP operating margin 6.1%, up from breakeven in Q4 of last year. Looking ahead, we're more committed than ever to helping our customers realize even greater value from the Qualtrics platform while focusing on both revenue growth and margin expansion. We believe that macroeconomic challenges will persist through 2023. This is reflected in our guidance as well as our focus on operating with discipline in 2023. We're initiating full year 2023 revenue guidance of $1.665 billion at the midpoint of the range, representing 14% year-over-year growth and Q1 total revenue of $392 million to $394 million, representing 17% growth at the midpoint. And importantly, we expect more than double our full year 2023 non-GAAP operating margin at 10.5% at the midpoint, which is an increase of 650 basis points from last year. We finished the year with more than 18,750 customers as organizations invest in Qualtrics for our proven leadership platform capabilities and innovation road map. The number of customers spending more than $100,000 with Qualtrics annually increased by 17%. And the number of customers spending more than $1 million annually increased 32% year-over-year. While we continue to see increased scrutiny of deals in Q4, our win rates remained strong. And our existing customers continue to invest in Qualtrics, which you can see in our 120% net retention rate. The Qualtrics platform is becoming central to how organizations make mission-critical customer and employee decisions and drive automated actions to protect their revenue, increase efficiency and improve their operations. We help them quickly identify and resolve points of friction across all digital and human touch points. And that makes our business resilient even in times of macroeconomic uncertainty. In Q4, market leaders like Delta Airlines Principal Financial, Roche, Bridgestone, Farmers Insurance and Quanta grew their investments in Qualtrics because they understand the value of truly knowing their customers and employees so they can make the right decisions and take the right actions for them. And I couldn't be more excited about our expansion with the BMW Group. BMW is focused on customer-centric innovation, and we're proud to be their experience management partner. We're working with them to manage every aspect of the customer experience, from how people build and order their vehicles online to test drive at the dealerships, to service management for owners. With Qualtrics, they can bring all of their experience data together on a single platform to create a seamless experience across these channels. They'll be able to identify issues faster and intervene in the moment. And this will help the BMW Group deliver more connected, holistic and personal experiences, building deeper relationships with their customers at every turn. Another customer that continues to invest across the Qualtrics product line is Young Brands. In Q4, they expanded in both customer experience and employee experience for KFC. At a time when frontline employees are in short supply, KFC will use Qualtrics Discover, engage and social connect to rapidly collect and analyze millions of data points across 27,000 restaurants. And they'll be able to enhance the ordering and delivery experience across the network and give operators a real-time view of employee and guest feedback. So franchisees can take immediate action to improve experiences on the ground. On the product. We're leading the next wave of innovation and experience management with purpose-built solutions that help our customers do more with less for their customers and employees. As the leader in XM, we have a vast universe of experience data, advanced AI and analytics and a system of action that gives us and our customers a competitive advantage. In fact, in Q4, we passed a major milestone, doubling in 1 year to 10 billion Experience IDs on the XM platform. Experience ID captures structured feed bed across every touch point of the customer journey as well as unstructured feedback like effort, emotion and intent. We build this into a rich profile that allows customers to know their customers like never before and then take the right action at the right time. Together, these Experience IDs form the largest database of human sentiment in the world. We're the only ones with this technology, and it makes the Qualtrics platform incredibly sticky for our customers. Now I'd like to highlight a few new innovations from the quarter. We launched CrossXM, a new innovation that enables leaders to see how their employee, customer and brand experiences impact one another with just a few clicks. For example, CrossXM reveals how key employee metrics such as manager support, career development and recognition directly impact customer outcomes. So leaders can focus on initiatives that will drive their highest value. Qualtrics is the only company that manages these experiences together on a single platform. For customer, service is the number 1 reason customers switch brands. And in Q4, we delivered new contact center innovations, including real-time agent assist and automated call summaries, to increase agent productivity, drive operational efficiency and improve customer service. Real-time agent assist uses advanced AI to analyze the support conversation while it's happening and to deliver real-time informed recommendations and automated call summaries deliver instant call recaps like capturing all of the relevant details of the customer support call, including sentiment like confusion or frustration that only Qualtrics can discover, and then trigger what needs to happen next. In employee experience, we launched Manager Assist, which gives every manager of the data and the tools that they need to increase productivity to reduce unwanted attrition. Manager assist brings sophisticated analytics to employee feedback, including engagement survey data as well as insights into feedback that they're sharing on Slack and Help Desk conversations and even social sites like Glassdoor. A great example of the value of employee experience in this environment is the new relationship that we form with Qualcomm. Qualcomm is intensely focused on making the right investments in 2023, and they standardize on Qualtrics Employee XM replacing their stand-alone engagement systems. Now Qualcomm will be able to look at feedback holistically across the organization to identify high-impact actions that build confidence in the future of the company and improve both engagement and retention. In March, you're going to have a chance to see these and other latest innovations and be with thousands of our customers live in person at X4 in Salt Lake City, and we hope you're going to be able to join us. Our ecosystem continues to be a key contributor to our growth. We have more than 400 partners in our network creating unique IP by leveraging the Qualtrics developer platform. And we continue to strengthen our strategic partnerships and work together to solve our customers' most pressing challenges. In the quarter, Qualtrics and ServiceNow jointly closed a multimillion dollar deal with a Fortune 500 energy company. This company is going to bring together ServiceNow's customer service management with Qualtrics customer XM Discover, to give service agents the tools that they need to automatically trigger actions based on feedback, uncover drivers for customer satisfaction and to improve their cost to serve. The XM platform is the system of action and is growing around workflow integrations like this across critical systems such as SAP, Microsoft, AWS and ServiceNow. And these workflows continue to deliver increasing value for our customers. The number of customers using 5 or more Qualtrics' workflow integrations more than doubled in Q4 compared to the year before. In closing, we continue to manage for long-term durable growth. And you're going to see that in our strong net retention rate, our growing customer base and the number of customers that are spending $100,000 or more. We've been actively realigning our resources to the highest priorities of our business with an eye on both growth and efficiency. And as part of that, earlier this month, we made the difficult decision to eliminate approximately 270 roles globally across the company, which is less than 5% of our workforce. The decision was made after careful consideration, especially for those that are leaving. And our priority is to support them in what's next -- and whether that's a new role of Qualtrics or outside the company. Demand and loyalty from customers remain strong, which is going to give us an opportunity to accelerate our growth in an economic recovery. I'm proud of our team who continue to demonstrate their ability to adapt to dynamic markets and the changing customer needs in the marketplace. And of course, I'm grateful for our customers and our partners for putting their trust and Qualtrics. Thanks, Zig, and good afternoon, everyone. As Zig said, we generated solid growth and profitability in the fourth quarter. Total revenue was $389.1 million in the fourth quarter, up 23% year-over-year. Subscription revenue was $327.8 million, up 26% year-over-year. Professional services and other revenue was $61.5 million, representing 8% growth year-over-year. Our remaining performance obligations representing all future revenue under contract ended the quarter at $2.174 billion, up 25% year-over-year. This metric includes both new and renewal software contracts, along with our professional services business. For reference, Q4 2021 RPO included an opening balance of $130 million related to the Clarabridge acquisition. Current remaining performance obligations, which is all future revenue under contract that is expected to be recognized as revenue in the next 12 months was $1.202 billion, up 19% year-over-year. For reference, Q4 2021 current remaining performance obligations included an opening balance of approximately $78 million resulting from the Clarabridge acquisition. Fourth quarter calculated billings were $571.6 million, up 11% year-over-year. As a reminder, Q4 2021 deferred revenue included an opening balance of $36 million related to the Clarabridge acquisition. FX movements resulted in a headwind of just over $13 million or approximately 2.5 percentage points of growth to calculated billings in the fourth quarter. Fourth quarter subscription billings grew 14% on a reported basis and 17% on a constant currency basis. Our XM platform is mission-critical for customers in these uncertain times as demonstrated by our net retention rate of 120%, while gross retention remained consistent with historic levels. Q4 marked the first quarter Clarabridge began to contribute to our net retention rate, and its impact was consistent with our net retention rate for the quarter. Given we calculate net retention rate on a trailing 12-month basis, Clarabridge subscription revenue will continue to layer into our net retention rate calculation over the next 3 quarters. We ended 2022 with more than 18,750 customers an increase of approximately 2,000 compared to year-end 2021. customers spending more than $100,000 in annual recurring revenue grew 17%, year-over-year to 2,262 customers, and we finished the year with 189 customers spending more than $1 million annually, up from 143 at the end of 2021. Turning to margins. Our Q4 non-GAAP gross margin was 75.9%, down slightly versus the prior quarter, while non-GAAP subscription gross margin of 87.5% was consistent with the prior quarter. Our non-GAAP operating profit for the third quarter was $23.9 million, resulting in a non-GAAP operating margin of 6.1% compared to 0.1% and in Q4 of 2021. The increase in our fourth quarter operating margin reflects our slowed pace of hiring and ongoing investment discipline as we focus on durable and efficient growth. Operating cash flow for the fourth quarter was $23.9 million compared to $13.7 million in the year ago period. Free cash flow in the quarter was $8.9 million compared to negative $60.4 million in Q4 of 2021. As a reminder, free cash flow may fluctuate on a quarterly basis due to the timing of cash collections, and we believe it's best to assess our cash flow performance over an annual cycle, given the billing seasonality in our business. We ended the quarter in a strong cash position with approximately $720 million in cash and cash equivalents and no debt. Moving now to our Q1 and fiscal year 2023 business outlook. We are focused on delivering durable, efficient revenue growth despite what we believe will be a challenging macroeconomic environment throughout 2023. We are streamlining our go-to-market, including leveraging our partner ecosystem for both business development and services fulfillment. We see strong retention, growing pipeline and strong win rates across our business. This combination at our size and scale enables us to take share during macroeconomic uncertainty while driving significant operating leverage. These factors are reflected in our Q1 and 2023 guidance. We expect total revenue for the first quarter to be $392 million to $394 million, representing 17% year-over-year growth at the midpoint. Within this, we expect subscription revenue to be in the range of $333 million to $335 million, representing 19% year-over-year at the midpoint. We expect Q1 non-GAAP operating margin in the range of 4% to 5%. As a reminder, we are excited to be holding our X4 Summit in March, and our guidance reflects an anticipated margin impact of approximately 350 basis points related to X4 in the quarter. We expect non-GAAP net income per share of $0.01 to $0.02, assuming 605 million weighted shares outstanding. We expect to incur approximately $5.8 million in onetime expenses associated with our reduction in force. The majority of these expenses will be incurred in the first quarter. For fiscal year 2023, we expect total revenue in the range of $1.661 billion to $1.69 billion and subscription revenue in the range of $1.406 billion to $1.414 billion. At the midpoint of the ranges, this represents subscription revenue growth of 15% year-over-year and total revenue growth of 14% year-over-year, respectively. We expect non-GAAP operating margin in the range of 10% to 11%, implying 650 basis points of expansion at the midpoint, and we expect free cash flow margin to move more in line with non-GAAP operating margin for the full year. We expect non-GAAP net income per share between $0.20 and $0.24 assuming 625 million weighted shares outstanding. As we begin 2023, I'd like to echo Zig and thank all of our employees and partners for their continued hard work and for our customers who continue to recognize Qualtrics as the clear category leader in experience management. We are in a strong position to take market share while delivering long-term durable growth through a challenging macroeconomic environment and to leverage our leading platform, size and scale to accelerate growth when the macroeconomic environment stabilizes. We're thrilled to be bringing X4 back in person this year, and we're looking forward to seeing many of you in Salt Lake City in March. This is Elizabeth on for Keith. You mentioned deal scrutiny continued into Q4. And I was wondering if you could provide any color on just the changes you saw in particular, around yield scrutiny over the last 3 months? And I'm curious if -- there's an opportunity to see some improvement in just the willingness to spend. Now that 2023 budgets are a little bit more firmed up and companies can get a bit more transparency on their go-forward plans. This is Chris Beckstead. I think what we saw in Q4 was pretty consistent with what we saw in the latter half of the year for 2022 and pretty broadly geographically overall. Inside of that, we saw continued strength in our win rates, especially from a competitive perspective. And so we felt like we continue to be very well positioned. With regards to entering the new year, we just got done with our field kickoff this week. And the field is excited to get off to a strong start for 2023. And it's early days in terms of what's going to happen with new budgets, but we're excited and motivated and driven to go after and make 2023 a great year. Look, let me add a little bit, Elizabeth. This is Zig here. I mean, first off, no one's immune to what we're seeing in the marketplace, but there's also been a continuation, as Chris said, of just the general pattern of people exercising more scrutiny, deal cycles extending. And so that's been something that we've talked about. But we believe that we're faring better than others because of the value of the platform, particularly right now where companies are honing in on technology and solutions that affect the way that they can drive performance in their own companies, things like how to drive revenue with customers, understanding what's most important, how do you take the right actions in the right places, while at the same time, finding ways to be able to save costs and operate more efficiently. And we happen to hone into areas that are at the intersection of those points, given the way that we've designed our platform. And it is why we continue to see demand remaining strong in spite of the fact that you see elongated deal cycles. So that's the additional context. Great. And I just wanted to quickly follow up on your comments about Clarabridge discover in the NRR, which ticked down from last quarter. Is the comment there that wasn't a benefit in the quarter. And since that's a trailing 12-month metric, we should -- it should layer in over time. Just trying to think directionally, is Q4 kind of the bottom or NRR? Yes, the comment relative to ClearBridge is that the NRR that it added coming in for this first quarter was consistent with the 120% that we represent that we recorded. Certainly, as we continue through the macroeconomic challenging time, you could see the NRR continuing to decrease until there's more stability. And consistent with the comments I made in my prepared remarks, when macroeconomic times stabilize, we believe there is a very clear opportunity for us to reaccelerate where we're at growth profile. Rob, I wanted to ask about how you thought about the cadence of subscription revenue growth in 2023? I heard Chris talking about macro environment being consistent. And then I look at the subscription guidance implying a decel from 19% to 15% for the full year. So are you assuming that the macro environment gets worse? Maybe just a little more detail underpinning how you thought about linearity this year. Yes. I think part of the question, Gabriela, is relative to the guidance, right, for the full year. And consistent with our guidance philosophy and methodology, we believe that it's good to be prudent with how we guide for the full year, and our guidance takes into account a persistence of those macroeconomic challenges that we're seeing. So Q1 is here and upon us. And so that guide is closer to us. And then as we look at the full year, there's certainly, again, some prudence in that guidance for the full year. Okay. And for Chris, I appreciate the comments on leaning on partnerships in the channel. Give us a little more detail on how you're executing on efficiencies in sales and marketing without potentially compromising the deal pipeline? Yes, great question. As you see in our operating margin [indiscernible] our performance in 2022, we are seeing the leverage we expect from our business model, including the sales and marketing costs coming down as a percentage of revenue. One of the big changes for 2023 as we finished fully integrating Clarabridge, including from a go-to-market perspective. And so we've integrated the Clarabridge sellers in with our customer experience sellers and brought that together so that they're both able to carry the full bag and run independently in a more efficient way. And then as -- we set up our structure in a way that as we continue to scale the business and continue to grow based upon the unit economics, we see continued opportunity to improve our sales and marketing as a percentage of revenue based upon that business model. And so we're set up to scale and continue to have that support our long-term profitability objectives through continuing efficiency in sales and marketing. Part of what also is important to note, we've talked about this before, is the nature of how we built our platform and the ability to efficiently expand into new use cases and how that then nicely ties in with the way that the sales force is starting to scale. And so that, frankly, is one of the innate capabilities of the company's business model and how that nicely ties in with the way the technology has been designed in the first place. I just wanted to touch on the $100,000 and $1 million customers. It seems like there was a pretty big tick up in Q4. Can you maybe just talk about how the business performed in Q4 in enterprise relative to some of your other segments, mid-market and SMB? And was Clarabridge or XM Discover, was that a part of the contributor to the big jump in large customers this quarter? Yes, thanks. In terms of looking at the business in Q4, in particular, we did see the macroeconomic challenges across the board. We did have some great examples of strong execution, especially with upselling, as Zig talked about in terms of some of the examples he gave of customers that are using the platform that have continued to expand and continue to bet on both customer experience and employee experience. So I think that upsell and strength with our existing customer base helped as that metric reflects both new customers but also customers that expand into larger organizations into the $100,000 plus customers as well as the $1 million plus customers. We also saw strong execution internationally. Zig gave the example of BMW that we are really pleased with that example. And so I'd say nothing particular to point out other than we feel like we're executing relatively well in the current challenging environment we have overall, and our existing customers continue to grow and expand. I want to add to that just for a second. I mean, one of the characteristics of this business is the fact that we have strength in the enterprise. We also have strength in the mid-market, and we're diversified across many different industries. And that plays in nicely as you go through the ebbs and flows of the economic cycles. And that will also act as fuel to the way that we manage and grow the business towards some of the long-term growth objectives that we have. So the markers that we highlighted, a $1 million-plus customers, $100,000 plus are very much in tune with some of the milestones and objectives we set for ourselves of where we want to be growing the business as people take more and more advantage of capabilities that are built into the platform. And so we think that is an important signal an indicator for how we're building the business. And frankly, experience management overall is growing as a category. And if I can ask on some of the innovation that you have in the contact center offerings. It seems pretty exciting, especially the real-time agent assist. Does that change the core buyer and from the rest of the Qualtrics platform? And what does that mean for your go-to-market motion? It's nice about it. And yes, they are exciting new innovations, but what's nice about it is it naturally extends on the set of buyers that are already working with us. One of the beautiful things about our technology is using the ability to reason on the data, create insights that are highly actionable. And now what we're doing is we're taking the additional next step, which is to create purpose-built solutions that create highly efficient actions at high -- that create high level of value for customers. And I think the one you pointed out Real-time Agent Assist is one of several examples. But again, back to the core of your question, which is it extends on the buyer universe we're working with. However, also expands the budget pool that we can be working with. And it actually fuels the consolidation of larger sets of budgets that are coming our way that are uniquely tied to the nature of the intelligence in our system. This is actually Peter Burkly on for Kirk. So Zig, I appreciate your comments on the macro. Just curious, what would have to happen to see sort of reacceleration in your business over the course of the year relative to your current expectations? Like are there any verticals or regions or perhaps use cases that you would call out there holding up better today or worse? Well, look, it's a good question, but -- and I'll let Chris expand on this if he has any additional comments. But one thing is important to keep in mind is that we continue to see demand grow for our technology. And in fact, the nature of what we're doing, there are more strategic decisions that are being made around the use of our platform, and that's informing larger budget pools that are becoming available to the types of solutions that we can end up providing and often far more effectively than pre-existing legacy systems who might be using or even service-oriented-type solutions that they might have put together. So demand continues to grow, right? Now we also have highlighted the fact that we're seeing deal cycles extend. There's more scrutiny, more process, that's quite consistent across many different technology universes. So part of your question is, you would actually see that speed up effectively, right? And it would be done consistently across geographies and frankly, across different industries. So Chris, do you want to add anything? Yes. The only thing I'd add is from an industry perspective, high tech has been an area, I think it's been well documented. It's been challenging with a lot of conservatism built in, especially in the U.S. So we're anticipating that to continue to be challenging. But if that were to improve, that could also help us improve our results as well from an industry perspective. But as Zig pointed out earlier, one of the beautiful things about Qualtrics is we're diversified, right? We fell into health care, we saw in the public sector and a variety of places. And so we feel like we're positioned to -- regardless of what happens, to do relatively well. That's really helpful. Maybe just a quick one for you, Rob. You guys have all taken a pretty thoughtful approach just in terms of discussing your ability to perhaps deliver more margin upside if growth were to see some pressure given the macro. And I think your fiscal '23 guide sort of kind of reflects that reality. So just curious how you guys are thinking about that balance today and what leverage you're finding in the business to drive those higher margins? Yes. Chris talked about some of those earlier in terms of the sales efficiencies that we're seeing. This is something very important that I want to emphasize again. We are operating from a position of strength given our size, our scale and our category leadership we have the ability to continue to deliver durable top line growth while also delivering the margin improvement. So really pleased to see how we're moving that margin up in the current year up to our guide between 10% and 11%. But I would also emphasize that, that is a step along the way in our margin expansion and would reiterate our long-term targets for fiscal year 2026, where we'll achieve over 20% operating margin and over 25% free cash flow. I'll just add to that, and we've said this before, but it's always worth repeating. We see significant margins in this business, and a lot of that ties in with the long-term margin targets that we've set out. And you're seeing evidence of our progress against that given the sequential quarter-to-quarter margin improvements that we've been making. And it's a big focus. We believe that our responsibility is to be strong business operators. We're committed to doing that both on the top and the bottom line. That's the making of a great business. This is [indiscernible] on for Mark Murphy. Just a quick question on -- you guys have referenced elongation in scrutiny a couple of times now. Are you guys seeing anything in the way of deal compression or people selling projects kind of indefinitely? Or has it just been contained to that elongation? Definitely, it's more on the elongation as we're working through deals. We're consistently finding that there's additional levels of approval that our customers are needed to additional buy and across different organizations, whether it's procurement or the CFO or whatever. And what we're hearing from our buyers themselves is that they are very interested in the Qualtrics platform, and they're wanting to move forward. And we're working to help provide the material to be able to coach through and get through that process. But it's just taking longer and additional scrutiny that's driving the longer one. But we're not seeing a change to our win rates, for example, as a result of that. And we're also not seeing a change in share gains that we're making as well, which is really important, both in expanding and consolidating as well as net new customers that are coming our way, which is reflected in the update on the total number of customers. Got it. And one thing that you guys have talked around a little bit. But are your customers finding new applications for CX or EX any for products as their priorities have changed from kind of growth to more balanced approach to a little more caution? Or is it maybe new departments that are coming up that didn't maybe 6 months ago? No. What we're seeing is people really honing in on the purpose-built use cases we've developed, a lot of that ties in with the themes around how we help companies drive revenue and how we actually create cost efficiencies for them. And what we found is that people are prioritizing our platform. And the way that we can play a role to achieve those objectives at scale where you can see material benefits to their companies, especially at a time where you've got to make the right choices and where you're going to spend your money. And the way we've designed our platform happens to actually help to hone in on the higher priorities that exist in some of these buying centers. I guess I'll start off with one for Chris. I know you talked a little about sales kickoff. Just how are you guys thinking about evolving the go-to-market strategy given the macro, both across all of your solutions, but in particular, with XM Discover given that solution traditionally has been a longer and more heavier sales cycle. Yes. So no major change to our sales strategy other than what I indicated earlier, which is that where you're now into the Clarabridge acquisition that enables us to be able to merge in essence, the Clarabridge sales organization with our existing CX sales organization. And that's a great opportunity for both efficiency and also great for our customers because now we have a single seller who can sell the combined solution, which is also how we've designed our product portfolio is to have a single overall customer experience solution across both engage and discover as well as some of the other innovations that we've talked about that are coming out. And we believe that model will drive efficiency with a single sales organization focused on driving that and seeing some great gains there. Like the thing I'll comment at the top is Discover and our Engage capability, those are platform-level technologies. And they are now showing up in a variety of applications that are built on top of our platform. And they then materialize as product capabilities that buying centers can efficiently procure to solve real business problems that they want to go after, right? So we're making it easier and much more convenient for how companies can take advantage of solutions that are designed specific to those opportunities in the marketplace. Super helpful. Just following up one for Rob. You've always talked about seasonality of billings and RPO becoming more back-end loaded with the inclusion of Clarabridge among other factors. Obviously, today, you're running into a more difficult macro. So I guess in the context of deal cycles lengthening from 4Q, how do we think about the seasonality of billings into fiscal '23, in particular for 1Q? Yes. I think as we've talked about the challenges that we're seeing, which I think a lot of the market and the technology world is seeing with the additional scrutiny and bill cycle lengthening is not new to Q4. We've seen that for the majority of we saw that for the majority of 2022, and we expect that to persist into 2023. So given that, there's nothing that I would call out in terms of changes in the seasonality if those things persist, then we would presume that the seasonality would stay fairly similar to what we saw in 2022. Chris and Rob, 2 questions for me. First one, and I don't know if this is for you, Zig or Chris, but you were talking about ServiceNow, so maybe I'll point it at you, but whoever wants to go out and go for it. I like hearing about the multimillion-dollar deal. What I'm curious about with ServiceNow. And I think last quarter, you all talked about being a top 5 marketplace seller in AWS and then SAP. If we could look at those 3, where are we terms of the resources really being up to speed? They know the game plan. They have their marching orders. And how much are you starting to mature actually pipeline activity versus maybe more opportunistic early on type stuff? I'm trying to understand if we could hear more of this kind of resonating each and every passing quarter as there's more pattern recognition with either of those 3 partners? And then I had a follow-up for Rob. Okay. Yes. So I'll start, and Chris can add. I mean, first off, it's really important to point out the power of the ecosystem that's being built around our platform and both on how partners build off of our platform from a software integration and innovation standpoint as well as how partners construct solutions and build services that unlocked value on specific business opportunities or business problems that customers are working on. And so companies like E&Y, for example, in the way that they end up constructing solutions that might tie in with business transformations that their customers are working on. I think we're in very early stages as a company. We're very focused on ecosystem. But frankly, relative to the opportunity that we have ahead. We're taking measure approaches. We're focused. We've got milestones. There's objectives, there's accountability, but we're in very early stages of the opportunity that we see ahead. And we think that, that will materialize both in market opportunity, pipeline growth as well as in efficiency and leverage that we get for the business model as the larger ecosystem and constructing and building solutions around the system, as I have just described. You pointed out ServiceNow, that's a beautiful example. I think we're in the early stages, but I think that there's really good indication that we're on the things that. We'll have a lot of other customers that will want to go and replicate and they come both in small, medium and large opportunities. And we've pointed out one example in what I described during the earnings call as well. So thanks, Terry. What's your next question? Sure. Itâs for Rob. In terms of â somebody already asked about seasonality for billings, so I wonât ask that. But Rob, I mean, should we think about 120% is like the flag in the ground in terms of the NRR as we progress through â23? Or is there some cushion actually kind of how youâve put your forecast together and maybe it could actually be a little bit below that? Just a little bit more on that. Yes. I think it definitely could drop below that 120%. And given where weâre seeing the business and the growth and the guidance that weâve provided, I think thatâs natural to understand on the subscription revenue growth. Weâre guiding at 15% at the midpoint. So you would expect in line with that, the NRR to come down some, but it will continue to be a key part of how we grow this business is with our existing customer base, and we continue to see significant opportunity for expansion and cross-sell with that customer base. This is Luke on for DJ. So given employee experience with such a hot area of investment during what has been a really seeded job market over the last year, with things finally softening in the labor market? I'm curious to what degree you've seen a change in maybe the urgency or priority of adoption around that solution relative to the rest of your offerings, if at all? Yes. So I think it's really important to recognize that it's not one solution, it's a portfolio of applications that are designed around the employee life cycle from everything from the onboarding experience of new employees to transition that happens all the way through to understanding the well-being and things that actually drive performance and impact. And that's really important is that because we have a large portfolio, we're able to orchestrate the right combination of applications for problems that customers are looking to solve. In addition, though, it's really important to understand that they are built on the same platform that our customer experience, product experience and brand experience-related solutions are built on. And as a result, we're innovating. I mentioned one of the new innovations called CrossXM. And CrossXM is a very unique system because of the ability to be able to understand correlation that takes place between what is happening with an employee base and the impact its having on customer-facing performance metrics within the business. If you look at Yum! Brands and what they're doing with KFC, they're trusting Qualtrics as a sole platform for employee experience and customer experience across 27,000 restaurants, leveraging the capabilities that we built at that intersection. And we're seeing a lot of that. And so it plays in nicely in the advantages regardless of what timing customers might take to fully realizing all of the capabilities. But because you can unlock off that same system, turn it on, it actually helps to drive a desire to leverage Qualtrics strategically. And over time, turn on additional solutions as necessary. So we're seeing employee experience far well in the marketplace, given the nature of how it tunes into the things that companies are paying attention to. The other interesting statistic, there's a recent LinkedIn reports that came out. It shows the fastest-growing roles within companies. And it was interesting, we noted that 3 of the 5 fastest-growing roles are employee experience-specific roles. And they're roles that have to do with solutions that we've built for them. So that's another interesting indicator of just trends that we think are tuned in really well with the way that we've been innovating and creating value and partnering with customers. That's great and very helpful. And then just maybe one for Rob. And it's been talked about a lot already, but just thinking about your NRR of 120% in the context of your 15% subscription growth next year, do you see maybe that growing as a percentage of the overall growth mix sort of that existing customer base contribution? Yes. It's something we've talked about in terms of where we're seeing more impact from the macro is relative to landing those new logos. And so when you think about going forward, there is certainly the potential that a larger portion of our growth comes from the existing customer base for a period of time, but that's also, we believe, gives a lot of opportunity as the macro stabilizes for us to then go and increase the customer base along the way. Certainly, the growth will continue to come from both places. You see that in the total number of customers increasing this year. But as a percentage of the total for the, let's call it, the near term, you could see the existing customer base become a slightly larger part of the overall growth. I had a quick question just to make sure I was understanding the billings number correctly. So I'm taking out the Clarabridge portion out of last year's Q4, is that correct? Yes. And then if I do the same thing for CRPO when I look at current bookings, I'm taking out $78 million from last year's Q4 CRPO. Is that also correct? Okay. And then just to get -- is it like possible to give like the -- how much of it was currency impacted for current bookings? I know you guys gave it for subscription billings. Yes. The overall impact is about that 2.5 percentage points of growth, and that's for the total billings. That is almost entirely subscription billings. But -- so you could think of them as one and the same in terms of the FX impact. Okay. Got it. And then just last question on these. Can you explain like the delta between CRPO growth and the total RPO growth? Yes, the CRPO growth is the current. So as we continue to do multiyear deals that have 2 or 3 years or maybe longer under total contract you can see the CRPO -- the RPO, which is all revenue under contract grow faster than the CRPO in any given period. It's a question on your customer conversations. It's either for Chris or Zig. I guess it's relating towards your expansion opportunities and activities. You're talking about, clearly, you're seeing more deal scrutiny is elongated cycle like everyone is seeing. My question is, what is underlying that? If I -- how much of the scrutiny is related to customers absorbing what the maybe had previously spent on Qualtrics and what they had bought versus what your customers are seeing in terms of demand changes to their own business? Yes. I would say it's not customers absorbing. We have great adoption and usage and renewal rates from our using customers. I think it's more of the customers themselves and their scrutiny themselves in terms of their financials and spending money and putting in additional controls and looking at, especially for new programs of looking at that and having additional approvals or CFO looking at those types of things. And so when our buyers are going in there and they're interested in expanding a program, it's harder to get things out internally within our customer base, and they've got to go through additional approvals to get it done. So I don't think it's reflective of them absorbing what they've already purchased from us. It's more a matter of internal budget approvals within our customer base themselves. Can I ask you one follow-up? Can you comment or share with us the terms that you're seeing with the top of the funnel activity? Lots of comments on -- we understand what's going on with the cycles. But what are you seeing in the very early stages. How is the top of the funnel trending compared to what you've seen in prior quarters? Awesome question. As Zig mentioned earlier, demand remains really strong for our platform and program for our customers that continue to put this as a priority area of spend. And we're entering this year with significantly stronger pipeline that we entered last year overall. And so that has us as excited, and is it's positive signal that this is an area of prioritization of spend across all of the solutions that we have overall. And so that's real positive. We had a real focus on continuing to expand our pipeline development, even seek out opportunities, and that's borne fruits. So we see that positive signal at the same time, as we've discussed, we do continue to expect this deal scrutiny to persist. And so we're just uncertain on the timing of the conversion of that pipeline. But the pipeline itself is starting out significantly stronger than we did last year. The other important trend around pipeline, and I referred to this earlier, is that more budget centers are looking to consolidate relatively less efficient point solutions that they've been running, for example, in the call center. And there's many other examples like that. And so the color and the mix of the type of pipeline coming our way is unlocking access into adjacent budget centers and/or maybe deeper levels of budget that people want to deploy towards our system, which also contributes to the building up of increasingly higher levels of pipe and also expands the opportunity. That said, keep in mind what Chris said also, which is deal cycles still are elongated and people have more process that they're actually applying to the way that they end up making decisions. This does conclude the question-and-answer session as well as today's program. Thank you, ladies and gentlemen, for your participation. You may now disconnect. Good day.
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EarningCall_1210
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Good morning, and welcome to the Synovus 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 a question. [Operator Instructions] Please note, this event this event is being recorded. Thank you, and good morning. During today's call, we will reference the slides and press release that are available within the Investor Relations section of our Web site, synovus.com. Kevin Blair, President and Chief Executive Officer, will begin the call. He will be followed by Jamie Gregory, Chief Financial Officer, and they will be available to answer your questions at the end of the call. Our comments include forward-looking statements. These statements are subject to risks and uncertainties, and the actual results could vary materially. We list these factors that might cause results to differ materially in our press release and in our SEC filings, which are available on our Web site. We do not assume any obligation to update any forward-looking statements because of new information, early developments or otherwise, except as may be required by law. During the call, we will reference non-GAAP financial measures related to the company's performance. You may see the reconciliation of these measures in the appendix to our presentation. Thank you, Cal. In many regards 2022 was a banner year for Synovus. We began last year with an investor day which affirmed to the market who we are and detailed our path forward to become a more innovative, resilient, and high-performing bank. As the year progressed, we faced an increasingly volatile operating environment. However, our team rose to the challenge, continuing to execute the plan laid out in February. Given our strong footprint, the ability to monetize rising rates and the performance of our business units, we've demonstrated, throughout 2022, our ability to execute and deliver profitable growth, resulting in top quartile return on average asset, and efficiency ratio levels as compared to our peers. We achieved this success while also investing in the future and pivoting where needed to address the changing economic, liquidity, and credit landscape. I want to thank our team for delivering on our purpose again, in 2022, enabling people to reach their full potential. Feedback through resources, like J.D. Power showing record client satisfaction scores, and 15 awards from Greenwich Associates for excellence in service to middle market and small business clients prove we remain trusted partners to a growing and loyal legacy client base across our geography. Credit for this kind of recognition goes to this exceptional team and our ongoing investments in strong, scalable capabilities and solutions that add value. Today's report is shaped by continued growth and stability in our core banking franchise, given our ability to deepen the wallet share of existing clients and consistently attracting new relationships. We are also benefiting from investments in technology, process improvement, and innovation, as well as a common sense approach to expense, credit, and capital management. For these reasons, we exit 2022 a stronger company, with a tremendous amount of momentum as we continue to execute on our roadmap which will allow us to deliver sustainable, top quartile financial performance. Now, let's review 2022 and fourth quarter highlights on slides three and four. We realized robust revenue growth in 2022 as net interest income expansion was fueled by double-digit loan growth and our overall asset sensitivity given rising rates. A challenging mortgage environment pressured fee income. However, excluding mortgage, client fee income collectively increased high single digits on a full-year basis, signaling the depth and breadth of our core client relationships. Our efforts to double down on the commercial client segment is producing outsized growth as our commercial lines of business generated $4 billion in loan growth, all at higher spreads, while adhering to our conservative credit standards. To that point, credit metrics improved over the year, and currently stand at or near historically low NPA, NPL, NCO levels. We applied the same disciplined approach to capital management, growing capital in the quarter and ending the year with a CET1 ratio of 9.63%. Our two-year Synovus Forward initiative surpassed its $175 million run rate goal in the fourth quarter. And although the initiative is complete, the emphasis on expense control and efficient revenue growth is more deeply engrained in our culture. And we identify and act regularly on new opportunities to generate incremental value to our financial performance. Despite increasing pricing pressures on the deposit side, we managed deposit costs well throughout the year, benefiting from prudent strategy and an extended lag on deposit repricing. Overall, deposit production rose 30% for the year, and was sourced from multiple lines of business. I was especially pleased with our sales efforts in the fourth quarter as our teams' increased sales activity resulting in overall growth of $900 million in new production quarter-over-quarter. The operating environment for deposits remains competitive, with the retention of client balances and growth in new production remaining primary focuses in 2023. While delivering great financial performance during the year, we also continue to make progress with the development and rollout of the key initiatives that will allow us to deliver new sources of revenue in 2023, and well into the future. CIB continues to prudently grow and execute reaching 20 team members in the fourth quarter, and booking their first capital market fees and depository relationships. Maast also reached a key milestone as they were live with their first client, and have booked revenue during the month of January. On the Treasury & Payment side, we fully completed our client migrations into the Gateway portal, and went live with our new foreign exchange platform. We continue to see traction with the investments we're making in Treasury & Payment Solutions as the growth in production and the associated revenue continues to outpace the underlying markets and our peer benchmarks. In order to continue to increase the capacity of our commercial relationship managers while improving the client experience, we are also investing in new technology and reengineering our processes to streamline the client underwriting and onboarding experience. On the consumer side, we further streamlined our branch network by closing 36 locations during the year, while investing in analytics and digital capabilities to ensure we continue to efficiently and effectively serve our targeted client base. Simply, 2022 was a year of progress across our entire organization. I am extremely proud of our team and their accomplishments, and encouraged by our positioning as we enter 2023. Thank you, Kevin. I'd like to begin with loan growth, as seen on slide five. Total loan balance at the end of the fourth quarter, at $44 billion, reflecting quarterly growth of $1.1 billion. On an annualized basis, excluding PPP, this represents a growth rate of 11%, our sixth consecutive quarter of annualized double-digit loan growth. Both was again led by our commercial lines of business, and was diversified across multiple industries and segments. For both [C&I] [Ph] and CRE asset sites, growth was a function of moderated production and low levels of paydowns and payoffs. Particularly for transaction-driven sectors such as CRE and corporate M&A, activity and pipelines remain muted as a result of the current environment. In addition, current underwriting standards account for higher risk in certain sectors. And where we are extending credit, we have been able to exercise greater pricing power to drive margins as reflected by increasing spreads on new floating rate commercial production in the fourth quarter. Moving aside fixed, the industry-wide headwinds for deposit growth remained in the fourth quarter as continued interest rate hikes, seasonal spending, and other liquidity deployment drove account diminishment. Despite these pressures, we were able to growth core deposit balances which increased by $373 million quarter-on-quarter. This growth was a combination of a bank-wide focus on new deposit production and seasonal benefits from public funds. As evidence of deposit momentum, we have around deposit production, when looking at the fourth quarter, new production excluding public funds increased over 50% from Q3. Our recent efforts, both to generate and retain deposits, have been encouraging. And our focus is on maintaining that positive momentum within what remains a challenging deposit environment. To that end, we will continue to ensure that we have balance between prudently managing deposit costs, while remaining competitive through this FOMC tightening cycle. Our average cost of deposits increased 50 basis points in the fourth quarter to 0.88%, which equates to a total deposit beta of 21% through Q4. As a result of pricing discipline and continued pricing lag, this beta continues to remain lower than the 35% to 40% range we had previously communicated as our base case for total deposit betas, this rate cycle. With recent deposit pricing pressures and a fed funds rate that appears likely to approach 5% in 2023, we still believe that we'll reach this range as the cycle matures. Now to slide seven; disciplined deposit pricing, loan growth, and interest rate increases led to growth in net interest income in the fourth quarter. NII came in at $501 million, an increase of 5% quarter-on-quarter or 28% versus same quarter one year ago. The growth in NII for Q4 is supported by both higher loan yields which continue to outpace the deposit cost and the consistent pace of loan growth which I spoke to earlier. The net interest margin was 3.60% in the fourth quarter, an increase of 11 basis points quarter-on-quarter. Supporting NIM are higher asset yields, which continue to increase alongside the recent pace of FOMC rate hikes and are supported by spread widening and the continued growth in our floating rate loan portfolio. While funding costs have also increased, the pace of increase in deposit rates has remained somewhat more consistent and measured than that of the assets are. This time it served to be a significant tailwind to the margin as we progressed through 2022. As we look forward to the coming quarters and approach what is likely the later phase of the Fed tightening cycle, NIM is expected to be more heavily impacted by the delayed effects of deposit repricing. Assuming rates remain relatively stable from current levels, over the medium term the margin will be supported by fixed rate asset turnover and hedge maturity. And as we enter 2023, NII will continue to be supported by expected loan growth and pricing discipline. Slide eight shows totaled adjusted non-interest revenue of $101 million, down $4 million from the previous quarter and down $15 million when compared to the same period in 2021. Negatively impacting Q4 fee income were two tax related valuation adjustment which in combination totaled approximately $5 million, and were partially offset by benefits recognized in the tax provision. Outside of these tax related valuation adjustments, we recorded another strong quarter of non-interest revenue. On the wealth side, revenue generated from client's movement in the short-term investments has provided a positive offset to industry deposit pressures. On the commercial side, increase in client privacy continues to be a key strategic focus. We can point a progress made this year with syndication fees up 59% on a full-year basis despite a challenging capital markets environment. On the card side, we crossed a noteworthy threshold as commercial card spend exceeded $1 billion contributing to a 20% increase in full-year card fee. Commercial on all proceeds are also gaining momentum with strong pipeline heading into 2023. Moving on to expenses, slide nine highlights total adjusted non-interest expense of $307 million, up $13 million from the prior quarter and up $22 million from the same period in 2021, representing an 8% year-over-year increase. When looking quarter-over-quarter, the majority of our expense growth was attributable to performance related cost, investments in new business initiatives, and infrastructure spend, all previously disclosed as planned increases in Q4. Similar factors drove the year-over-year expense increases. And our top quartile efficiency ratio of 52% for the year highlights are alignment between performance and expense growth. Next to slide 10 on credit quality, our credit performance and the credit quality of our originations remain strong. The NPA and NPL ratios remain stable overall and are at or near historically low levels. The net charge-off ratio was 0.12% for the quarter in line with recent levels. In the fourth quarter, our ACL was $501 million or $1.15% of loans. As detailed in the appendix, given continued loan growth the ACL increased $22 million quarter-on-quarter while the ACL ratio remained relatively stable. This ratio reflects the positive performance in the loan portfolio, offset by a negative bias influencing economic scenario metrics for 2023 and 2024. We are confident in the composition, diversification, and strength of our loan portfolio. As we recently discussed at industry conferences, when looking further at our exposures that are more sensitive to recessionary pressures, we remain convinced that our targeted and selective approach to industry and sector lending will provide protection from an economic downturn. We also feel that we are well-positioned to detect and respond to shift in commercial loan performance through tool such as our client specific cash flow analytic, originally introduced in the pandemic. As seen on slide 11, the common equity Tier 1 ratio increased to 9.63%, reflecting our commitment to retain our strong organic earnings to support core client loan growth while also maintaining strong capital levels. For the year, we deployed over 70% of our organic earnings towards supporting core client growth, while also returning roughly 30% to our shareholders through our common dividend, both consistent with the capital management priorities we detailed during our 2022 Investor Day. Looking into 2023, we will continue to prioritize capital deployment towards client growth. And we'll remain mindful of the evolving economic environment as we manage within our target CET-1 ratios. Additionally, our planned quarterly dividend increases 12% to $0.38 a share, subject to board approval reflects our confidence in our stable earnings profile. Thank you, Jamie. Given the more uncertain economic environment, we have utilized wider ranges on estimates and have shared more detail on the assumption supporting these estimates. We expect loan growth of 5% to 9% in 2023. While lower levels of pipeline activity in some business units and a run down in our third-party portfolio will act as headwinds. We have a number of existing businesses with strong pipelines as well as newer lines of business such as CIB that will support overall growth exceeding that of the general economy. We're also assuming a normalization of prepayment activity and utilization levels that are consistent with those experienced in 2022. It's also worth noting that pricing discipline is a key focus in the current environment, where pricing power continues to improve and we therefore expect wider spreads to persist in 2023. The adjusted revenue growth outlook of 8% to 12% aligns with an FOMC rate that reaches approximately 5% in 2023. The wide revenue range accounts for less certainty in the deposit environment. On the fee income side, we expect mid-single-digit growth driven by continued expansion in core client fee income, impacting fee income, our checking account enhancements plan to be implemented in the first-half of the year that is estimated to negatively impact annual service charge revenues by approximately $5 million to $10 million. On the adjusted expense outlook of 5% to 9%, the year-over-year growth is a function of three primary drivers. First, approximately 40% of the growth in 2023 is associated with core operating expenses. Secondly, we have two sizable environmental factors affecting our expense outlook. Health care costs and the rise in the annual FDIC assessment rate are collectively forecasted to account for 20% of the overall growth. Lastly, we remain committed to our investments and new initiatives such as CIB and Maast, which in combination with other revenue based investments and projects will comprise approximately 40% of our 2023 expense growth. However, despite these expense headwinds, we have found ways to prudently trim cost and we are benefiting from a full-year of Synovus forward expense saves that will allow us to drive overall positive operating leverage and PPNR growth of 11% to 15%. Moving to capital, as Jamie shared, we plan to maintain our same capital management philosophy in 2023, with a focus on prioritizing core relationship growth and maintaining a strong capital position, all while providing shareholders with a competitive dividend. While our Board approved a $300 million authorization for the year, as was the case for 2022, any share repurchases will be dependent upon loan growth and the overarching economic factors. Lastly, while we don't talk about it often our tax rate guide of 21% to 23% accounts for a number of successful initiatives that we have implemented in recent years from affordable housing to solar tax credits. These initiatives offset forecasts that negative headwinds in 2023 and serve a dual purpose of consistently reducing our tax rate while also benefiting our communities given our focus on driving actions associated with our ESG objectives. Our strong momentum has carried us well through the first few weeks of the New Year, and we are so proud of the 2022 accomplishments that resulted in solid financial performance and meaningful progress in nearly every area of our transformational growth plan. We're confident in our strategic plan and our ability to hit key 2023 financial targets outlined today, even as we navigate the volatile economic terrain. 2023 is a year of focused execution for our team as we emphasize investments and pour our energy into three key areas; first, advancing successful execution and productivity gains within our core businesses, allowing us to deepen relationships, grow our client base and enhance financial performance. Growth in core businesses enables us to invest in new and future sources of growth, including Maast, CIB, and new Treasury & Payment Solutions. Secondly, continuing to benefit from contributions generated by our new growth initiatives and adding talent in key businesses and markets to expand our presence and profitability. And then lastly, maintaining a cautious and resilient risk profile through capital management, deposit generation across all lines, and overall credit vigilance. As we head into the Q&A segment, I want to thank our incredibly talented and passionate team again, and affirm our commitment to providing the best career and workplace experiences possible. In 2022, we progressed in our DE&I, launched our new leadership development program, increased base pay, and enhanced incentive plans and enriched benefits like parental leave. As a result, Synovus was again named the top fourth place in Atlanta, and designated a great place to work. But we cannot rest on our laurels. We're committed to listening and investing even more, in 2023, to meet the needs and exceed the expectations of our workforce. I also want to mention a few examples of the success and achievements our lines of business delivered in 2022. Our Wholesale Banking team delivered record results, representing the largest growth engine for the company; $5.3 billion of funded loan production, $2.3 billion of deposits acquired, and $39 million in fee income highlighted the year. We also onboarded 55 new team members to support future growth. By focusing on empowering our local leaders, our Community Bank returned to a growth orientation in 2022, with both commercial and private wealth loan portfolios growing for the first time in many years. Moreover, our geographic banking units continue to serve as a portal of entry and a primary referral source, with over 6,000 referrals made to other lines of business. Our wealth management units, including securities and trusts, grew fee income $10 million or 7% in a year, with significant headwinds from lower equity markets. However, the teams were able to overcome this given strong new client acquisition and the expansion of existing relationships. As referenced earlier, Treasury & Payment Solutions increased production and fees significantly in 2022 driven by success in core cash management solutions as well as commercial card and international services. And our consumer line of business optimized our branch network by closing 13% of our facilities, while expanding our digital and analytical capabilities which resulted in a more efficient and scalable organization. With disciplined deposit pricing and high single-digit loan growth, the consumer line of business expanded their PPNR by double digits. And certainly, none of these lines of business results would be possible without the hard work and dedication of our corporate services support team. Lastly, I am pleased with our 2022 efforts to build and strengthen our communities. We launched a meaningful partnership with Junior Achievement in mid-2022, one component of more than $3 million and 24,000 volunteer-hours invested in our communities across the Southeast. We will now begin our Q&A session. [Operator Instructions] Okay, so our first question comes from the line of Steven Alexopoulos from J.P. Morgan. Your line is open. Please go ahead. Wanted to start first on the loan outlook, if I look at the loan outlook, it's very strong. Most banks are guiding to strong growth in average loans for 2023, but not strong growth in period-end loans. So, I'm curious, what's your assumption for the economy that underlies the forecast? And what gives you so much confidence at this point that you could deliver mid-to-high single-digit growth in period-end loans? Steven, it's a combination of several factors. To your point, when we look at the economic forecast, that there are parts of the forecast, that would show in the latter half of the year, that you could see contraction in the economy. But we believe, in total, that when you look at our C&I pipeline, first and foremost, we think we will continue to see good growth on the C&I front. That comes from pipelines, but it also comes from some of the newer businesses that we've just initiated, like corporate and investment banking, where we really don't have a portfolio to this point but we'll be able to continue to generate growth from the new production. Secondly, we continue to see a constructive environment on the home equity side as well as on portfolio mortgages. Obviously, that volume is down. But when you look at the need for home equity product given rising interest rates, we continue to see a good productive environment there. The area that we're seeing a decline is really on the CRE side, we've seen pipelines decline 60% to 70%. And so, when you think about this year compared to '23, the real difference will be that C&I will continue to grow in a double-digit fashion, consumer will be in that lower single-digit. And then, instead of being double-digit for CRE, it's going to be in the low single-digit for CRE -- or double-digit for C&I, low single-digit for CRE. Part of that is just due to the fact that the pipeline is down, but the other part is we'll start to see payoff and paydown activities really start to pick up in '23. So, when we look at it by asset class and by business unit, we have certain units that are continuing to see pipelines expand; we've had others that contract. But, the end of the day, you kind of look at all of those and you'll kind of a mid single-digit growth rate next year. Yes. The only thing I would add to that is just our non-core third-party portfolio. You should expect to see that attrite as we go through 2023. Okay, that's helpful, Jamie. And then for my follow-up question, when I look at the net interest margin, basically in line with expectations in terms of the expansion this quarter. But given what you're seeing on the deposit side, right, talking about a further remix non-interest-bearing, Jamie, how do you see NIM trending in 2023, at this stage, I recognize it could change in a month, but right now, if we look at where you ended the fourth quarter, how do you think about NIM for 2023? Thank you. Yes, it's a great question, and it's kind of the million-dollar question. As we look at 2023, we expect the margin to be down marginally from where we ended in the fourth quarter. And basically what will play into that is, in the first-half of the year we do believe that we will see the pressure of deposit lags. We expect like the quarters with the largest deposit cost increase to be the fourth quarter, that we just experienced, that we're talking about today, and the first quarter. And so, the first-half of the year we'll see the margin headwinds associated with those lags. But how this impacts the margin will depend on how long the lag is and how deposit cost increase as we go through it. As you know, longer lags and cost outperformance would be margin tailwinds, and the opposite is true with shorter lags and higher cost. Our current expectation for the first quarter is that we see deposit cost increase at a little bit of a slower rate than we saw in the fourth quarter. But we do expect to see in the back-half of the year, the NIM headwinds that we'll see in the first-half turn to tailwinds as our fixed rate exposures become a tailwind with repricing. And all of this is contingent on the interest rate outlook. And so, our guidance today includes the Fed going to approximately 5% and holding there, consistent with their outlook. And so, that's embedded into this forecast. Maybe just to ask the net interest margin question a little bit, on your last quarter, we talked about NII dollars growing basically in sync with the loan growth in 2023. Is that still the right way to think about spread income dollars? As we look at NII, looking through the full-year of 2023, I would just call it uneven as we progress through the year. Our base case for NII in the first quarter is for it to be similar to what we just experienced in the fourth quarter, outside of the impact of day count. And so, for that, for us that's about $10 million. But as we progress through the year, there are just a lot of uncertainty with monetary policy, competitive pressures on deposit pricing, and the timing lags. So, as we look at the full-year compared to Q4 annualized, there are scenarios where you could have NII increasing. And that would be driven by loan growth timing lags, betas at the lower end of our guidance. And our guidance hasn't changed through the cycle of 35% to 40% total deposit beta, but -- and the converse is true to that, faster repricing, higher deposit betas would obviously be a headwind. But again like I just mentioned in the response on Steven's question, we do think that the pressures from deposit cost are going to really be the highest in the first-half in the year, but then we have those tailwinds that'll flow through in the second-half of the year. And Brady, I'll just -- I'll state the obvious, I mean you see it in the '23 guidance, but revenue growth of 8% to 12% obviously exceeding that of loan growth. So, for the full-year, Jamie is talking about relative to the fourth quarter, but full-year, margin will expand 22 to 23. So, NII would actually be growing at a faster pace than what loans would be growing. All right, that's helpful. And then my follow-up, as I look at last -- you had the Investor Day, you ramped up service forward, you had the new initiatives from the corporate and investment bank, and also Maast, like there was a lot of new things announced. But as you look at 2023, will Synovus continue to be announcing some new initiatives or is this more a, "We have what we have, and it's time to execute?" So, look, I think, Brady, you always have to have an eye on the future in looking for new sources of revenue. So, I'm sure that we'll have some new ideas and things that will begin to develop and initiate on, but we had in the back of the document, this is really a year of focused execution. We believe that we've made tremendous progress in core businesses and focusing on productivity gains and ensuring that we're getting full share of wallet. I was really pleased to see, as I said on the prepared remarks, when you look at our deposit production in the fourth quarter, total deposit production was about $2.5 billion. It's the first quarter I can remember that deposit production outpaced loan production. We only had $2.2 billion in loan production. And so, there is opportunities to continue to focus on our core businesses to ensure that we're getting fulsome relationships and that we're delivering the highest level of value to our clients and profitability. The second part of that is making sure that some of these initiatives that we kicked off during Investor Day deliver. Obviously, in our expense guide for '23, we have a considerable amount, about 40% of the growth tied up with current initiatives. And we believe that that's prudent to continue to invest there given that, as we look at '23, and '24, and even '25, the amount of revenue that's going to be produced by those initiatives will more than offset the expense and be a major driver in top line growth. So, we want to make sure we deliver on those. But we have a sandbox, and we need to think about what are the new items that we uncover as opportunities to generate growth or efficiencies, and that's what we really talk about Synovus Forward. We're not going to do a Synovus Forward 2.0. But what we try to do is embed in our culture the idea of coming up with better ideas to both drive new sources of revenue and define new efficiencies. And that's just something that we have to do going forward given the economic volatility and challenges that we'll face. Thank you. Our next question is from the line of Michael Rose of Raymond James. Your line is now open. Please go ahead. Just wanted to touch on the -- okay, thanks, yes, just wanted to touch on the dividend increase, I think that was probably a little bit larger than I would have thought. And I saw that you -- looks like you've approved a $300 million share repurchase program. Just wanted to get some details around that and how active you plan to be as we move through the year, just given that you're within your CET1 range? Thanks. Yes. As we think about the dividend policy, we try to pay out 30% to 40% of earnings to the dividend, and we think that's a good place to be, we think is what is right for our shareholders. But we really want to make sure that we're retaining as much capital generated through earnings for core client growth. And we believe that that gives us that flexibility, you know, [technical difficulty] scenarios, in scenarios where rates decline and the world changes, as well as scenarios where we continue to grow and that economy remain strong. So, that's how we think about. With regards to the share repurchase program, that's the same approval as we had in 2022. And as you know, in 2022, we repurchased only $13 million in shares, but our expectation is that loan growth will be slower in 2023. And we're starting the year at a higher CET1 ratio, closer to the high end of the range. So, as we progress through this year, we are going to monitor our capital ratios. We are comfortable where we are. And as we get to the top end of our range, as we -- to 975, we are going to revisit our share repurchase strategy, and that's a point where you may see us out in the market buying shares. All right. And then, just as a separate follow-up question, I think there is going a lot in the news about commercial real estate and resets as properties come up for renewal. There is an article in the journal about it today. I often hear from some investors that there is some concerns. You have got some third-party loans. You have got decent amount of commercial real estate. Obviously, there are issues pretty -- and going through the GFC, can you just provide some kind of overall context around your philosophy around the credit portfolio? Maybe where you are pulling back? And how investors can get more comfort just giving all the changes that you made over the years as we potentially got through another credit cycle? Thanks. Hey, Michael, it's Bob. I'll start with that and Jamie or Kevin can certainly follow, but just -- let me maybe just quickly go back to what we said at Investor Day as it relates to sort of credit risk management. Obviously, our intent was to spread the balance sheet out. Building out corporate specialty lines of business I think that was our key focus for us. Secondly was to stay diversified within our concentration limits and to build those out. I think that's been accomplished. And then finally and probably most importantly was to make sure we've built a robust credit shops within our lines of business in the first line of defense with our OEMs et cetera. So, we've got credit resources deeply allocated in our business units. So, from a Bob context that framework is what we are operating under. As it relates specifically to CRE, those same sort of overarching frameworks apply. We stay balanced. We're not outsized necessarily. We do have $3 billion in office. That gets a lot of attention. But if you back out the medical component, that's about half. Within that category, a large percentage is at or near hospitals, universities. So, we like our office. We are not immune to what is going in our office, but we certainly are either comfortable with where we are. Other asset classes are relatively balanced. And on the C&I front, that balance continues. So, that's our guidance from credit as it relates to policy exceptions and managing within our policy. We certainly are vigilant about that. And will continue to be so. So, I think it's just more of the same, but building it out at the frontline, Michael, and continuing to execute on what we laid out in February as we go forward. And Mike, I'll jump in a little bit here. I mean we have a very long history in CRE. And that's what is getting a lot of attention today. And as you can see in the appendix of our deck on slide 19, we are trying to give investors the details they need to make their own assessment on the quality of the book because we feel very comfortable with where we are in an uncertain environment. And that's why you see us looking at the average LTVs but also the higher LTVs. Anything -- and we are using 70% which is fairly conservative as a tranche just to give a look into our portfolio. So, investors and analysts can come to their conclusions, but we feel comfortable with our strategy. It's one we have a lot of history in. And it's going to be as part of who we were in the past. And it's going to be a part of who we are in the future. And we feel good about that, but we try to get all the insights we can into that portfolio given the headlines. And Michael, as a quick follow-up to that we are running internal stress test constantly on our CRE book and under severe adverse conditions et cetera. And weâd like the way the results of those stress test. We do it by asset category. We stress a whole host of variables, but suffice it to say that that work is being done. And we feel comfortable that the portfolio can absorb some stress. Again, we are not immune to credit challenges, but we feel really good about the results of that. Thank you. Our next question comes from the line of Jared Shaw of Wells Fargo Securities. Your line is now open. Please go ahead. I guess circling back on the deposits. The beta performance has been pretty good so far. As we look at that loan growth expectation, should we assume that deposit growth will match that? And maybe that's where we're seeing the accelerated beta, just bring those in and how should we be thinking about the level of DDA under that environment as well? Yes, it's a very important question as we look forward to 2023, and just want to be really clear that as we think about our balance sheet growth in 2023, achieving the high end of our loan growth range requires stronger core deposit growth. And so, those do go hand in hand, but the environment is pretty uncertain, and it's too uncertain to precisely estimate, full-year deposit, core deposit growth, but we do expect to continue to see the strong production, we've seen in the past couple of quarters. And our teams are focused, we've increased the focus on the teams, we've changed incentive plans, we have deposit initiatives in flight. And so, we think that organic client deposit growth will materialize in 2023. On the environment side, we do believe that diminishment will reduce as we go through 2023, similar to the trend of reduced diminishment, we've seen in third quarter and the fourth quarter, we believe this stability and Fed policy, both on rate and balance sheet will allow for a more stable deposit environment. So, all in all, our current expectation again, which is uncertain that we expect core deposit growth to be in the low to mid-single-digits for 2023 and we expect the pressures that we experienced in last year and 2022 to continue albeit at a little smaller in the beginning of 2023. So, growth is likely going to be weighted to the back half of the year. And so, Jared, on the business front there, so two sides of that equation, as Jamie mentioned, we're ramping up production on the deposit side, diminishment is starting to abate a bit, it's important to note when we look at the balances that we lose in a quarter, about 96% of the balances that we lose are with existing relationships. So, it's not losing deposits. It's not closure. It's folks that are using their cash, or in many situations that we had a record quarter in the fourth quarter of moving money off balance sheet again into treasuries on the security side. So, there's a lot of money movement that's seeking yield. And we think that will continue to slow, that combined with increases in production will help to drive the production and growth that Jamie talked about. The other side of the equation is loan growth, and I want to be clear that, our job is, as we've said, is to go out and deploy capital for our clients. And so, we're going to continue to be open to originate loans. And that's why our 5% to 9% guidance. But the other thing we can do is we come up on renewals of existing loans or we look at certain asset classes, we may make the decision that given our cost of funding, we may not renew it alone, if we're not getting the right level of profitability or particular asset classes, we may decide to downsize, similar to what we've done with third-party given the underlying profitability with wholesale funding. So, I think you have to look at both sides of it. But we obviously are focused on generating faster growth on the core deposit side and continuing to serve our clients. But we have about $9 billion of contingent liquidity through securities and through FHLB. So, we really don't have a funding problem, we have a challenge to make sure that that funding comes on as cheaply as we can get it. And to circle back to the NIB question, as I mentioned, there's a lot of uncertainty in the outlook, but within products, I would argue that the uncertainty increases. As an industry, we've seen a significant trend of clients taking advantage of rates and switching out of DDA, we expect that to continue in 2023. And that's embedded in our outlook. It's embedded in our beta assumptions through the cycle betas. But we're also expecting to see continued strong client growth in DDA that will serve to offset that mix shift, I just described. So, how those puts and takes play out in 2023 is uncertain. But our current estimate is they will fare pretty well offset each other. Okay, thanks. And then, I guess just for my follow-up, looking at the expenses guide, it's a pretty wide range. And you talked about being able to be flexible there, I guess, with the backdrop that there are some increases in fixed expenses, like you said, with health care and cost of living and FDIC, what are those levers where can we see expense growth moderate if the overall growth isn't there? When you look at our expense outlook first to kind of want to step back and kind of give components of it, we have core operating expense increases. So, you can think about things like merit, and just normal inflationary pressures in third-party spend, things like that. That's about 30% to 40% of our NIE increase year-over-year, when you look at our growth initiatives, those larger ones are CIB and Maast, that's about 40% to 50% of our NIE increase year-over-year. And then, we have the environmental costs, like the FDIC increase, that are about 20% of the increase year-over-year. So, that kind of gives you a breakdown on where the expense increases are coming from. But to your question around, where's the flexibility, the first place I would point is on variable compensation. So, in a scenario where revenues are lower, it is likely that variable compensation will also be lower, and that's automatic, it happens naturally, and that's about 15% of our expense base. Second, in a slower environment, we have the ability to spend at a slower pace on some of our growth initiatives. And then, third, we have the largest expense categories. And so, that's personnel, that's third-party spend, and that's real estate. And so, as you've seen with us in the past, through the Synovus Forward initiatives, we can always go back and assess opportunities in those areas to reduce expenses. Thank you. Our next question comes from the line of Brad Milsaps of Piper Sandler. Your line is open. Please go ahead. Thanks for taking my questions. Jamie, I'm just kind of curious on to extend the funding conversation, how much can the bond book sort of help you out to the extent you'd like to do that in case, deposit growth does fall short of your kind of loan growth targets, just want to think about, whether you plan to shrink that or kind of what the outlook might be? Our outlook right now for the securities book is for relative stability. But Kevin mentioned that we have over $9 billion in contingent liquidity available to us, and that includes the unencumbered securities in the securities portfolio. So, if I were to shrink the portfolio by $500 million and get the cash from shrinking it, or if I was to repo securities at 100%, I could get the 500 million that way. So, it's a liquidity-neutral portfolio, just given the quality of the securities that we invest in. So, when we think about that, the liquidity is there as it is, and so our management of that book is a liquidity play. It's also an asset sensitivity play, because investing in those securities is fairly similar to receiving fixed except for you get a nominal spread. And so, that's philosophically how we think about it. And we expect as I said, relative stability in that portfolio as we go through '23. Got it, thank you. And as my follow-up, you mentioned in your comments, opportunities around fixed rate asset repricing I think in the deck, 38% of the loan book is fixed. Are there any larger pieces coming up that that reprice, can you kind of give us a sense of what you might pick up and to the extent that the swap books would have offset any fixed asset repricing this year just kind of wanted to get a sense of kind of what you think the opportunities there in terms of, kind of fixed rate asset repricing this year? Yes, when you look at the fixed rate assets on the portfolio, we have securities portfolio, $11 billion book value at just over 2% yield, that prepayments on that are slow, maybe around $75 million a month. And so, that'll be kind of a little bit of a tailwind, but not as material. I mean, the fourth, the jump in the fourth quarter was pretty strong, and we wouldn't expect to see increases like that, as we go forward. Our residential mortgage portfolio, a similar duration as our securities portfolio around $5 billion and you look at that yield in the mid fees. So, as that pays off, that'll definitely be accretive and then we have kind of other fixed rate assets that are approaching or right at $12 billion. And that those are -- there are opportunities for increases there. Those are not as a material as far as increases as the other fixed rate assets as the mortgages. The hedge portfolio is a meaningful tailwind, and so you can see in the appendix when we put the hedge maturities in there, you can see them in the second quarter, we have a billion maturing. And you can see the jump up and the remaining hedge yield after those maturities, those maturities in the second quarter will be about seven basis points accretive to the margin going forward, just a second quarter billion. And so, we will see a tailwind from that, that benefit will happen in the third quarter and beyond, not in the second quarter itself, but that's how we think about those fixed rates, and we do believe that the opportunity is pretty material as we go through and have maturities and pay offs and pay downs. Thank you. Our next question comes from the line of Kevin Fitzsimmons of D.A. Davidson. Your line is now open. Please go ahead. Just was hoping to touch on the revenues. I believe you mentioned in the outlook, while you don't have a separate item in the outlook, I believe, and then the growth section that you expected to grow at a mid-single-digit pace. I just wanted to check that that's correct. And what kind of baseline that's off, and then it seems like I recognize that the valuation adjustments were probably not expected. But it seems like you've been adjusting to core fee revenue, and at the lower end of the range, as communicated just in early December. So, just wondering, was a mortgage or were there other items that were a surprise to how low they were? So, Kevin, I'll start with the fee income guidance. So, yes, mid-single-digits is embedded in the revenue forecasts off a base of roughly $413 million. And what that is, as you know, we expect to see core client fees continue to grow, whether that's on the treasury and payment solutions side, whether it's on the card side, whether it's on private wealth, where we've continued to see growth, those are the areas that we've been investing. And that's where we actually saw growth in 2022. The headwinds obviously, on mortgage, although we don't see mortgage rebounding from a production standpoint, you won't see the year-over-year drag that you saw in '22. So, overall, we feel very comfortable in that mid-single-digit fee income growth level. And then, I'll turn it over to Jamie for the second part of that. On the valuation, those are things that we analyze from time-to-time and run scenarios on these deals. And so, there're two different deals that impacted us in the fourth quarter. The first was a new market tax credit deal. And basically what happened there is when we ran the math, that's something that you basically reduced the valuation of the asset, as you take the tax credits, and the tax credits came through, and we reduced the value of the assets. So, that's why you see a lower ATR in the fourth quarter, as well as an offset. The other was solar deal that as we looked at the Forward benefits of that deal, they were reduced, and there's still a positive IRR, it still helps us achieve our ESG objectives. But it is reduced IRR. And so, that's why there's a valuation adjustment on that. Okay, great, very helpful. And just we talked about the balance sheet already, but I just want to make sure I understand. So, the loan-to-deposit ratios, just a little below 90% here. So, given that the intent is to not necessarily utilize wholesale bonds much, but to fund loan growth with deposit growth for the most part, would you -- that ratio to migrate up only modestly over 2003 like what's your comfort level with taking that ratio? That is our assumption for 2023 is for it to increase moderately. And again, I think the philosophy around liquidity management is similar to the answer that Kevin gave on loan growth. These all move in tandem. And we'll be monitoring loan growth in the context of core deposit growth as we proceed through the year but we're very comfortable with where we are. And there may be times where we choose to use broker deposits to fund growth. There may be times where we choose to use Home Loan Bank or other sources to fund loan growth but the loan-to-deposit ratio to us is more of an output, but yes, in our base case, we do expect it to increase moderately. Thank you. Our next question comes from Christopher Marinac of Janney Montgomery Scott. Your line is now open. Please go ahead. Okay, thanks. Good morning. Just a quick question about -- Bob, you mentioned about stress testing earlier. Does that lead to better pricing on new CRE loans that you have this year? And does that contribute turning to some of the revenue upside? Yes, thanks Chris for the question. Yes, I would say answer is as Jamie mentioned in his remarks and we think we have got some pricing discipline in the market. We have got opportunity for spread enhancement when we do deploy capital in the loan account. So, I feel pretty good about that. On the stress test, that was more of a credit quality exercise versus a pricing exercise. But nonetheless as we do deploy capital, we -- particularly in CRE we have got a little bit of - we have got the ability to increase spread slightly. And Chris, I'll put a explanation point on that -- to Bob's point. As we look at things like CRE construction, what we are doing as an organization is we are increasing the minimum requirements from a profitability standpoint to be able to do those. And it's not so much to your point. It's not a risk decision. But it's more of a profitability discussion. And to put some evidence behind our ability to generate incremental spread when you look at the second-half of 2022 and compare it to first-half, we saw about 40 basis points of incremental yield over index for all of our commercial loans. And so, I think for a -- when you look at risk rating for a better credit production level, we are getting much wider spreads. And that's something that we will continue to do given the higher cost of funding going forward. Great. Thank you, Blair for that. That's helpful. And just a quick follow-up about operating leverage and the guide has it positive. Beyond '23, does some of the expense growth that you have this year create flexibility in forward years just to have less expense growth, and then maybe perhaps in easier time to get into ongoing positive operating leverage? Yes, absolutely, Chris. And I'll let -- Jamie, I jumped in quick on this one. So, we will probably fight over who answers it. When you look at Jamie talked about the 40% to 50% of incremental expense increase this year for just new initiatives, over time those new initiatives are starting to put off revenue. You'll see revenue growth in '23 for things like MAS, CIB Analytics, new treasury and payment solution, the exponential growth in revenue will be much greater than what you'll see in expense in out year. So, you will see that sort of S curve with many of these new initiatives. And you won't see the same level of increase year-over-year from some of those new initiatives. So, we believe that '24 and '25 could be even better from an operating lever standpoint just based on those new initiatives. Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Kevin Blair for any closing remarks. Thank you. Thank you, Candice. And I want to thank all of those who are listening on today's call and for you continued interest in Synovus. As we close out the chapter on 2022 and we focus our full attention on executing in '23, I personally remain confident in our ability to deliver on our goals and objectives as it relates to all of our stakeholders. I know that we have many team members who are listening on today's earnings call. And so, I just want to say to you I am so proud of what you do and your passion for delivering on our purpose. It's truly our team members that differentiate us with our clients and amongst our competitors. I am also very proud of what we achieved in 2022 and what we continue to build. Enhanced growth, efficiency, and profitability were all delivered during this past year. But more importantly, we produced it in a way that will allow us to carry this momentum into 2023 and for that matter 2024 and beyond. And lastly, I am proud of the broad-based growth and diversification we are developing in asset classes, revenue streams as well as our business segments. Equally, I am proud of the pace of change and the overall agility of our company which will enable us to adapt more quickly as the environment changes. And it will change and to mitigate the challenges and risk that we face as we continue to execute on our strategic plan. As you have heard today, we have many things working very well. And we have many new exciting initiatives that are afoot. I also want to personally thank our senior leadership team for your hard work and dedication. You make all this change possible, and your commitment and your drive inspires me on a daily basis. As always, we're committed to regularly and transparently reporting our progress. And we look forward to, and appreciate the continued partnerships with each of you on the call today. And then finally, I can't close out today's earnings call without thanking Kessel Stelling, who officially retired from our Board and our Company on December 31. I am grateful for his many contributions to Synovus, as well as his mentorship, friendship, and his continued investment in our success as he remains in an advisory capacity over the next couple of years.
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EarningCall_1211
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Ladies and gentlemen, thank you for standing by. Welcome to the Freeport-McMoRan Fourth Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Thank you, and good morning. Welcome to the Freeport-McMoRan conference call, and happy 2023 to everyone. Earlier this morning, we reported fourth quarter 2022 operating and financial results, and a copy of our press release and slides are available on our website at fcx.com. Our conference call today is being broadcast live on the internet, and anyone may listen to the call by accessing our website homepage and clicking on the webcast link for the conference call. In addition to analysts and investors, the financial press has been invited to listen to todayâs call, and a replay of the webcast will be available on our website later today. Before we begin our comments, weâd like to remind everyone that todayâs press release and certain of our comments on the call include forward-looking statements, and actual results may differ materially. Like to refer everyone to the cautionary language included in our press release and presentation materials and to the risk factors described in our SEC filings. On the call today with me are Richard Adkerson, our Chairman of the Board and Chief Executive Officer; Maree Robertson, our CFO; Mark Johnson, our Chief Operating Officer of Indonesia; Josh Olmsted, who is our Chief Operating Officer for the Americas; Mike Kendrick, who leads our molybdenum business; Cory Stevens, who heads our Engineering and Construction and overall Global Technical Services Group; Rick Coleman, who is actively involved in all of our construction projects, as well as Steve Higgins, our Chief Administrative Officer. So, we have a full complement of management team here today. And weâll start -- Richard will make some opening remarks, and then heâll turn it back to me and weâll cover the slide materials, and then weâll open up the call for your questions. Turn it to you, Richard. Yes. Thanks, Kathleen. Thank you all for joining us today. As Kathleen said, after my overview remarks, which will be brief, she will review our results for the quarter. It was a strong fourth quarter. The numbers speak for themselves. It reflects the performance of our global team, and I much appreciate everybodyâs hard work. I read one of you said this morning in a report, mining is a tough business, and it certainly is. Nobody knows that, I think, better than me. But what weâve done and is reflected in our results for 2022 and particularly the fourth quarter, is remarkable. Most of you, who know our business and maybe all of you do, recognize the need to look at Freeport into two major segments. Our operations in Indonesia by PT Freeport Indonesia is characterized by very large volumes, very low cost because of the grades and the gold content, largest gold mine in the world is a byproduct. As youâll see in the fourth quarter, it operated as the worldâs second largest copper mine with a net unit cost of $0.06 a pound. Our business in Americas is quite different. We have among the largest mines in the world, the mines have low grades, thereâs much more material to be processed, to be mined in process to recover the copper, and itâs an operation that gets challenged by low copper prices and factors like inflation. But when you look at the results and what our team has done this year, itâs been very positive. Itâs also characterized by having some large future brownfield expansion opportunities, which is particularly meaningful given the situation of the copper in the world. Indonesia, it was just rock solid performance. Weâve been operating underground there for 40-plus years now. Weâve been investing in the current underground operations that we have been ramping up over the past three years to become the largest underground mining operations in the world for the past 25 years. It just reflects the long-term nature of our business. The last three years have really been notable. We completed mining the Grasberg open pit, which had been the bulk of our operations since the discovery of the ore body in the late 1980s. We completed mining that pit at the end of 2019. Then early in 2020, we faced COVID. And for years, this transition was viewed as a risk overlying Freeportâs business. And itâs just a major accomplishment that weâve reached our targeted mining and metal production targets that is whatâs arguably the most complicated mine in the world. And itâs all results of the hard work and accomplishments of our team there, very proud of them. The Americas business has done very well in meeting the challenges that weâve had there, dealing with inflation, dealing with a period of low copper prices, we have issues that are challenged in terms of getting workers for our operations in the Americas. Our operation in Peru was facing a severe challenge with COVID that they manage very well. The political situation in Peru right now is very complicated. There are protests throughout the country. Our team is doing very well. We are continuing to manage housing, feeding our people and continuing our operations. We are slowing down a bit to make sure we have supplies for the long run, but we have support by our workforce and fundamental support for our business by the local community there because weâve established such a great relationship with them. So we are -- as we look out now trying to predict short-term copper prices is very difficult. We actually donât even try to do it ourselves. We deal with short-term negative movements when they occur by having a strong balance sheet and a conservative financial policy. Itâs actually good to see right now that market sentiment going into 2024 is much improved over the end of -- going into the fourth quarter. But we are on the outlook for the well-known risks that the world faces today, and weâre prepared to deal with it. We are a long-term business. And we -- everything we do is focused, not on the short run other than to protect ourselves by having a strong balance sheet, managing our business in the right way, but our success is going to be measured over the long run. And copperâs long-run outlook is increasingly positive based on fundamentals of demand and supply. We committed to copper 20 years ago when we were a single asset company, the rationale for acquiring Phelps Dodge more than 15 years ago is being reinforced today by the combination of this really special mine we have in Indonesia and the global operations and growing operations that we have in the Americas. It was the right decision 20 years ago to focus on copper and is the right decision now. Kathleen? Thanks, Richard. Weâll start on slide 3, which summarizes our performance for the full year 2022. And just a couple of notes on the fourth quarter from our press release. We finished the year with a strong fourth quarter. Copper and gold sales exceeded our October guidance. And our consolidated unit net cash costs of $1.53 per pound in the quarter were better than our estimates going into the quarter. With average copper realizations in the fourth quarter of $3.77 per pound, we generated strong margins with fourth quarter adjusted EBITDA at approximately $2.25 billion. Looking at the year, we are proud of the performance of our team stayed focused on effective execution and on driving results in a volatile macroeconomic environment. After successfully growing our volumes in 2021 by 19% for copper and 59% for gold compared with 2020, we achieved another year of growth in 2022, with 11% higher copper sales volumes and a 34% increase in gold volumes. Our team in Indonesia has successfully and materially grown production levels and a sustaining large-scale, low-cost production at the worldâs largest underground mining complex. In the Americas, our teams in Peru and Chile proved resilient in restoring production during 2022 that had been impacted by the pandemic. And our teams in the U.S. maintain production at 2021 levels despite ongoing labor shortages and we also made significant advances on new technologies to enhance value. For the year, we generated $9.5 billion in adjusted EBITDA, and that was a year of dramatic swings in commodity prices and cost drivers. Our operating cash flows for the year, which were net of $1.5 billion in working capital requirements was in excess of our capital investments in our operations, and we nearly tripled our cash return to shareholders, pursuant to our performance-based payout policy. We ended the year with net debt, excluding the debt associated with our smelter of $1.3 billion, and thatâs substantially below the level of mid-2021 when we initiated our performance-based payout policy. On slide 4, youâll see weâve listed notable accomplishments during the year. In addition to driving value in our operating and financial areas of achievement, weâre very proud of our work with third parties to validate all of our operations under the Copper Mark standards, the measurable progress weâre making on our climate initiatives and the expanded disclosures weâve developed to enhance transparency and accountability. Weâll talk about markets next, and weâve got a slide on page 5. We experienced significant volatility as many of you have seen during 2022, with copper prices trading from a high of $4.87 per pound earlier in the year, falling to $3.18 per pound midyear and partially recovering to $3.80 per pound by year-end. Prices continued to move higher in early 2023 to a level currently approximating $4.25 per pound as several of the macroeconomic clouds began to lift. We discussed on prior calls that the dramatic moves in 2022 have been largely -- been based on sentiment rather than fundamentals. The facts are that the physical markets for copper have remained tight even during a period of weaker economic data coming out of China, and thatâs evidenced by the low levels of available copper inventories throughout the year. At the same time, copperâs importance in the economy continues to grow as a result of the intensity of use in clean energy applications and the global acceleration of electrification. We believe weâre still in the early innings of a broad-based secular driver of long-term demand. The ability of the industry to meet this multiyear period of growing demand continues to be challenged, leading to large market deficits in the future. You read about these challenges every day, and itâs getting harder, not easier, higher long-term prices are needed to incentivize new supplies. Weâve lived through the ups and downs in the copper market. Weâve effectively managed our operations and balance sheet during periods of volatility, and weâre prepared for this, but we believe the long-term fundamentals point to a real step change in how copper is valued in the economy. Turning to our reserve position on slide 6. We benefit from a geographically diverse high-quality portfolio of copper mines with significant exposure to gold and molybdenum. Our strategy, as Richard discussed, is centered around being foremost in copper. And we benefit from a portfolio of assets with characteristics that are very difficult to replicate. We show our reserve position at the end of 2022 with over 100 billion pounds of proved and probable reserves. We have an average reserve life of over 25 years. We added twice the amount of reserves we produced in 2022, principally at our U.S. mines in the Morenci and Safford Lone Star districts where weâre focused on future growth. In addition to proved and probable reserves, we have enormous mineral resources of 235 billion pounds of copper. Over half of this is located in the U.S. where we have established operations, a great track record and a valuable franchise. Weâll continue to work as we go forward to convert these resources into viable mine plans and future production. Itâs an extraordinarily valuable resource position in a world thatâs going to need more copper in the future. We wanted to focus a little bit on molybdenum on this call. And on slide 7, weâve got some information about our molybdenum business. Weâre a leader in that industry. Weâre the worldâs largest producer by a significant margin. And with the price move over the last couple of months of over 50% in molybdenum, we thought youâd be interested in learning more about our business. We produced 85 million pounds of molybdenum in 2022, and thatâs comprised about 60% from copper mines as a byproduct and the balance from two primary molybdenum mines that we operate in Colorado. And these are the only primary molybdenum mines that are currently operated in the United States. We also operate downstream processing facilities to produce products that are used in a broad range of metallurgical specialty steel and chemical applications. The price move from $18 per pound at the start of the fourth quarter to over $30 per pound currently has been driven by some of the same supply issues that have impacted copper. And in addition, demand drivers continue to be supported from the oil and gas, aerospace and power generation sectors. So, we note on this slide, the impact of a $5 change in molybdenum prices, itâs material at $400 million in annual EBITDA and $375 million in cash flow. And the recent move of over $10 per pound, if sustained at a higher price, adds additional leverage to our results. Looking at our operating stats for 2022 on slide 8, youâll see our sales for the year were about 35% from the U.S., 28% from South America and 37% from Indonesia. In the U.S., our sales were similar to 2021 levels, and we grew sales volumes by 10% in South America and by 20% in Indonesia. In the U.S., weâre continuing our focus on productivity, given the current limitations on adding to our workforce, weâre taking advantage of technology advancements and opportunities to expand production from leaching at low incremental cost, and weâre planning our next phase of growth, as weâll talk about in a few minutes. As discussed, the biggest resource position and source of long-term growth we have is a real opportunity in the United States. In South America, both Cerro Verde and El Abra grew production in 2022 in a complex social and political environment. After successfully recovering from the pandemic-related interruptions in 2022, our team in Peru is now dealing with challenges associated with civil unrest that youâve all read about. Weâre prioritizing the safety and security of our workforce. Weâre navigating disruptions to transportation routes and supply chains. To date, the impacts have not been significant but the situation is dynamic day by day, and weâre watching it very carefully. The bottom of the chart shows the 2022 cost performance. As weâve talked about on prior calls, we experienced significant inflation pressures across the business during 2022, particularly for energy and other commodity-related consumables, and in the second half of the year, started to see inflation from a rising cost of materials, supplies and services. The situation started to improve in 2022 with a number of the commodity-related consumables, but weâre still dealing with costs in excess of historical levels. If you look at the average cost for the year at Grasberg of $0.09 per pound is remarkable, particularly in the context of this cost environment. Richard talked about the significant success story of the Grasberg transition, and weâve got some details on slide 9, significant success for not only Freeport but also something for the global mining industry to be proud of in the country of Indonesia. We started planning for this transition over 25 years ago, and the team has just done an outstanding job. We benefit from the fact that several from the team who were involved in the planning of this project, including Mark Johnson, whoâs on this call, stayed with it over this period. And over the years, weâve added great talent to our team with experts from around the world. The success of this project, the mutual respect built over the years between Freeport, the government of Indonesia and local communities has established a really strong foundation for the future. Weâve got the opportunity with this resource to plan a new phase of development longer term and are continuing to discuss with the government the opportunity to extend our long-term partnership beyond 2041. If you go to slide 10, weâve got an update on our smelter project. And this is our key feature of our commitment to the Indonesian government, was to expand domestic copper smelting and refining capacity in Indonesia. Weâre making really good progress on constructing the new smelter in Eastern Java, itâs near our existing smelter, PT Smelting at Gresik. You can see from the pictures that construction is advancing. Weâve got thousands of workers now on site. Weâre working very closely with our EPC contractor to try as much as possible to make up delays that were caused by the pandemic. We reached a milestone of over 50% completion recently and we are expecting to begin commissioning the smelter during 2024. As you recall, the capital investments for this project are being funded from a successful bond offering that PT-FI completed during 2022. And so, we have the funding between the bond offering and a revolver at PT-FI to fund this project. Moving to our growth outlook. This is exciting opportunities for the Company, and we continue to plan our next phase of growth. Weâve got benefit from having multiple organic projects to develop within the portfolio over time. We operate all the mines we have interest in. Weâre able to share experiences, new technologies, operating synergies and best practices across the portfolio as we develop projects, and we can direct capital across the portfolio to the highest value opportunities. Our proven technical capacity capabilities and management is a notable strength. And importantly, weâve earned a track record and a reputation for operating sustainably and responsibly. The world, we believe, is going to need all of our projects and more. The project with the shortest lead time is our Americas leach initiative. Weâve talked a lot about it in recent calls. The economics are compelling, low capital intensity, low incremental operating costs and a low carbon footprint. The new data analytics capabilities, we are continuing, to be applied to prioritize our work streams on the highest value. Weâre continuing our work to apply covers to the leach stockpiles because of the benefits that you get from heat retention in enhancing recoveries, and weâve identified new areas that were not pursued historically. Weâre also continuing to test various additives that can further enhance recoveries. This is a really significant opportunity for us. Weâre continuing to target a run rate of 200 million pounds per annum by the end of this year and success of this level -- at this level would provide opportunities to scale larger. Weâre in a great position to lead this innovation with our long history in leaching and large inventory to work with. At our Bagdad mine in Northwest Arizona, weâre progressing a feasibility study to double production at that site. We expect to complete the feasibility this year, and weâll be in a position to assess options on how we time the future development. We started advanced planning to commence construction of a new tailings site that would support the existing operation, but would also provide flexibility for the expanded production. And as a brownfield expansion, this project could be developed more quickly than a greenfield development. Our Lone Star opportunity is really something special. Weâve been successful in increasing production levels substantially above the original project. And weâre really in the early stages in the development of this mine, as we mine the oxide ores more quickly, weâre opening up the opportunity for a major sulfide development long term. The resource is massive. Youâve seen the numbers, 50 billion pounds of potential resource here. Weâre doing a lot of drilling. And importantly, itâs located in an established mining district in the U.S. In Chile, weâve defined the opportunity for a major expansion at our El Abra mine. As we continue to monitor regulatory and fiscal matters in Chile, weâre planning a project to invest in infrastructure, water infrastructure to provide flexibility to extend existing operations and optionality to support a new concentrator. Weâre also planning at El Abra to test new leaching technologies in the near term, to evaluate the potential for expanded leach production and possibly competing technologies to a concentrator. Weâre continuing our development of the Kucing Liar deposit in Indonesia. Weâre really gaining a lot of efficiencies from the work we did at Grasberg Block Cave. And similar to that development, this is a long-term project. We expect to have initial production from Kucing Liar deposit towards the end of this decade. Moving to slide 12. We provide a three-year outlook for our sales volumes. And as we talked about, we achieved two years of growth in copper sales. And currently, our forecast reflects sales in the â23 to â25 period that are similar to 2022 levels. Our mine production is actually going to be higher than our sales by about 100 million pounds in 2023 and 2024. And that is a result of our domestic processing arrangements in Indonesia where the point of sale has changed from selling concentrate to selling cathodes. And so, a portion of our production will be inventoried until itâs processed and sold through our smelters. Previously, this inventory would have been held by third-party smelters. Weâve got small revisions otherwise to 2023 guidance that reflects assumption of a continuation of tight labor markets in the U.S. Thatâs impacted our ability to increase mining rates. And success also in our leach recovery initiative could provide some upside in the U.S. as we look over the next three-year period. In the reference materials on slide 30, we provide information on our 2023 sales by quarter. The reason for the drop in the first quarter reflects the impact of the tolling arrangement in Indonesia. But, you can see the balance of the year is fairly stable at over 1 billion pounds of copper sales per quarter. Moving to the cost outlook for 2023, weâre providing guidance of average cost of $1.60 per pound for the year. That compares with $1.50 per pound in 2022. We show a comparison to the two years, and youâll see the site production cost line item is about 4.5% higher than the 2022 average. And thatâs a result of assumptions that weâve made in our forecast for higher average electricity and coal costs compared with the 2022 average and also higher power requirements, principally in Indonesia, and the impact of higher cost of equipment components, supply costs and labor cost increases. The other line items are offsetting. Youâll note a decline in royalties and duties. That really is reflective of a recent reduction in our export duty in Indonesia as a result of the smelter progress. Iâll also note that this assumes a molybdenum price of $20 per pound in 2023. The current price is $30 a pound and each $2 per pound change in molybdenum is $0.02 a pound. So, if current prices hold, would have roughly $0.10 a pound less cash -- unit net cash costs and this reflects. In recent months, inflationary pressures have been less severe than we experienced during 2022. Weâre encouraged by that. And weâre going to continue to focus on managing costs that we can control. Weâre continuing to pursue technology-driven enhancements to mitigate the impacts, particularly in the U.S. Getting to our cash flows, significant leverage to copper prices. Weâve got on slide 14, we show modeled results for EBITDA and cash flow at various copper prices ranging from $3.50 per pound to $5 per pound copper. These are modeled results and we use the average of 24 and 25 with current volume and cost estimates and holding gold flat at $1,900 per ounce and molybdenum flat at $20 per pound. And youâll see here that annual EBITDA would range from nearly $9 billion per annum at $3.50 copper, to $15 billion per annum at $5 copper. And our operating cash flows would range over these prices from $6 billion at $350 copper to $11 billion at $5 copper. And we show sensitivities to various commodities on the right and input costs. With our long-life reserves and large-scale production, weâre well positioned from future -- to benefit from future metals intensive growth trends with prospects for increasing cash returns under our performance-based payout framework. Our capital expenditure plans are summarized on slide 15. The capital expenditures totaled $2.7 billion, excluding the smelter in 2022. Weâll note that this was lower than the $3.3 billion estimate we provided going into 2022, and that reflects lead times and our focus during the year to prioritize critical projects. The current forecast for 2023 totals $3.4 billion, and thatâs a slight change from our previous estimate of $3.3 billion for 2023. And capital expenditures for 2024 currently forecast to approximate $3 billion as spending on the Grasberg projects reach completion. We always are very careful in managing our capital cost to maintain flexibility in response to market condition, while ensuring that our investments are sufficient to support a reliable long-term production profile. Returning to the financial policy that we began to implement in the second half of 2021, itâs really centered on three priorities. The cornerstone of the financial policy is maintaining a strong balance sheet and liquidity. And that provides significant flexibility for the future. Weâve been executing on this performance-based payout. It provides for 50% of our free cash flow to be allocated to shareholder returns in the form of dividends and share purchases and the balance available to invest in our projects. Since commencing the performance-based payout policy in the second half of 2021, weâve returned about 60% of our free cash flow to shareholders through dividends and share purchases. And at the same time, we also further strengthened our balance sheet, providing capacity for funding new projects over time. We did not purchase shares in the second half of 2022 because of the significant change in market conditions and the resulting impact on cash flows in the second half of the year. The improved market conditions will drive increased free cash flow, which will boost shareholder returns, and our future discretionary share purchases will be dependent on our cash flow and overall market conditions. We believe the three priorities of balance sheet strength, allocating cash flows to a mix of shareholder returns, and organic growth will enhance long-term value of our business. In closing, I just want to reiterate our view about the positioning for the Company, a bright long-term future supported by our attractive portfolio of assets, supported by the fundamentals of the copper business and the positive outlook for the markets we serve. Our team is energized. Weâre motivated to continue building long-term value in our business and on executing our plans responsibly, safely and efficiently. Good morning, Richard and Kathleen. And thank you for taking my questions. I would like to sort of ask around Freeportâs growth appetite. And as you think about the copper price environment and how the market is trending, has anything in your mind changed around how you view Freeportâs need to pursue or accelerate growth plans? Thereâs clearly been a lot that has changed in the broader macro environment as well. And I wouldnât mind hearing about how maybe some of the leaching opportunity can play into that and what the potential annual run rate basis could look like when fully developed? Thank you. Thanks, Emily. With leaching, weâre not constraining ourselves to conserve capital or anything else. Weâre -- we believe this is such a great opportunity for us that we are pursuing it as aggressively as we can, and we are pursuing it on a number of different fronts, some using outside vendors, some doing things on our own, some in joint ventures with companies. Itâs just such a great opportunity to add production at low capital cost and with low carbon. So, itâs not something weâre constraining. The other projects that we have, and Kathleen reviewed them, we have a series of major capital projects that are multiyear large capital requirements. And for those, we are working hard to prepare ourselves for them and doing work so that we can go forward. But we are going to wait until the uncertainties that weâve been facing recently are -- become clearer. As I said, the current sentiment is much stronger than it was three months ago, but thereâs still a lot of overhang in the market, as you can see in the market today. So, we are waiting to see that our project in Chile is dependent on the direction the country goes in with this current consideration of its laws and its constitution. So, that is really going to be on hold until that becomes clear. So, weâre not preparing any major change in the first part of 2023 versus what we did in 2022. Emily, on the leaching run rate, the 200 million pound target that weâve laid out, those -- we believe that that can be attained just from these operational changes that weâre making. The heat retention, leaching in places that we werenât leaching previously, directing the solutions to places where we can enhance recoveries really from data analytics that weâre getting that are helping us -- helping guide our operations every day. Those things we think we can get just operationally. The -- on top of that, this research and development thatâs going on with respect to additives, that could scale it larger. So, this 200 million pounds that weâre talking about, we think that is really just bringing more of a light on our leach stockpiles and moving aggressively to -- over the last several years, the focus on the industry has been more on concentrating. And now weâre putting focus back on these leach initiatives, and weâve identified some things. I wouldnât say low-hanging fruit, but itâs achievable things that weâre doing, and weâre already starting to see results. Just given the uncertainty out there with respect to both Chinese and ex China markets, can you give us an updated outlook on what youâre seeing from your customers? Like are you seeing any indications of slowing demand? Richard, do you want me to take that? Orest, weâre not -- I mean, thereâs pockets -- of course, in the residential markets thereâs pockets of weakness, but there are -- weâre just continuing to see strong physical demand, weâre selling everything that we can produce. And thereâs no ability for us to, at this point, produce more that customers are looking for. So, on balance, Iâd say the physical market continues to be healthy, and we have -- most of our insights come from within the U.S. because weâre a very significant part of the U.S. marketplace. And -- so generally, the market is continuing to be strong, and weâre selling everything that we can produce. And if we could produce more, our customers would want it. Even looking back to 2022, youâll recall, I mentioned I think on more than one conference call that there was a disconnect between even then the physical world we were dealing with, with our customers and what the market was doing. So, it has been striking as to the strength of demand that weâve had, we had no problem selling our production. Weâve actually -- there was a shortage of wire rod in the United States that was -- where we couldnât meet everything that was being produced. And then, with our copper concentrate customers, including China, people were buying all that we produced and actually wanting more. So, market sentiment is better now. And but our customers continue to be very positive. You have $1.3 billion of net debt as of the end of 2022. Your net debt target range is $3 billion to $4 billion. So, I guess, the first question is, is that the range that we should think about? Are you comfortable maintaining net debt below that range? In other words, if you really want to get to $3 billion to $4 billion, how do you get that from here, generating positive cash flow? You can step up the buybacks, maybe accelerate returns. But do we get to a $3 billion to $4 billion range this year, or is that not going to happen? No, I was just going to say, Chris, and Kathleen can talk about the details. When we announced the financial policy, as I looked out and I said, the likelihood is, cash is going to come in faster than we can spend it just because of the nature of our capital projects are long term. It takes a lot of time. This has happened before Freeport. Two previous occasions in our history, we got down to zero net debt. This is setting aside the smelter because thatâs financed on its own. But, what this does is by having that cushion between where our debt is and our debt target is, it will allow us to readily be able to finance future construction projects. But itâs just the way the cash flows in versus -- we donât feel any compulsion to spend money to get the debt up to that target. Okay. So, should we think of it more as a net debt target of below $4 billion rather than $3 billion to $4 billion? Got it. Okay. Good. And then sorry, second question on Grasberg. You -- it looks like youâve increased your gold production guidance for 2024, â25 and â26, but copper volumes are pretty much the same. So, is there something -- whatâs happening there to result in an increase and what you expect to get out of that mine in terms of gold over those three years? Well, while the numbers look simple, the mine planning is complicated. And we report the results of our mine planning quarterly. And what youâre seeing there is some revisions in mine planning to optimize resource recovery. It wasnât any target. Itâs just the way that -- the way that the mineralization of these ore bodies fall out as we change future mine plans. And... Yes, there was some changes between Grasberg Block Cave and Deep MLZ. And additionally, weâve been getting higher gold recoveries than we had previously forecast. And thatâs helping us as well. So, those are the main differences. And itâs not a targeting it -- itâs not a targeting exercise, Chris. I mean, we didnât do something to try to get more gold. It was just -- if we look at the orebody, we maximize the value. Itâs a dynamic process and report to you the results of that process, and thatâs what it is. Good morning, Richard. Good morning, Kathleen. Very nice to hear from you both, and thank you for your time and the update today. I wanted to hopefully ask you two questions. Just one on the C1 cash cost guidance for 2023. To what extent might some of these higher costs year-over-year continue into 2024? Like what is the percentage of those that are more structural as opposed to potentially more cyclical? I think you can look at -- I think you can look at the makeup of our costs. On that slide, we provide a makeup. And labor cost is something thatâs kind of stays with you. Materials and supplies, a component of that is commodity driven and a component of its services driven. The energy, I think, is more variable and things like sulfuric acid is more variable. So, you can look at that pie chart and get a feel for which ones have the ability to change, and we provide some sensitivities on things like currencies and diesel costs. Okay. And one thing thatâs -- one thing thatâs a real benefit of Freeport that we say a lot. Iâm not sure if this is recognized as much as it ought to be. But, we operate every mine that we have an interest in. We have joint venture partners. But unlike other operations where those joint ventures are run as a standalone business, we operate globally through our operatorship rights. And that makes us really important customers of our suppliers. Weâre generally one of the very largest customers of people who provide our major supplies. And so, as those suppliers globally have been working to pass along their input cost, our global supply team working with our operations have been affected in mitigating certain of those costs. Weâve had some impact. But again, itâs a real dynamic situation and -- you saw we came in below our quarter-ago estimate. Some costs are moderating, some are carrying over, but itâs just an ongoing thing. And we give you the best outlook we have, and then we work hard to try to operate with as low a cost as we can. And then, I wanted to follow up on your comments around El Abra and the plans to advance water infrastructure. Are you considering desalination capacity? Is that what youâre referring to there? And then... Well, weâre working on it right now, and weâre structuring, so that we have the alternative of going forward with our current operations and maximizing those or undertaking a large-scale investment and new concentrator there. So, weâre approaching it to give ourselves the alternatives of going in either of those directions. But we wanted to get started with that because it was going to be required one way or the other. Yes. And so, weâve got to go through a permitting process on that as well. So, itâs unlikely weâll have any material spending on it until a few years out. It takes time to do it. But as I said, we -- in the past, weâve been delaying that so -- we made the decision on the concentrator expansion. And in recent months, weâve decided we need to go ahead with the permitting for the water, desalt plant, so that -- because weâre going to need it one way or the other. Good morning. Congratulations on all the progress in the tough business. Thinking of the slide 11 with the five projects, I realize it takes a lot of engineering resources for each of these projects. Is five sort of the maximum number or do you have time for a little more? Youâre engineering El Abra but the constitution and taxes and all that stuff is up in the air. So, thatâs a big investment in time. You donât have the Sierrita mill, Chino mill or an additional Morenci mill projects there. I know you canât do anything -- everything. But a $30-plus molys Sierrita new mill must be very attractive, youâre budgeting 20 and maybe lower for the long term at 15 for your reserves. Is there too much Indonesia in your CapEx and not enough Americas since youâre the biggest U.S. copper producer? And with politics, the U.S. looks better every day. I know thatâs a lot of thoughts, but how you fix the projects? Well, no. And you know itâs a good new story to have this large pipeline of future projects, and I personally believe the world is going to need that copper. Going to your last question first, there is no relationship between Kucing Liar and projects in the U.S. It doesnât bump out projects. It doesnât prioritize anything. Itâs something that fits right in. It will be financed by PT-FI out of cash flows from PT-FI. And it will support our volumes there through our current operating rights to 2041. Weâre talking with the government about extending those. Thereâs opportunities for Kucing Liar beyond that. And we believe, although we havenât been engaged in drilling exercises in the Grasberg Block Cave and Deep MLZ and who knows what else is down there because we really havenât drilled to explore future opportunities. Now, John, you know the thing about Grasberg, ever since we discovered it, it keeps getting bigger and bigger and bigger. But thatâs on its own, there is no effect on what weâre doing at Kucing Liar with what we do in the United States. So, we have the financial resources to do -- in the Americas, the United States and South America. So, the ones weâve listed are the ones we believe are the largest, most significant executable projects initially. The Bagdad expansion is a straightforward doubling of mill capacity, and weâve dealt with water issues and so forth and... It has moly, Bagdad. And the biggest problem, quite frankly, at Bagdad is getting workers. Itâs just a challenge getting mine workers in todayâs world who live in these remote communities where our mines are. But thatâs a very executable project, itâs not that complicated. But -- and as we deal with the workersâ situation in housing, as markets clear up, thatâs one that would be ready to go. As I said, El Abra is depending on the direction of the government there. Lone Star, which really looks like it can be another base level high-profile operation for Freeport in the future, weâre going to maximize it through the oxide, ore and continue to understand how we attack the big sulfide resource that weâve identified in. Then beyond that, you mentioned Morenci, Sierrita, and thereâs other older mines that we have. Chino has a growth opportunity. All those are in stages of evaluation and understanding what we have. Obviously, when you sit down on top and look at this organization, you want to be focused. You donât want to just have a scattergun approach. But all of those things provide us growth opportunities from inside our company, which makes it very unlikely that weâll be acquiring smaller operations to pursue externally. You can just see whatâs going in the world when you have to pay a big price, you get a resource and then you put the capital on top of it. And that ends up with a very large investment to try to recover. Itâs much better because we get no value today from these future resources that we have within our own portfolio. And with success in developing those, all of the incremental value goes to our shareholders and not somebody elseâs shareholders. I was just going to say your question about the molybdenum situation. We do have excess milling capacity at our Climax mine. And weâve been operating at below capacity in recent years because of market conditions, but we have started to do a stripping campaign there that will allow us to expand production from Climax. Over time, it doesnât require a new concentrator or anything like that. So thatâs our first one -- and the incremental costs are attractive. So, we are doing that. And as Richard said, weâve got -- we got a lot of projects in the background. But these are the ones that are strategic and that weâre focused on. The leach technology is a near-term project. And Bagdad long term -- I mean, medium term and the Lone Star major expansion longer term. El Abra, we believe, will get done. Itâs a project that itâs attractive and it will get done. Itâs a question of when. So, we donât have a good view yet on when that will go forward. But this investment in some infrastructure and water is going to give us some optionality to support an expansion. So, weâve got all our people focused on these things and we have an enormous resource base like we were saying in the U.S. where we already have established operations and community support. So, weâre in a really good position as we look forward as to what this world is going to need in terms of new copper supply. None of this can go quickly as you well know. If I could follow with one more. A few years ago, Freeport bought a drinking water system and a sewage system for Arequipa, the third largest city as you were tripling the El Abra mill and mine -- excuse me, the Cerro Verde mill and mine. And I think you might have some rail -- short-line rails, so that you donât have as many trucks on the road. Could you just confirm that your tons per day are 350,000 to 400,000 tons a day and no mishaps at Cerro Verde? I think, thereâs a lot of confusion in the press about conditions... Yes. So, in the last several days, weâve been operating -- weâve been operating at around that 350,000 level. Prior to that, we were closer to 400,000. Weâve really been operating at 10%, 15% lower just to deal with supplies. And so, weâre watching that every day. And Iâll let Richard comment on the community situation. But in terms of operations, weâre continuing to operate, but we have limited our mill throughput just to deal with the limitations and the concerns about key supplies. Yes. And Iâm glad you asked the question because I wanted to elaborate on what I said about Peru in my opening comments. I think all of you know that the Cerro Verde milling complex is the largest in the industry, 400,000-plus per day capacity. The tailings dam will be one of the largest earthen dams ever constructed in the history of mankind, if not the largest. And what John is referring to is a number of years ago, we did as a community project invested in a freshwater system for Arequipa, the second largest city in Peru. And then, as we were developing the expansion of the concentrator and tailings dam, we shifted away from building a new dam on the river that runs just outside of the sea of Arequipa. We come in and we built a wastewater collection and treatment system. And with doing that, we got water for our concentrator and we markedly improved the ecology of the river, and that has been very positively received by downstream farmers and community itself. And thatâs really helped foster our positive relationship there. And our team there does overall good. Now, having said that, the situation in Peru is very complicated and nobody at this point can predict how itâs going to unfold. The motions are very high. The government is reluctant to use extreme steps to deal with roadblocks and disruptions and this thing in the day-to-day evolution. And so we are faced with the problems that caused us to cut back on our production rates to conserve line and other inputs so that we could continue to operate. We have the ability to house workers on a temporary basis on site. Most of our workers live in the region of the city of Arequipa, and sometimes those roads have been blocked. So, weâre prepared for it. Our team does a great job in managing things like this over time like COVID and -- but I just wanted to make the point that these concerns that people are raising are directed towards the issues with the government and not directed against us at Cerro Verde and our operations. And so far, weâve been able to continue to operate. I was intrigued by your comment about labor and availability and such. I guess, youâre talking a bit more like in the U.S. But -- how much is that situation limiting -- limited your volume plans for 2023 is probably a small percentage. But is it more secular pressure of getting the qualified productive miners and operators for all your mines? Is that also going to be a limiting factor on how the industry reacts to try to move forward with the market signaling in the future, theyâre going to need more supply? Yes. Well, during COVID, we did have some impacts on our mining rates, and also suspended some milling operations at Morenci. And Iâm speaking about the U.S. right now. And we started ramping back up in the U.S. during 2021, and that continued into 2022. And we have a situation where we currently have about something on the order of 1,300 job openings. And weâve got typically 10,000 to 12,000 employees in the U.S. And so -- and weâve seen a lot of turnover as well. And itâs just been a very competitive marketplace for labor, as youâve read about it, in the U.S. And we donât have that situation in Indonesia or in South America, but we do have competition in the U.S. with other sectors, and thatâs continued into 2023 and whatâs caused us to change our outlook somewhat. We could have in 2022, produced more, if we were fully staffed. And I believe that is the case again this year. And thatâs why weâre making some progress on hires and we are conducting training and some of these workers that weâre hiring now are new to the industry, and so we do have to go through training, and the experience level is not what it was five years ago. So, weâre going through that process. I think it does have some implications to -- the ability to develop a mine in the U.S. is just the labor force. But weâll see what happens. Youâre starting to see some changes in payrolls and that sort of thing, and weâll see how this unfolds. But it is a factor in our U.S. mining output. Yes. So, itâs broader than mining. I mean, when I talk with people to business council, business around the table, itâs a common theme you hear across many industries. And when all the COVID relief funds went out, that was a factor. I mean, face it, our work is hard work. And itâs harder to drive a big haul truck than it is to drive an Amazon or UPS or FedEx truck. So, we compete with those. We pay our people strong living wages. Weâre giving people substantial increases this year. We invest in recreational facilities, try to deal with housing. Itâs an issue in Colorado with our molybdenum mines. You can imagine what itâs like there. So, itâs a big issue for us. And as a result, our mine rates start meeting what we would like for them to meet, and that affects not only current but future production, and itâs a strategic challenge for us. But, itâs not just us and itâs not just the mining industry, but the mining industry because the nature of the work presents special problems. This leaching initiative that weâre pursuing is not labor-intensive, because itâs already -- the material has already been mined. So, thatâs a real opportunity for us to execute on. And if we -- what it opens up to us is unbelievable. I mean, we have -- Morenci the largest leaching operation in the world. It has been for years. And by enhancing the existing leaching operations using all these tools, data analytics and heat covers and supplements, itâs really amazing. But then it opens up historical leach stacks and potentially places like Lone Star using leaching to replace or minimize concentrator investments. So, itâs really exciting. Itâs beyond just this 200 pounds that weâre targeting now. But with success, itâs a great opportunity for us. And itâs not a fracking deal like it was in oil and gas industry. Itâs not going to turn the dynamics of the supply situation upside down. But for a company like Freeport with the leaching operations that we have and the application with success to historical leach sites and future mine development, itâs something thatâs really exciting. And the great thing about it is to see the excitement of our own guys and own team thatâs working on it. Itâs really gratifying. With the revision [ph] in the mining, building [ph] in Chile at least sort of moving in the right direction, it would be interesting to get some color on what youâd realistically like to see to be comfortable with moving forward with El Abra expansion? Yes. I had the chance for the first time to meet the President of Chile when I was at APAC in Bangkok, and we had a very long conversation in advance of his presentation and it was really positive. And he explained to me what heâs facing, which I can appreciate, Kathleen met with him earlier. And so, like whatâs going on in a lot of different countries around the world, particularly when commodity prices go up, people see the opportunity to take financial benefits through royalties and taxes and use them to meet social needs. And itâs just always a balancing situation. At one point, Chile built its whole economy on copper and was very successful. When I was talking with people in Indonesia, the Congo and other places, I would always point to Chile as an example of a country that to be successful by encouraging mining. Chile for a number of reasons, labor and now government situation is losing -- has lost and is losing competitive advantage that it once had. So, these government officials run on a platform of enhancing social programs and then they end up facing the reality of they go too far with that, what that does to their country in terms of its currency, in terms of its economic viability and investment and so forth. President of Chile understands that, and you can see that there has been a more positive tone of dealing with these issues. Weâre not a real leader in Chile, although we are in the global copper business. So, we participate with the government, with other companies there and the conversations that are going on and share our experiences that weâve had in working globally on these kinds of issues. So, the current direction is clearly more positive than it was a year ago. The President is facing a low level of popularity now. And so, itâs a question of facing reality for political leaders. And we certainly lived our -- based our share of those things. And as a mining company, you work hard to gain the trust of the politicians. If you do things the right way, youâre sensitive to their issues. You donât try to take advantage every time you have a chance to take advantage. Weâve actually walked away from projects, because governments -- we didnât believe the deal the government was offering us was sustainable long-term deals. And thatâs proved out to be the case. So itâs a complicated deal, big part of a business for the leader of a company. And youâve got to -- as I said, listen, be responsible, and work to find middle ground so that itâs a win-win deal and youâre not taking advantage of anyone and youâre representing your stakeholders. Youâre not letting somebody take advantage of you. And thatâs what Chile is going through. I believe that the reasonable compromise will be reached because itâs in everybodyâs interest for that to happen. Weâll also be looking at the -- how the constitutional process advances this year. And it appears the financial package is moving forward and theyâre reaching some determination, looks as if thatâs progressing. But we also want to look at how this constitutional process unfolds as well. And in the meantime, weâre maintaining our options by planning to move forward with the water infrastructure investments. And you know, I canât let this call go by without telling you how personally pleased I am with our much improved relationship with the government in Indonesia, where we had a multiyear discussions, negotiations over our mining rights in our contract and so forth. Itâs just been remarkable whatâs happened in the last six months, I made three trips there. We had -- the President had an incredibly positive visit to our job site at the end of August, early September. He asked me to accompany his investment minister and Kathleen was there, too. We did a university road trip and then -- but the two of us went back for the B20 part of G20 and got to see the President and others and itâs just the -- and then APAC and Bangkok. Itâs just a great feeling to feel that weâre all altogether now working to -- for the benefit of all the stakeholders and having the success weâre having on the ground at PT-FI. All right⦠All right. I was starting that. Thank you everybody for participating today. And you know weâre always available for follow-up calls. You can call David initially and he can make arrangements to talk with Kathleen or me or whoever we need to bring into conversation. Thank you for your participation. Itâs great to have a quarter like this, and weâre really excited about our future.
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EarningCall_1212
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Good afternoon. My name is Chelsea, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation December Quarter 2022 Earnings Conference Call and Webcast. All participant lines have been placed in a listen-only mode to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. And I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and Market Analytics. Sir, please go, ahead. Thank you, Chelsea, and welcome to our earnings call to discuss the results of the December quarter and our March quarter outlook. Joining me is Rick Wallace, our Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. During this call, we will discuss our results released today after the market close. All materials can be found on our IR website. Today's discussion is presented on a non-GAAP financial basis, unless otherwise specified. Whenever references are made to full year business performance, they are calendar year references. A detailed reconciliation of GAAP to non-GAAP results is in the earnings material posted on our website. Our IR website also contains future investor events, as well as presentations, corporate governance information and links to our SEC filings, including our most recent Annual Report and quarterly reports on Forms 10-K and 10-Q. Our comments today are subject to risks and uncertainties reflected in the risk factor disclosure in our SEC filings. Any forward-looking statements, including those we make on the call today, are subject to those risks, and KLA cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. Our CEO, Rick Wallace, will begin the call with some quarterly comments and highlights before discussing the semiconductor industry demand environment. Bren Higgins, our CFO, will conclude with the financial highlights, as well as our guidance and outlook. Thanks, Kevin, and thank you all for joining us today. I will summarize KLA's performance in the quarter and summarize calendar 2022. I'll also provide a brief perspective on the overall semiconductor demand environment, as well as outline KLA's priorities for 2023. Before we get into details, I want to first acknowledge our global KLA teams, who've continued to deliver for customers despite persistent challenges. KLA's results are proof of their commitment. KLAâs December quarter have revenue of $2.98 billion, which is above the guidance range, with 27% growth on a year-over-year basis and 10% sequentially. Quarterly non-GAAP net income was $1.05 billion. GAAP EPS was $6.89 and non-GAAP EPS was $7.38, with each finishing above the midpoint of the guidance ranges. Calendar 2022 was another year of record growth, profitability and free cash flow. Specifically, revenue increased 28% in 2022 to $10.5 billion, marking the seventh consecutive year of growth, driven by 36% growth in semiconductor process control systems. KLA also demonstrated strong operating leverage on our revenue growth in 2022, with non-GAAP operating profit up 31% in the year. Non-GAAP incremental operating margin on the revenue growth was 46% for the year. Calendar 2022, free cash flow was up a healthy 18% to a record $3 billion, with free cash flow growth exceeding our 15% long-term target growth rate. Now I'll summarize some specific highlights from the quarter and the year. First, KLA continued to deliver strong relative outperformance versus peers. KLA substantially outperformed overall WFE market growth in 2022. Looking ahead, our leadership in critical markets, such as wafer and reticle inspection are expected to demonstrate resiliency in a year of contraction in overall WFE demand, setting the stage for another year of relative strength for KLA. Second, our Patterning Systems revenue grew 17% sequentially, which is up 69% on a year-over-year basis. Third, KLA delivered record revenue in the 10th consecutive quarter of sequential growth in our specialty semiconductor process segment, demonstrating resiliency and expanding market opportunity. Fourth, the KLA Services business grew 14% year-over-year in the December quarter and was up 15% on a full year basis. Finally, the December quarter was another exceptional period from a capital returns perspective as we completed the $3 billion accelerated share repurchase component of the $6 billion share repurchase authorization announced last June. KLA December quarter and calendar 2022 results and strong relative performance once again highlight the critical nature of KLA's products and services. Our consistent strong execution against various challenges in the marketplace, both in terms of macroeconomic uncertainties and addressing persistent supply chain challenges highlight the resiliency of the KLA operating model, the dedication of our global teams and our commitment to assertive capital allocation and delivering long-term value to our stakeholders. Looking at 2023, we know that this will be a year of industry capacity adjustments as customers fine-tune their CapEx plan to address decreased demand in some segments. However, we recognize that the semiconductor industry continues to be positioned for long-term growth, benefiting from the continued advancement of leading-edge technologies, increasing investment in legacy nodes and innovation and growth of new enabling technologies such as advanced packaging. To address this period of adjustment and maintain our commitment to growth, we're emphasizing three main priorities for our teams in navigating 2023. First, we will continue to make sure that we support our customers by delivering on our commitments and continuing our levels of investment in R&D. Second, we'll stabilize our spending levels. To strategically navigate the current environment, our focus will be on stabilizing spending, while maintaining R&D investments to drive market leadership. Our expectation is for R&D investment to increase in calendar 2023. Third, we'll emphasize development of our workforce. After a strong hiring pace, we're currently at approximately 15,000 employees worldwide. Optimizing training and developing our workforce will help ensure continued strength for the long-term. Thanks. As Rick has detailed, we delivered strong December quarter and calendar 2022 results that demonstrated consistent execution by the global KLA team. While supply chain challenges remain an impact on certain products, we continue to demonstrate resourcefulness and the ability to adapt to meet customer requirements. Quarterly revenue was $2.98 billion, $184 million above the midpoint of guidance and just above the guided range of $2.65 billion to $2.95 billion. Revenue outperformance in the December quarter was driven primarily by KLA's broadband plasma optical pattern wafer inspection and mask inspection systems, resulting from favorable mitigation of identified supply chain risks, as we move through the quarter. Non-GAAP diluted EPS was $7.38, above the midpoint of the guided range of $6.30 to $7.70. GAAP diluted EPS was also above the midpoint of guidance at $6.89. Non-GAAP gross margin was 61% and just below the guidance range of 61.5% to 63.5%, due to the impact of increasing non-cash inventory reserves taken in the quarter as we adjusted our factory output expectations and supply chain commitments to the current outlook, which has weakened at an accelerated pace over the past several months. These reserves were primarily taken against high-volume products and are consistent with shifting customer delivery dates and resulting backlog adjustments in the quarter. Given the diversification of end demand across technology nodes, the extendability of our product platforms and the expectations for growth in our service business, it is likely that we will realize a benefit from releasing these reserves over time when industry growth resumes. We estimate that these adjustments had a roughly 200-basis-point impact on GAAP and non-GAAP gross margin compared to what would have been assessed in a normalized industry environment. This impact was offset somewhat by higher business volume and by a strong product mix realized in the quarter. Non-GAAP operating expenses were $555 million, slightly above our estimated $550 million for the quarter. Total non-GAAP operating expenses comprised $332 million in R&D and $223 million in SG&A. Non-GAAP operating margin was strong at 42.4%. Quarterly non-GAAP net income was $1.05 billion. GAAP net income was $979 million. Cash flow from operations was $688 million, and free cash flow was $595 million. Breakdown of revenue by reportable segments and end markets and major products and regions can be found within the shareholder letter and slides. Switching to the balance sheet, KLA ended the quarter with $2.9 billion in total cash, cash equivalents and marketable securities, debt of $6.1 billion, a reduction of $200 million in the quarter and a flexible and attractive bond maturity profile supported by strong investment-grade ratings from all three agencies. Over the last 12 months, KLA has returned $5.2 billion to shareholders, including $4.5 billion in share repurchases and $689 million in dividends paid. Looking ahead to calendar 2023, we expect industry spending to slow with the continued expectation for CY 2023 WFE demand to be down approximately 20% in the year, down from approximately $94 billion to $95 billion in CY 2022, due to increasing global macroeconomic concerns highlighted by our customers in most end markets and widely reported customer CapEx expectations. This WFE estimate reflects our current tops-down assessment of industry demand as follows; In memory, we expect WFE investment to decline by more than the market, with DRAM down more than NAV as memory customers respond to lower consumer demand by cutting production and factory utilizations to bring device supply in line with demand. We expect foundry logic to decline less than the overall market with leading-edge investment declining less than legacy. KLA's unique broad portfolio differentiation and primary value proposition are focused on enabling technology transitions, which our customers continue to invest in regardless of the business environment. While capacity plans could change, technology road map investment tends to be more resilient and aligns with KLA's highest value product offerings, where we continue to have supply chain constraints inhibiting our ability to add the additional volumes to meet current demand. This demand adds additional confidence in our business expectations as customers align shipment slots with road map requirements. In this industry environment, we will continue to focus on meeting customer requirements, maintaining a high level of investment in R&D to advance our product road maps and KLA's market leadership and align our operating structure with topline expectations, which we expect to be in line or better on a relative basis, while delivering strong relative financial performance. Our March quarter guidance is as follows. Revenue of $2.35 billion, plus or minus $150 million. Foundry logic is forecasted to be approximately 85%, and memory is expected to be around 15% of semi PC systems revenue. Within memory, DRAM is expected to be about 71% of the segment mix and NAND 29%. We forecast non-GAAP gross margin to be in a range of 60.5% to 62.5% as product and segment mix and lower volumes dilute gross margins versus the 2022 baseline in the quarter. Based on current market demand assessments, we do not expect incremental inventory reserve requirements to be a factor in the quarter. For calendar 2023, based on our current industry outlook and the impact on overall volume, segment contribution and product mix within the semiconductor process control group, we are modeling gross margins to be greater than 60% with variability quarter-to-quarter attributable to product mix fluctuations. Operating expenses will decline in the March quarter to approximately $545 million. For calendar 2023, KLA will continue to balance investments in technology, headcount, and infrastructure to support our long-term growth objectives, while managing the business against the expectation of a softening near-term outlook. As a result, we expect quarterly operating expense levels to decline as we move through the balance of the year. Other model assumptions for the March quarter include other income and expense net of approximately $62 million and an effective tax rate of approximately 13.5%. Based on our current assessment of geographic revenue and profit expectations, you should continue to use 13.5% as the tax finding rate for calendar 2023. Finally, GAAP diluted EPS is expected to be in the range of $4.06 to $5.46 and non-GAAP diluted EPS in a range of $4.52 to $5.92. EPS guidance is based on a fully diluted share count of approximately 139 million shares. In conclusion, though calendar 2023 will be a year of contraction after three strong years of growth, we remain confident that the secular trends outlined in our Investor Day last June are driving long-term semiconductor industry demand, and investments in WFE are durable and compelling. Broad-based customer demand across multiple production nodes, increasingly strategic role semiconductors plan influencing national industrial policy, a robust design environment at the leading edge and growing semiconductor content across technology nodes remains important trends. These are long-term secular growth drivers for the industry as technology investment and node transitions reflect the value that semiconductors in our industry have in lowering costs for our customers and enabling a broader application universe for semiconductor-based technology across multiple end markets. For KLA, we have a strong historical track record of delivering relative outperformance across industry cycles. To be competitive over the long run, our customers must continue to invest in product roadmaps irrespective of market conditions. Furthermore, KLA services has continued to grow consistently over multiple decades due to the critical nature of KLA products to improving yield learning and driving fab productivity. Our operational execution, coupled with the power of our portfolio strategy, positions us to continue to deliver sustainable relative performance over the next several years. We will continue to maintain our R&D investment and our product development roadmap to enable market share expansion, support customers' technology roadmaps, and multiyear fab investment plans. This provides an element of stability that shores up our confidence in the demand outlook for the future. These factors, combined with the KLA operating model that guides our execution, positions us well as we execute our strategic objectives. These objectives fuel our growth, consistent operational excellence and differentiation across the diverse product and services offering. They are also the foundation of our sustained technology leadership, consistent industry-leading financial performance and growing capital returns to shareholders. Thank you for taking the question. I guess first question, you talked about expectations to outperform WFE again here in calendar 2023. So curious, can you kind of walk through is that a comment on total revenues or just process control? And within that, how should we be thinking about the benefit from backlog/deferred revenues, particularly in the March quarter? Trying to make sure I calculate that right in my model. Hey, C.J., so I'll start, and I'll let Rick chime in if there's more. But I think there's a few factors as you think about KLA's performance generally as we're looking at this year. Obviously, we had a very strong 2022 from a relative point of view. And when we talk about that, we're really talking about the compares against WFE, right? Because there's other industries we're in, and it's less clear. But given the semi PC compared to WFE, if you look back historically, we've always done well in down years for WFE, because our customers across all our segments pull back on capacity but continue to invest in technology and their technology road map. So that's always a positive factor for us. We also see PC intensity moving up because it â where you generally see more cycling is in memory and so given the relative PC intensity in logic and foundry that tends to be something that's good for us as well. Relative to EUV and the dynamics around EUV Reticle and EUV, our optical pattern inspection business are inflecting. So that gives us incremental, I think, support in terms of growth as we expect both those businesses to be better performers relative to the overall industry, and they're big parts of KLA. China impacts another factor, right? I think if you look at some of the peer companies and some of the export control dynamics as a percent of the total, I think they are impacting some of our peers perhaps at a little greater degree than KLA. So I think for all those factors, we feel pretty good about our position as we think about just our performance relative to the overall market despite the strength of what we saw in 2022. In terms of Q1 and backlog, I mean, the deferred revenue hasn't really changed. We haven't had the issues that others have had in terms of â of having those â the deferred revenue bloat up related to some of the supply chain challenges that were well chronicled. So that's fairly normal in terms of how we look at 2023. The backlog did come down. We did some scrubbing related to the China export principally. So we saw some reductions there. We'll see the performance obligations come down about $1 billion overall. So, some of that being the effect of the China dynamic, but also we did revenue at a level that was above the new bookings. So, not a lot, and there's still a significant amount of backlog, and I think that we'll see that play through as we move forward here. So some of that is tied to longer term to facility projects out beyond 12 months. 45% to 55% of our backlog is for delivery outside the 12-month window. So hopefully, that gives you a little bit of color on the overall and our expectations for 2023. And C.J., maybe just to add one thought. When we laid out our investor plan for '26, at the time we did that, we actually anticipated that there would be a contraction between '22 and '26. We obviously didn't know when, but we felt that, that was going to happen. And our assumptions for that model were based on our percent of WFE, which, as you know, is a combination of the process control intensity in our share. We don't see any degradation of that in 2023 based on what we see. So we see holding percent of WFE or maybe continuing to make progress. So we still feel pretty good about the trajectory that we laid out in '26. And even though there will be -- these puts and takes based on projects that come and go, I think we feel pretty good, and we don't think 2023 will be a problem relative to that longer-term plan. Great. Very helpful. As my follow-up, you talked about expectations for gross margins north of 60% for the whole year, guided 61.5% for March. I guess this is kind of a two-part question. I guess, how do you see kind of a trough revenue quarter here? If you can answer that. And does that mean that we would be below 60% in the back half of calendar 2023, or you think you can stay north of 60% every quarter for the year? Thanks so much. Yes, I think what we could stay above 60%. Look, there could always be quarter-to-quarter dynamics in a given quarter depending on the mix of the business that could drive us beneath that level, but our expectation is that for the year will be better than that overall. I would expect, and as we said over the course of last quarter, that we thought that Q1 was likely the higher quarter in the year and that we would see a drifting down in terms of the run rate. And just to make the math work, you would see a lower second half than the first half. So, I think you likely stay north of a couple of billion in terms of revenue levels, and we should be able to hold 60% in terms of a run rate from a gross margin point of view. Yes, thanks for taking the question. I wanted to kind of double click on your WFE expectations and then how do you think about your model. Are you thinking about first half or second half WFE being relatively balanced for the year and then within your kind of forward revenue expectations for KLA as well? I think my statements earlier were more KLA-centric, but I don't think we're going to deviate that much from overall WFE. Obviously, that gets into the other businesses and markets that we don't participate in. But generally, I would expect that we're at a higher run rate, a WFE run rate, in the first part of this year than we are in the second. So yeah, I would think that it's probably down. I don't know how much it's down, but it's probably lower in the second half than the first half. Got it. And then just kind of maybe bigger picture. But one of your larger customers have talked about a temporary decline in the 7-nanometer utilization rates, but at the same time, also talking about working with their customers to introduce to backfill capacity, introduce new products over the next few years. I guess how do we think about that dynamic in the context of like your print check business and the mass shop? I think that it's much more -- it's baked into our assumptions on the overall reduction in WFE that they're going to be shifting. But I don't think the mix between our products is really going to change for that period if you think about where logic is positioned. The other thing that Bren mentioned, as you know, as EUV gets increasingly adopted, even if it's at lower capacity, we'll see more demand for print check and in reticle in general. So the strength of those businesses, we think, continues on a relative basis, albeit in a declining overall market for some period of time. But those are product lines that right now, we don't -- we're still supply-constrained in terms of our ability to support customer needs on those products. Yeah. If 7-nanometer capacity demand falls off, right, and we don't expect to impact, you would expect to see wafer starts maybe come down at that node. Most of the investment we expect to see is at the more advanced nodes. Customers are always looking to optimize the productivity of their capacity. Depending on their views, it could be temporary, in which case they'll idle some of that capacity or run it at a lower utilization rate. And then if in the longer run, they feel like they can move it, they'll try to move it. They do have the technical challenges though that if you were to move from 7 nanometer to 5 nanometer, you have the introduction of EUV from node to node. So the technical challenges of trying to reuse that capacity is much more difficult in this environment than it was, let's say, 10 years ago. Guys. Thanks for taking my question. Your services business last year was strong, right? It was up 15%. Historically, like this segment does not decline during downturns, right? Very stable subscription services contracts, expanding support opportunities, legacy nodes, more software attach, et cetera. But you do have a transactional part of the business, right, tied to manufacturing activity. You've got your EPC services business in there as well and the impact from China export control. So lots of puts and takes. So does the team believe it can grow services revenues this year? Yes. Yeah, you're right. We do have some puts and takes. But if you look at the -- and just for some history, right, if you look at our service business overall as it relates to semi process control, we've only had one down year going back at least the last 20, maybe 25 years, and that was in 2009, where we're facing an extremely challenging macroeconomic environment. So you're right that when things slow down, particularly in memory, as an example, customers will scale back in terms of the utilization of their equipment. But we still have a lot of equipment that's coming off of warranty that's going into contract that's been shipped over the last few years. Customers continue to run the installed base typically to support even if they're not investing in new capability. EPC is a little more transactional, and I would expect EPC service to be flatter year-to-year. So I don't think we're going to grow like we did this year, where we grew 15%. But I would expect to see a mid to high single-digit growth rate in services overall. So I think when you look at our overall business, and we talked about semi PC growing roughly in line overall with the market, maybe a little better than that. Service is growing mid to high single digits. And I think EPC Systems is going to be somewhere in less than -- have a decline, but a decline that's less than what we're seeing on the WFE side. So because we have had a weaker 2022, that business is much closer to consumers. And so I think they entered into some of the more challenging environment a little bit sooner, but that's how we're thinking about the overall. And the other factor, Harlan, when you consider our business, our service is pure service, as we talked about. And also it's really not about consumables. So from the standpoint, their capacity goes down, some of the consumable related service business will go down as a result. Ours because of the nature of what we do, and often, even if customers are constraining capacity, they're trying to optimize yield, and so that's why I think our service fares pretty well in this kind of environment. Great. I appreciate that. And strong patterning growth in 2022, I think patterning was up like 50%. Obviously, part of that is being driven by EUV, DUV little adoption. And if you look at ASML's results, I mean that continues strong. But I think they're looking for EUV little systems being signed off, units being signed off this year to grow like 40%, both for EUV and Deep UV. So those shipments are always sort of a good board indicator for your business? You've got positive exposure of wafer, your reticle inspection systems, print check, litho metrology. Is this going to be one of the -- it was clearly a bigger driver last year. Is this going to be one of the bigger drivers of the potential out-performance this year for the team? Well, I think you're right in some regards. And certainly, when it comes to technology transitions, a lot of what's driving the metrology is related to those tech transitions such as gate all around, right? The work that's going on there is driving it. But there is a part of that business that's tied to capacity. So that's really puts and takes inside of that business. So it's not entirely just related to the tech. And again, when you look at the overall market growth in the different segments, our view of lithography as part of WFE is a little different than what was stated maybe overall because of the deferred revenue component of that. So again, I think KLA is going to do well as we go forward in 2023. And the metrology as it pertains to technology advancement development will be strong. And both in -- as both metrology and overlay related as companies, our customers try to advance in terms of the tech notes that have a lot of challenges in those two areas. Thanks for taking my question. If you look at the full year WFE view of down 20% in the kind of the mid $70 billion, that view -- that overall view doesn't seem to have changed in the last three months. But something else seems to have downshifted in the commentary from you and your peers. I'm just curious if, Rick or Bren, if you would take a look back in the last three months, what has changed from an assumption perspective? Is there a certain part of the market that you are exposed to? Like has there been any change in the last three months? Because the overall number doesn't seem to have changed. Yes, Vivek, it's a good question. Not much has changed, frankly, in terms of how we've looked at it. Obviously, we had the strength of Q4, which contributes to the marginal weakness in the March quarter, where we had $184 million in incremental revenue above the midpoint in December. And so that clearly came out of the March quarter. So that puts a little bit of pressure on the March quarter. But as we look at the overall year, it generally looks very similar to what we had three months ago. So I don't think that much is different. It feels pretty consistent. Well, I guess, yes, it's kind of similar to what we said. But at the time, it wasn't what a lot of customers were saying yet, right? So at that time, there hasn't been as many announcements for CapEx reductions. So we kind of forecast that, that was going to happen. And so with that kind of the news, it kind of got to this point where we're about where we said. That wasn't the case when we first viewed what was probably going to be a correction in 2023. So I would say it's kind of landed where we thought, but there was a fair amount of news in getting there as people said they're going to cut their CapEx. Got it. And for my follow-up, if I'm hearing you, March is perhaps not the trough quarter for the year that, I don't know, maybe it's June or September. Any way to gauge what that kind of conceptually the trough quarter could be? Because when I look at memory, I think it's only about 15% of process control in Q1. Is that the trough for memory, or can it get even lower than that? Yes, Vivek, I'm not going to guide each of the quarters. It feels today like things are stronger likely in the first half. There's some investments at the very end of the year that could cause the December quarter to be stronger depending on the timing of the fab construction. And so there are some things in, I'll call it, in Q4 that could swing the quarter-to-quarter one way or the other. But as I said earlier, I think that the second half is likely lower than the first half, and I'll stick with that for now. Hi, there. Good afternoon. Thanks for letting us ask a few questions. Maybe just to double back on the performance obligations. It sounds like -- I could be a little bit off here. But in terms of 12 months RPOs, maybe it's -- maybe ended the December quarter kind of a $6 billion-ish kind of level. Is that about right? And is there a point in terms of as you draw that down a little bit maybe over the next few to several quarters, is there a point in the year you can kind of point to where you think that number will stabilize? So we're going to report -- we'll likely file our Q sometime in the next day or so, so you'll have the specifics on it. But your math is about right. It's a little bit higher than that, and we'd still expect 45% to 55% beyond 12 months. And as I said, some of the adjustments that were made were related to some more clarity around China export restrictions, so that was a factor in some of our adjustments. I think, as we progress through the year, look, we'll see how the order flow plays out over time. But -- and there's still work to be done in terms of whether we are able to continue to get some licenses that we're still working through in some time. That could have an effect as well. But I don't expect to see -- I think, it's going to level off. I don't expect to see it come down all that much. I think, it will level off, as we move forward over the course of the year. But, look, things can change, and that's the best visibility I have today. Okay. Yes. That's fair. And this is probably just digging into a question that was recently asked. But, I mean, I think the math might suggest that in the March quarter, the memory system revenue could be something like $250 million, maybe $250 million to $300 million. Maybe that's not trough, but it seems pretty low comparable to recent periods and going back low ways. And so, maybe not trough, but not too far off, is that kind of unfair conclusion? I would have to -- yes, you're right. I mean, it's lower than it has been for a few years. I don't know if it was lower in any given quarter back, let's say, in late 2018 or early 2019 in that time frame. I'd have to look. But it's certainly as a percent of the total as low as it's been for some time. Great. Thanks for taking my question. The revenue decline in the March quarter is a little more severe than we kind of expected. I guess, we had thought the revenue is relatively stable, especially given the large backlog you had going into the quarter. Is it just that you were able to pull in some of the revenues into the December quarter, or was it my assumption that revenue could be stable in the near term was incorrect? Sidney, it's a great question, and you're absolutely right. It pulled in into the December quarter. When we started the quarter, we had risked out some of the... Thank you, Chelsea. Sorry, we got cut out there. I know a little in answer to Sydney. So Sidney, let me just start again. Your question was about just the quarter-to-quarter changes. And you're absolutely right that we did see the strength in Q4, and that was a pull forward from the March quarter. As we were looking at the business back in October, we had some systems where we were dealing with some supply chain issues, particularly as it relates to broadband plasma and reticle inspection products. As we work through the quarter, we were able to work with those suppliers, get the parts we need, run through our qualification processes and complete those tools. Customers, given the demand and balance we've been dealing with for some time on these products, our ability to supply relative to where demand is, we're more than willing to take the products when we had them finished. So when you add the two quarters together, the number is basically the same. And our view here is we're going to keep the line moving, particularly as it relates to getting these systems out the door to meet customer requirements. And so we finished them and we shipped them at the end of the quarter. Okay. That's helpful. Thanks. Can I ask the second question? You talked about expecting operating expenses to come down throughout the year. What is a good level to think about exiting this calendar year? Talk about maybe what are the areas you see more -- you'll see more of the cuts. And are there any of the actions impacting the gross margin positively as well? Thanks. Yes. I think the gross margin guidance we gave earlier stands for itself and reflects some of the actions that we're taking just to deal with. One of the challenges in our factories is we're coming off, which drove our inventory issue that we had this quarter as well as we're coming off pretty high growth expectations in a pretty short period of time. It wasn't that long ago when people were talking about $100 billion of WFE this year and 105 or more into 2023, so $100 billion in 2022. And so there's been about $30 billion plus of WFE that's come out in a relatively short period of time. That had an effect on some of the buying that we've done to drive our supply chain the way that we have. But also, it will have to deal with some of the underutilization of the factory resources that were put in place to support higher volume levels. But the guidance I gave in terms of gross margin reflects those actions and what we plan to do. I would think that by the end of the year, we'll probably be looking at a quarterly run rate based on how we're running the business today. And our expectations for topline, somewhere in that -- I'll say, somewhere around $530 million to $535 million. So, we'll see it trend down as we go according to each quarter, more or less. And depending on how we see the topline evolving, not only as we look at the second half of the year, but as you start to look at 2024 and size 2024, then we'll come to a determination whether that is appropriate level for us to be at or whether we need to do more or less from there. All right. So, I have a question on the memory investments. Are you expecting memory CapEx reduction to be broad this year, or just one or two memory makers? I'm expecting it to be pretty broad. Look it will vary by customer. And as you know, it's not our strongest market in terms of overall exposure, and we tend to be more focused on the technical part, right, technology roadmaps, less so than capacity. So, when we look at it -- I think it's pretty broad across all our customers, but varies according to some of them, right? I don't think they're all completely consistent. Got it. And then on China WFE, are you expecting China WFE to be down as much as overall WFE? And what's holding China WFE? Is it the trailing edge investments? And what's driving higher investments on the trailing edge? Is it all to end market or maybe higher process control intensity? Yes. Most of the logic investment has been at the legacy nodes. The other thing that gives us some confidence about 2023 that I had mentioned in the earlier answer was the infrastructure investment that's happening in China for mask investment, mask infrastructure, and for wafer infrastructure, which is parts of WFE that we're exposed to that some of our peers are. So, when I look at the overall, inclusive for KLA, inclusive of what we expect in export restriction, which hasn't changed from what we talked about a quarter ago, I think overall, we'll see our business in China likely decline less than the overall WFE. Hi guys, thanks. There was a question before about EUV and I'm wondering if you can sort of help give a number in terms of how much of your revenue attaches directly to EUV. There's not a ton of inspection in the litho cell, but you certainly get pulled along with anything that helps sort of ordered onto scaling. So, -- and obviously, EUV does that. So, I'm kind of wondering if you can handicap, how much of your revenue gets carried along with EUV? And then I had a follow-up. Thanks. Yes, Tim, we don't really break it out like that, but I can kind of give it a shot and talk about applications that are related. The main one, the most obvious one is â that's new is print check, and that is inspection that's directly related to EUV. And I think the other one is, of course, all the reticle stuff. There is some overlay work that also happens relative to some of the matching challenges associated with EUV. So I would say, part of each of those markets, and if you had to add them all up, probably 15% to 20% of what we're â overall, what we're doing in those markets is probably related directly to EUV as opposed to additional scaling. We can do some work and come back on that because it has been growing. The print check part has been driving a lot of the growth that we're seeing in the Gen 5 in particular work that we're seeing. So that's kind of how I'd handicap it Bren? Awesome, Rick. Thank you. Super helpful. Bren, I had a question for you on process control systems. It seems like the guidance â well, actually, it's a two-part question. It seems like the March guidance implies something in the 16.5% range for Process Control segment systems. So I wanted you to confirm that, first of all. And then the real question is the timing of when the process control systems bottoms because Lam is bottoming in March, but it seems like if I take low to mid-70s WFE, I assume you don't lose much WFE share. It's kind of hard to see the number not bottoming until you get to 1.1 roughly and you're still at 1.6. So, can you sort of answer those for me? Yeah. So your first question about margin, and of course, we don't guide the individual segments. But your assumption of where we are in March is about right. Obviously, we're going to manage the whole company to the top-level numbers that we provided and not necessarily focus on the individual pieces. The drop-off that you â and again, I'm not going to get into each of the quarters from a guidance point of view, but that would imply a fairly low number and then imply that I think that we would drop off more than overall WFE, current WFE expectations, which are down about 20% overall. So it's hard to say, how much happens when. But 1.1 feels like a pretty low number. Yeah. Hi. Thanks for taking question. Rick, I guess, my first question is just to play the devil's advocate. Last quarter, you said the process control argument was site detect road map and transition and not as much as to capacity, i.e., less technical. But end of the day, it seems like process control is not immune to the cyclicality. So I'm just kind of curious, are these just like regular cyclical issues process control actually really driven by tech and not capacity purchases, and long lead time inspection doesn't matter anymore? I'm just kind of curious. Or do you think we get back to trend line in a couple of quarters? Any color on that would be helpful, and then I have a follow-on? Yeah. I mean, I think it is the case, the process control, our business, in particular, is tied both to capacity but also to tech transitions, and it's certainly not just a tech transitions. So I think, you'll see the people that are more tied to capacity coming down more in this environment, and people that are tied more to pure tech holding up, and we're kind of in the middle of those two. Obviously, we have capacity businesses as they relate to, say, metrology that gets added as you add wafer starts. But the work that's going on in reticle and in advanced patterning inspections will be related much more to the Gen 4/Gen 5 stuff, which won't see as much of a decline. So I think, we're kind of -- we're more -- we have some more upside to capacity than maybe we did years ago. But we have -- at this point, certainly a large part of our business is associated with technology transfers, and there's more transfers happening now than there have been in quite a while, because the DRAM guys -- memory is -- as low as their level of investment is in capacity as in none, they're still driving technology transitions. And we know there are multiple players now in logic trying to move forward on that. So I'd say it's a balance approach, which is why we think we'll outperform this year, but not -- we're not going to hold flat relative to that because we definitely had some capacity components. So no, I don't say that we're immune to it, but I think we're less sensitive than pure capacity plays. Yes, Krish, we do share the market move in 2021, right, from below 6 percentile to the high 7 percentile. And so that clearly was driven by not just the technology transition that we talked a lot about, but also higher exposure to capacity opportunities. And we talked about this at Investor Day that with scaling with a more robust design environment, less reuse overall and more process flows that our customers were investing more in capacity from KLA in capacity environments because they're managing each design, test design rules in different ways, different process flows as a change in complexity into the fab. And for all those reasons, we were seeing more adoption of process control in what we'll call a more mature state in the fab. So obviously, that's the part that falls off as customers adjust those capacity plans. But to Rick's point, most of our leverage is in the development area, and it has the fab scales. And so that's why we feel pretty good about dynamics driving our relative performance this year and a continuation of the SAM expansion that we've seen over the last couple of years. Got it. Super helpful. Thanks, Bren for that and thanks a lot Rick. And as a quick follow-up, Intel just said a while ago, they don't extend their depreciation from five to eight years. I'm just kind of curious if that -- does that mean that it's in the useful life of semi-cap equipment from five to eight years? And what does that mean for us, I mean for process control tools? If you can extend the use of the equipment, does it mean that less purchasing over the longer term? So the actual useful life of equipment has been going up for years, and we showed that in some of our service work. Part of why our service business is growing is because the life extends well beyond the typical -- the historical view of that. So, I don't think that this is anything other than some recognition. There are different practices around the world with how customers choose to amortize or depreciate their equipment. So no, it has no effect. I think we're back to the same conversation about what drives reuse and what drives the next generation has to do with node migration and the ability for customers to -- in the case when they -- what we've seen a lot of now is filling in of the nodes that historically might have been just moved forward. So no, no change in long-term view based on that decision by one customer. And you're seeing demand rise in the legacy parts of the market, and that's been good for not only the service business and extending useful life, but we're also restarting older generation tools. It's allowing us to extend the life of existing platforms that we're selling. Some of our challenges around supply chain has been restarting some of those older generation tools to meet those demands. So I think it's a reflection of, at least to Rick's point and how it affects equipment overall, reflection of the strength of some of those markets and those opportunities. The good thing is as we are able to sell those tools, the incremental R&D to support those markets is fairly low. And so it creates a nice vector of not only of growth for us, but also growth in our profitability and leverage in our model. Thank you, Krish. Chelsea, I believe we're coming close to the bottom of the hour, top of the hour. Probably time for one more question. Hi. Thank you so much for taking the question. I just had a couple of housekeeping questions, if that's okay. The China impact, the export restriction impact in the December quarter and what you're assuming for calendar 2023, Bren, sorry if I missed this, but if you can remind us how big the impact could be or was in Q4 and... Yeah. So no change to what we talked about last quarter overall. We talked about a range of $500 million to $900 million across the business in terms of the impact to 2023, and so I don't have an update to that or a different view at this point. We'll see as we go, active engagement. Got it. And then on DRAM versus NAND, I think when you were going through the WFE assumption, you mentioned your expectation for DRAM to be down more than NAND. But when you think about your own business, KLA's business, I would expect DRAM to be a little bit more resilient given EUV adoption insertion and the benefits there. Is that the right way to think about your business in calendar 2023 on a relative basis? Great. Thank you, everybody, for your time. We know it's a really busy day of earnings. We also apologize for the technical difficulties we had during the call, but we will be catching up with all of you here afterwards. So I appreciate the interest and speak soon. Thank you, ladies and gentlemen. This concludes the KLA Corporation December 2022 Earnings Call and Webcast. Please disconnect your line at this time, and have a wonderful day.
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EarningCall_1213
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Good afternoon, ladies and gentlemen. And welcome to the Stride Second Quarter Fiscal 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode and please be advised that this call is being recorded. After the speakers' prepared remarks, there will be a question-and-answer. [Operator Instructions] Thank you. Good afternoon. Welcome to Stride's second quarter earnings call for fiscal year 2023. With me on today's call are James Rhyu, Chief Executive Officer; and Donna Blackman, Chief Financial Officer. As a reminder, today's conference call and webcast are accompanied by a presentation that can be found on the Stride Investor Relations website. Please be advised that today's discussion of our financial results may include certain non-GAAP financial measures. A reconciliation of these measures is provided in the earnings release issued this afternoon and can also be found on our Investors Relations website. In addition to historical information, this call may also involve forward-looking statements. The company's actual results could differ materially from any forward-looking statements, due to several important factors as described in the company's latest SEC filings. These statements are made on the basis of our views and assumptions regarding future events and business performance at the time we make them and the company assumes no obligation to update any forward-looking statements made during this call. Following our prepared remarks, we'll answer any questions you may have. Thank you. Good afternoon, everyone. I've said this now for the past couple of years that part of our ability to succeed longer term is dependent on the macro environment providing a tailwind for our products and services. A survey that was released just last week found that more than half of all parents have considered a new or different school for their child over the past year. As families continue to see a need for option, more and more are aware that our programs offer that alternative. And certainly, awareness for virtual programs like ours increased dramatically since the pandemic, and we don't see that reversed. In addition, families are increasingly engaged in their childâs education in a ways just a few years ago we didn't see. Parent activism on the child behalf, whether it be philosophical, safety, religious, medical or any other host of reasons on the rise. Now our total enrollment numbers were disappointing to us. We also said that we saw increasing in-year demand in the early days of October. Well, that continued with us through December and we ended the quarter with over 180,000 enrollments up from 174,000 enrollments at the end of September. And in the first few weeks of January, we are continuing to see strong demand [indiscernible]. That Q2 enrollment growth is the largest enrollment gain that this company has ever experienced. So we went from being down 8% year-over-year at the end of September and now being down to 4% percent. A number of factors are contributing to the strong results. In-year demand remains strong during the quarter and we're seeing record levels of retention of existing fees. Once families come to us, they are staying in our program longer. We're seeing many future families continuing to explore their options throughout the year. Not at the beginning of the year. Same survey I mentioned before was conducted at the beginning of January found that 26% of all parents are currently considering a new school for their children. And this benefit is reflected across our [indiscernible]. Lead and application volumes remain strong, referrals and return customers are also trending favorably. We get a number of customer referrals from existing or prior customers, so other customers has always been a pretty significant part of our business and continues to trend very strongly. And many customers who have either been in a program before or looked at a program within enrolled are reconsidering at very healthy rates. So clearly the market is not getting an alternative they are searching for. This is at a time when our position has an option for students [indiscernible]. The schools we manage and the partners in our network had worked hard to ensure we provide availability and access. Our programs has much flexibility as possible. As a result, we're seeing more students choosing Stride as [indiscernible]. So I believe long term, our core full time education offering, both general education and career education are on solid footing and on a growth trajectory for years to come. We're also beginning to make some progress into expanding our product service offerings. This year, we successfully launched a number of new product pilot products. We have a number of districts, both large and small signed up for our updated career platform pilot study [indiscernible] our next version of the platform is ready to use this sprint. We also have secured contracts with districts for our upgraded teacher professionals development platform and we successfully rolled out our tutoring platforms to a couple of test districts. Our new professional development product offers on-demand training for teachers based on educational test prep. The platform delivers course in leadership, [indiscernible] practices, counseling and special programs. It's proven because we would need training modules to the thousands of teachers we already trained this year for our manage progress and much of it is available now for free. We've received positive feedback on our products so far and now we're starting to see school take us. We secured an opportunity to deliver our [indiscernible] platforms in one of the largest school district [indiscernible]. I said last quarter that our goal for the year was to expand on our top line growth and aim to achieve a basically flat year-over-year adjusted operating income. Our revised guidance based on these improving enrollment trends continue to show that these are achievable goals. A big driver behind this strength is the sustained success in our career learning programs. I continue to believe that these programs can have an outsized impact on a continued field gap and labor challenges in the country today. A recent study demonstrated that 75% percent of high school graduates do not feel prepared to make college or career decisions after graduation. 72% reported that they will only sometimes are rarely exposed to a variety of career options. Meaning that for many students, it's not just about the ability to do a job, but rather exposure to the career assessment and Stride can be a part fixing that. Career programs offers students opportunities [indiscernible] with over 400 career courses, including career exploration and more in-depth experience. Students also recognized that schools need to be providing an important aspect of education. More than 60% of students in the same study feel that it is the responsibility of the school to expose them to these opportunities [indiscernible] responsibility of family and friends which can disadvantage many students. Our offerings will close these gaps and provide an alternative to schools for shifting their focus away from the parent's students for their careers. We also continue to see more companies willing to hire non-traditional candidates. Recent Gartner article on the top workplace predictions, except that the trend towards relaxing formal education and experience required in job posting will continue in 2023. This includes employers reaching out directly to external candidates with nontraditional background, something our new career platform address [indiscernible]. I think we have a unique opportunity in front of us to lead innovation around a number of educational products and services. That isn't limited to [indiscernible]. I previously mentioned that we rolled out and approved K-12 [indiscernible] we saw significant improvement in customer satisfaction. Recently, that same product was awarded children's home learning product at the year award. This award is best digital learning products for children aged four to 18 [indiscernible] curriculum design that allows students to work more [indiscernible]. On top of that, Tech Elevator was awarded the adult home large product of the year award, which recognizes the best digital learning products over the age of 18. These awards confirm our best in class product suite and encourage ne continue to prudently invest in our future. I'm also proud of the work environment we are creating in these transitional times. We recently ranked number 18 in the top 100 companies for higher jobs by FlexJobs. The great quarter for Stride [indiscernible] business are showing strong demand and improving trend with a favorable macro climate at our back. I believe we are on the cusp of having more meaningful success in some of our newer products and services. Now I'll pass the call over to Donna for a recap of our second quarter results and our updated guidance. Donna? Thank you, James, and good afternoon, everyone. First, let me quickly recap our reported results. Revenue for the quarter was $458.4 million, an increase of 12% from the same period last year. Adjusted operating income was $76.3 million, up $15.6 million or 26%, and capital expenditures were $16.9 million, an increase of $2.7 million. We are very pleased with the strength in both revenue and adjusted operating income in the quarter. As James discussed, we continue to see strong demand across all of our offerings. This is the first time we have seen enrollment growth from the first quarter to the second quarter. Average enrollments for the second quarter were 177.5000. And we finished the quarter in excess of 180,000. This growth supports our belief that students and families are more aware of the school options available to them. It also gives us the confidence to raise our full year revenue and profitability guidance, which I will discuss later. Now let me provide more detail on our second quarter results. Career learning revenue was $183.7 million, up 91%. This strong growth was driven by increasing Stride career prep enrollment and continued strength in our adult learning business. Middle and high school career learning revenue was $153.8 million, up over 100%. This was driven by a 58% increase in enrollments and a 29% increase in revenue per enrollments. The quarterly increase was driven by increased funding, some timing impacts and the better than expected retention that James discussed. We continue to see a favorable funding environment and for the full year we believe revenue per enrollment will increase just over 10% from last year. This increase is a combination of higher funding, better capture and mixing into higher funded states. Adult learning revenue in the quarter was $29.9 million, up over 42%. We remain on pace to finish the year with greater than 30% growth in this business. Quarterly revenue for our general education business was $274.8 million. The decrease from last year is due primarily to the decline in enrollments we previously outlined. Somewhat offset by an increase in revenue per enrollment. Gen Ed enrollments were 111.2000, down from 145.6000. However, in both career learning and Gen Ed, we actually finished the quarter with enrollment that exceeded our first quarter numbers, a phenomenon that company has not experienced previously. Revenue per enrollment for Gen Ed increased 17% from the second quarter last year. Similar to career learning, we anticipate finishing just over at 10%. Gross margin for the quarter was 37.1%, an increase of more than 100 basis points compared to last year. As we said last quarter, we're seeing a more normal seasonal pattern of our expenses this year in line with pre-COVID years. Additionally, I am pleased to say that we are starting to see some of the efficiencies we discussed last quarter had a positive impact on expenses. However, inflationary pressures still exist. Given these factors, we now believe we will finish the full year with gross margins that are flat to last year, a significant improvement on what we thought last quarter. Selling, general and administrative expenses were $102 million, up $11.4 million from last year. Most of the increase is due to scaling our adult learning business and our continued investment in new products. Stock based compensation was $4.9 million for the quarter. Adjusted operating income for the quarter was $76.3 million and adjusted EBITDA was $100.5 million. Interest expense for the quarter came in at $2.1 million and our effective tax rate for the quarter was 27.1%. And finally, diluted earnings per share totaled $1.19. Turning to our balance sheet and cash flow items. Capital expenditures totaled $16.9 million, up $2.7 million from last year. Free cash flow was $147.4 million, up $41.7 million from last year. This increase is tied to revenue growth and the timing of receipts from states that regularly pay us on a lag. We expect to continue to see positive cash flow for the rest of the fiscal year. We finished the quarter with cash and cash equivalents of $318.3 million. Turning to our guidance. For the third quarter of fiscal year 2023, we are forecasting revenue in the range of $445 million to $465 million Adjusted operating income between $70 million and $80 million and capital expenditures between $16 million and $19 million. For the full year, we are raising our revenue and profitability guidance and narrowing our CapEx guidance. We now expect revenue in the range of $1.775 billion to $1.815 billion, up from $1.71 billion to $1.79 billion previously. Adjusted operating income between $180 million and $200 million, up from $160 million to $190 million previously. Capital expenditures between $70 million and $75 million and an effective tax rate between 27% and 29%. Congratulations on the strong results. A few items that you had talked about with in improved funding environment. I know it's too early to give guidance for next year, but can we talk about what you think might happen next year? I know a lot of the states and districts are talking about funding right now in terms of what they expect for next year. So any color would be great. Generally speaking, the funding environment remains strong. I think as you know and as you referenced, a lot of states are sort of in session now and over the next several months to finalize what it will actually look like for next year. So anything right now is still pretty premature. In fact, a lot of the states don't even yet know. And there's a lot of back and forth that will go in the state negotiations around funding. But I think as you also know, some of it will actually depend on how local state economies are projected to be for the next year or so. So they'll take that into consideration as they go through their deliberations. But the early signs are, it continues to look pretty favorable. Okay. That's great to hear. You also a couple of times mentioned timing. I'm just wondering if we can get a little bit of color were there issues in terms of timing from both an expense and revenue perspective in terms of things may be deferred into the third quarter? So there was some impact of timing for both the -- primarily related to our [indiscernible] revenue. And so some funding adjustments that we would normally expect to see later on the year. We saw some of that a little bit earlier this year. The other thing more importantly is that with respect to our rates, as you know, like last year our attention ended up being higher than we had forecasted. We're a little bit conservative in our forecasts earlier in the year. And so we had a catch up sort of later in -- catch up sort of later in the year. And so when you look at sort of our year over year comparison, Q1 and Q2 was an easier comparison versus last year, because we had that sort of catch up last year in late third quarter and fourth quarter. Donna, I'm sorry. You mentioned the funding adjustment. Can you just explain that again? Is that a benefit in the second quarter? Does that hurt you in the second quarter? Roughly how much was it? Sorry. So Jeff, I think -- I want to be sort of maybe clear that these happen sort of every year. We always have some level of fluctuation. I think what we're seeing for the full year net-net, it'll probably be very consistent with last year. And so I think we're probably in the range last year and this year, timing is a little bit different. But I think as you see, our guidance suggests that we think we're going to end strong even though we did get the benefit in this quarter, in the back half of the year, we do expect to be very strong. Okay. I appreciate that. I can follow-up with the details offline. If I could sneak in one more question. I'm actually at an EdTech conference and we're hearing a lot about, AI, ChatGPT, et cetera. A lot of the folks thinks it could be positive in terms of helping them prepare their lesson plans, et cetera. But there's a lot more people who are seem to be worried about students abusing tools like this. I'm just wondering if you've seen anything, are you hearing anything, are you doing anything? Yes. So I mean, obviously, the sort of the past couple of months opening eye has exploded generally and of course it has had a lot of press around the education industry and for what it can do sort of inferior on education. And I think it's still too early to really know how it's going to impact the education space. I would say this though. I think early on, people were worried about Google search as it relates to education. And kids being able to ask questions to Google search and then along comes things like Alexa and things like that to help solve math problems, there are apps where you can take pictures of math problems and they give you the answers. This is not a new phenomenon. Technology -- the application of technology to assist in, I'll say, generically educational problem solving is not new. And I think as an industry, we have to -- our job is to ensure that we're teaching our kids critical thinking skills, which cannot necessarily be replicated yet in any of these technologies. And so we're going to continue to evolve our programs, our curriculum to focus on that. Obviously, to the extent that we're aware of, we do not promote the use of these tools to substitute work. But I think it's very early still on what the impact is going to be. And I think that we're certainly not pushing against it, because just like Google, I don't think the technologies are going to go away or there's going to be some magical way to stop people from using these technologies. I think we have to lean into it, find ways that we can really adapt with it as opposed to push against it. I'm seeing a lot of people in education industry, I think as you're referencing, thinking about how to push against it and that's I think probably not how I think about it. Hey, thanks, and really nice work in the quarter. First question here, just wanted to kind of ask how you've been managing teacher capacity through all this? It seems like enrollments are exceeding your expectations. So just how are you feeling about your capacity if you continue to see strong enrollment demand second half of this year and into fiscal 2024? So I think there's sort of a good news bad news this. I think we mentioned we actually were planning for higher enrollments in the beginning of the year, i.e., that meant we were sort of a little over hired in some places, obviously, this normalized some of that. So sort of like bad news early, bad news now. In that situation -- also in our situation unlike maybe a brick and mortar environment where you've got 25, 30 desks in the classroom, help to squeeze in that many more. We can add a few to different classrooms and class sizes and we have a little bit more flexibility there. We have yet to see across our network significant stress on our system that would be unusual, meaning, every year there's some level stress in our system. I think you see that across the nation today just with the teacher shortage. So -- but I don't think we see any unusual stress. And if you think about across 30 different states and 70 different programs, we're talking about 6,000 extra enrollments from last quarter spread across that -- across any different classroom size, you're not really talking about a real significant number. So I think for right now, at least we see it's manageable. It's obviously not a bad problem to have, but we are certainly monitoring it. And we're going to continue to make sure that we're staffing appropriately. Very helpful. As follow-up, I wanted to ask about -- I think you talked last quarter about some cannibalism from General Ed enrollment switching to career learning enrollments. Did that trend kind of continue as we look at the fiscal second quarter? And any rough quantification of how much of a shift that's been as we think about the first half of this year? Yes. And I think -- so the short answer is, yes, it continues and I think it's going to continue for some foreseeable future, because I think the career offerings specifically for high school students and for many middle school students, it's so much more compelling because you get all of that general education high school with an extra layer of career education on top. So it's sort of a no brainer and I think it's going to continue for some time to come. And I think if you look at, Iâd say, largely the growth in career education, even it's -- we've said this before, we look at it sort of right now in the aggregate because we think it's all sort of - one, we see 90% plus of the funnel for career education is actually generated originally from -- for career education is generated originally from general education. So we sort of see it as one pool right now. We do hope in the coming years that we will be able to have more distinct pools as we hone in our ability to attract incremental customers for our career education programs, but that has not yet happened. So predominantly it's still one pool. But it's also worth noting that the growth we saw from count date to to date. Some of that growth came in from Gen Ed as well. Hey, good evening. Congrats on the really strong result. I guess, letâs talk about enrollment so far in January. I know what happened last quarter unprecedented, but what are you seeing so far 24 days? I mean could potentially third quarter be higher as well? So definitely I don't want to predict where third quarter is going to end. Historically, third quarter is a quarter that declines as well. And in fact, the third quarter tends to be harder for us because you have the withdrawal that happen and you have less schools that have available spaces to actually backfill those withdrawals. So just logistically, the third quarter actually is, generally speaking, harder for us than the second quarter. Having said that, the first three weeks of this month so far we continue to see strength in our funnel, we continue to see strength in applications and demand, we continue to see growth in enrollments through the first few weeks of the month of the new quarter. But it's going to be hard, I think, to continue that trajectory at least that we saw in Q2 through the end of Q3. I don't think it's impossible to grow from Q2 to Q3, but it will be certainly very hard to keep the same trajectory. And if you look year-over-year, sort of the implication is we're sort of -- if we can keep going here, we can certainly get close to some year-over-year good comps. Okay, great. That's helpful. And then maybe I want to switch to adult learning. Growth accelerated in the quarter, it's 42%. And I think [indiscernible] this was in calendar fourth quarter, there was a ton of uncertainty going on in the macro. Typically a slower seasonal month for many out there and you accelerated. So can you talk about what drove the strength in the quarter and is that sort of step up sustainable for the rest of the year? Yes. So in the adult space specifically, which has the 42% growth year-over-year in the quarter. One is, I think we're executing well. I got to give a lot of credit to we've got a number of businesses in that that we have, I think, really strong leadership. They run fairly independently and I think they're just doing a really strong job. You may remember that we have one portfolio company in that adult education space galvanized that had been doing poorly. And I think I indicated previously in previous quarters that, it looks like this is a year we're turning that around and we're seeing that. So that obviously helps the whole portfolio. So I think really strong execution to market, I think we've said this also before, generally speaking, in recessionary type of markets that tends to bode well for adult education. So I think we're seeing a strong macro environment for it. And I think we've got the wind at our backs for those and we hope certainly to see continued growth. Great. And then just one more from me. I kind of wanted to narrow down here on the revenue per enrollment, because you've got a couple of things going on. I understand in the quarter, second quarter, there was some like one time anomaly catch up that's captured in revenue per enrollment. So we can't extrapolate that going forward. But then we said that second half revenue per enrollment is still going to be strong similar to last year. And then to tie it all together, I think you said it was going to be up 10% for the year. I think you said both. So I guess what I'm missing is, I mean, if second half is strong in revenue per enrollment, doesn't that bring you well above 10% year-over-year? Maybe I'm missing something, maybe it's conservatism given that we don't know what the funding environment is like, but I just wanted to tie that down. So one thing worth pointing out when I talked about sort of the year-over-year comps. And that last year we were more conservative with what we thought would happen with retention. And so, as we got later in the quarter, in Q4 we had a catch up because the retention was better than we had anticipated. And so the year-over-year for Q4 will certainly be less than what we saw in the first half of the year. So -- Sorry, just following up on what Donna said, because I think it's a really important point. I think we're seeing -- if you look sequentially, Q1 to Q2 to Q3 to Q4, historically over the past several years, sequentially we gain strength in revenue per enrollment through the year. Some of that's really just sort of the conservative nature of our estimates and things like that. And so I think that's appropriate. And so we sort of have some strength through the year. And I think this year, similarly, we will have some strength sequentially through the year, which does imply by the way that we will continue to have double digit gain. However, I think as Donna is indicating, in Q4 of last year that sequential strength, if you will, took a sort of a step up in Q4. It makes the Q4 comp harder. So even if we continue to have that sequential strength through Q4 of this fiscal year, the year-over-year comp in percentage terms is probably going to be hard to be very high in terms of percentage terms. So I think that's where you sort of get the full year percentage since there's going to be some dilution, if you will, in Q4 probably in the full year comp in percentage terms. Yes. Good evening. It's Tom here from Citi. Thanks for taking the question and congratulations on the results. First question I wanted to ask about was on market share. I mean, maybe I got sort of [indiscernible] the wrong way almost. I noticed [indiscernible] last week indicated that revenue was down for them. And I think overall enrollment fell in the same sort of quarterly period. I'm interested on market share. I know geographically you don't necessarily map on to exactly the same areas. But within the trends you saw, would you say that there is a share gain [indiscernible] and what you've done? You had a totally fair question. I'm going to answer slightly maybe from a different angle than what the way you're presenting it. I think that the short answer is, yes. We, I think, almost by default gained market share, almost irrespective of our growth relative to connections by the way. And that's for the very simple reason that we're seeing across the landscape of the U.S. virtual programs are getting shut down in brick and mortar schools. So therefore, the whole pie is starting to shrink a little bit right now and therefore as we sustain or grow as we've done, our market share sort of mathematically by default will grow. So I really won't speak to some of the other specific competitors and what they're doing and what they're seeing. But we are certainly seeing strength in our funnel, in our demand and we see that continuing through the year. We see that the overall macro trends around these programs continuing to be strong. And I think that it will work in our favor as brick and mortars continue to sort of either shrink or shut down their programs. But we certainly, I think, we consider that we have gained market share just because of, again, the shrinking overall programs across brick and mortar districts. That's great. And then the second question, I mean, obviously, fantastic news that you're looking for revenue per enrollment up 10%. I think previously it was 7% to 10% and then potentially gross margins flattish relative to upwards of 200 basis points conversion. I was wondering whether you could just unpack the drivers of those changes again. And specifically comment on whether some of that is also a function of just that spectacular sort of enrollment performance across the second quarter that you had actually hopefully growing the base that having more students in the mix automatically help both of those metrics. Thank you. So there are a couple of things that are happening. So we've got strong funding increase. You probably heard us talk previously about capture. So we're capturing more of the rate increase in attendance. There's a mix involved. We also did some pass through revenue where we actually have to spend the revenue that we received. So there are a number of factors that are actually impact our rate. But as James said earlier today, we're in a strong funding environment and the fact that we're actually growing in states that pay a high rate and shrinking in states that pay a lower rate, that certainly has an impact on that [indiscernible]. Also I want to give some credit. I think the team and Donna specifically her team has done a really fantastic job. We talked about driving efficiencies in our business and that was going to be both at the gross margin line and the operating line. And I think we've done that. And so we entered the year in a little bit of a hole and we had dig ourselves out. We are committed to digging ourselves out. And while the macro environment helped us, the enrollment has helped us, we have also driven some efficiency in this business and I think that also helps. So I think it's a real combination of factors. And if I could just follow-up, I'm sorry for being painful, but when you talk about capture, is that the element that's linked to strong enrollment and therefore your ability to actually extract funding that you're expecting? Is that how I should interpret that? So part of the capture is, if we have a student enrolled and we give the higher attendance or we meet certain criteria for those students, and we actually get the full amount of the PPR. So that's what I mean by capture. Capture is our version of the yield metric, okay? And so for every $100 that's available to us, on average we are able to capture or yield $75, we're always trying to yield more, 75% to 80%, 80% to 83% and through a number of efforts and a lot of that through engagement, as Donna was saying, there's a lot of different mechanisms for how that yield plays out. But essentially, it's a yield gain that we're trying to improve. And we are constantly focusing energy on how to improve that yield. And so I think this year we're having some improvements in the yield, essentially on yield metric. [Operator Instructions] Ladies and gentlemen, it appears we have no further questions today. So we'd like to thank you all so much for joining us on the Stride second quarter fiscal 2023 earnings conference call. Again, thank you all so much for joining us, and we wish you all a great evening. Good night.
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Ladies and gentlemen, welcome to the Givaudan 2022 Full-Year Results Conference Call and Live Webcast. I am Andre, the Chorus Call operator. I would like to remind you that all participants will be in listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. [Operator Instructions] The conference must not be recorded for publication or broadcast. Thank you, operator. Ladies and gentlemen, so good afternoon, good evening to Asia and good morning to the Americas. Welcome to our 2022 full-year results conference call. Tom Hallam, our CFO will also be on this call. We will take you through the presentation before answering your questions at the end. The company news on our full-year results were published on our Givaudan website before 7 oâclock Swiss time this morning. This is where you will also find the slides for today's presentation, along with the company news on our website both our 2022 integrated annual report and sustainability report also available. Iâd like now to start going through the presentation and invite you to turn to Slide number 3 to go through our performance highlights. So, I am happy to announce another solid set of figures. We are very pleased with our performance in 2022 despite the challenging environment that we have operated in throughout the year. We have indeed been facing an unusual number of adverse external circumstances ranging from high inflation in input costs to geopolitical tensions, the systems disruption in the overall supply chain, and a contrasted picture of the consumer and customer demand across geographies and segments. In this perfect of alignment of headwinds, we have demonstrated three things: Our ability to focus on supporting the growth of our customers with innovative and differentiating solutions, whilst ensuring an excellent supply chain to performance; The second one, the natural hedges of Givaudan across clients, geographies, and product segments has allowed to deliver a net positive growth; And finally, thanks to the collaboration with our customers who are on-track to fully compensate the sharp increase in input costs over 2022 and 2023. I'm therefore extremely grateful to all of the Givaudan employees around the world for their continued commitment to continue to deliver industry leading performance. In 2022, we reached, we actually passed the bar of CHF 7 billion with CHF 7.1 billion, representing a growth of 5.3% on a like-for-like basis and 6.5% in Swiss francs. This solid growth was supported by many levers. The strong contribution of high growth markets, which increased 9.9% on a like-for-like basis, the strategic focus areas, as well as the acquired businesses and the implementation of price increases as already mentioned. The level of innovation has remained high and I will come back to this shortly, whilst our new business pipeline remains strong. Finally, our new win rates have been very healthy. The EBITDA in Swiss francs was stable at CHF 1.476 billion in 2022, compared to CHF 1.482 billion in 2021. What is interesting to note is that we actually managed to protect our absolute EBITDA in Swiss francs despite two headwinds. Raw materials, energy and logistics totaled an increase of [CHF 360 million] [ph] for the full-year. And the Swiss francs has further strengthened across all currencies, across many currencies. The EBITDA margin was 20.7% in 2022, compared to 22.2% in 2021. On a comparable basis, the EBITDA margin was 20.9% in 2022, compared to 22.5% in 2021. The free cash flow amounted to CHF 479 million, representing 6.7% of our total sales. And as discussed before, this lower free cash flow rate, lower than usual, reflects the lower EBITDA percentage and the higher levels of working capital we have to keep throughout 2022 in order to protect our service levels to our customers. At the AGM, on March 23 of this year, the Board of Directors will propose a dividend of CHF 67 per share, representing an increase of 1.5% year-on-year. Let's turn now to Slide 4. Both divisions actually contributed equally strongly to our growth. Fragrance & Beauty reached almost CHF 3.3 billion growing 5.5% and Taste & Wellbeing reached CHF 3.9 billion growing 5.2%. Both growth rates are on a like-for-like basis. The good growth was achieved across most product segments. For Fragrance & Beauty, it was driven by the sustained strong performance of both Fine Fragrances and Fragrance Ingredients combined with the return to a positive growth of the Consumer Products business especially in the second half. For Taste & Wellbeing, the growth was strong, especially in sweet goods, beverages, and snacks and more modestly in savory and dairy. We also benefited from the continued growth momentum of our local and regional customers, one of our strong 2025 strategic growth platform, which grew again more than twice as much as with our global customers. Finally, all our strategic focus areas have contributed to our growth, including high growth markets Health and Wellness, plant-based proteins, and active duty. Let's turn now to Slide 5. We're actually back to the usual picture of high growth markets growing 4x to 5x the rate of mature markets. At the end of 2022, high growth markets represented 44% of our total sales, delivering 9.9% on the like-for-like growth. Overall, high growth markets contributed with high to double-digit growth rates to this result except for China, which grew a low single-digit given the continued stringent coverage regulations prevailing in 2022 and also the double-digit growth comparable in 2021. The Middle East contributed with strong double-digit growth levels, as well as Latin America, which performed strongly led by Argentina, Brazil, and Mexico. Most of Asia have also recovered, including Indonesia and India, the Philippines, and Thailand. Our size and our operations footprint give us a unique exposure to the diversity of these high-growth markets in which we continue investing both with additional talent and new facilities to service a wide diversity of customers. Mature markets, representing 56% of our sales in 2022 has also contributed to the growth. With a like-for-like growth of 1.9% led by an exceptional performance in Europe, an encouraging recovery in Japan, partly offset by a decline in North America. This demonstrates once again how Givaudanâs geographical balance contributes to the natural hedges against demand cycles where timing and intensity can differ by geography. Please now turn to Slide 6. You can see on Slide 6, the sales development by region for the group in more detail. So, it's worth mentioning, EME grew a record 11.9% against the high comparable of 2021. It was supported by the strong recovery and expansion of various markets, particularly in France, Italy, Spain, the UK, Northern, and Central Europe for the mature markets of Europe, but as well as the Middle East for the high growth market starts of Europe. Sales in Latin America continued to perform very well. Latin America recorded another outstanding growth of 10.4% driven mainly by Argentina, Mexico, and Brazil, volume growth and market share gain contributing to most of the growth. Sales in Asia Pacific, as mentioned earlier continued to recover despite a subdued performance in China, still impacted by the pandemic, as well as suffering from a very high 2021 comparable as already mentioned. Overall, the growth in Asia Pacific was 5.2% with India, Indonesia, and the Philippines contributing significantly to this result. Lastly, North America, which has reopened earlier than other regions in 2021, showed a decline of 5.4%. Our 5% growth in 2021 in North America was certainly not an easy comparison, but a certain amount of safety stock building by our customers, followed by a significant destocking as weaker consumption was encountered by our [customers] [ph] was certainly amplified the decline in the second half of 2022 in both Taste & Wellbeing, as well as in consumer products as part of the Fragrance & Beauty division. Let's turn now to Slide 7. Fragrance & Beauty sales were almost CHF 3.3 billion, an increase of 5.5% on the like-for-like basis and 5.3% in Swiss francs. The good growth was driven by the sustained strong performance of Fine Fragrances and Fragrance Ingredients combined with a sustained return to growth in the Customer Products business. In active duty, the single digit growth was achieved against a very high double-digit comparable growth in 2021. Across all businesses and customer groups, the [good performance] [ph] was also supported by the increased impact in the second half of the year of the pricing actions, which have been implemented with customers to compensate for the increase in input costs. When looking at the business unit level. Client balances, sales increased by 14.3% in 2022 on top of the very strong performance of 22.5% in the prior year. It's self-driven by the post-COVID rebound. In 2022, against any expectations, sales have continued this strong momentum due to the recovery of travel retail, in increased offering notably for independent brands in [indiscernible] and broader distribution with a well-established e-commerce reaching out to more consumers. All these combined with a high level of new wins for Givaudan. So, the [CAGR] [ph], the competitive average growth rates for Fine Fragrances over the last three years has been close to 10%. Western Europe, Asia Pacific, and Middle East grew strong double-digit shops, while North America declined mid-single digit against a double-digit comparable in 2021. The second business unit, Consumer Products, the sales increased by 2% on a like-for-like basis. This performance was driven by solid performance with local and regional clients, which more than offset the decline of volume coming from large customers. On the regional basis, growth was led by Western Europe, South Asia, and the Middle East, while sales in North America declined. On the product segment basis, the sales growth was led by Fabric Care followed by Personal Care. The compounded average growth rates for consumer products over the last three years has been 4.2%. Sales of Fragrance Ingredients and Active Beauty increased by 10.2% on a like-for-like basis. Active Beauty grew mid-single-digit against a very strong comparable in 2021, as already mentioned, and Fragrance Ingredients delivered a strong double-digit growth in 2022, supported by the balanced Fine Fragrance market demand for ingredients. The compounded average growth rate for Active Beauty and Fragrance Ingredients combined has been 9% for the last three years. Now, let's turn to the next Slide number 8. Sales of the Taste & Wellbeing division grew 5.2% on a like-for-like basis and 7.5% in Swiss francs. This is a very good performance if we remind that it compares to the 7.6% growth, which was achieved in 2021, actually the highest growth ever achieved by the division. Key growth pillars of the 2025 strategy, including Alternative Proteins and Health & Wellness, as well as all customer groups contributed positively to this sales growth. From a segment perspective, the good sales performance was achieved across all segments, but mainly in beverages and savory and snacks. From a geographic perspective, as you can see the growth performance was quite impressive in Europe, South Asia, and the Middle East, and in Latin America. Sales in South Asia, Africa and the Middle East increased by 17.6% on a like-for-like basis. This double-digit performance was achieved in India, as well as across African markets and the Middle East regions where Givaudan has a strong footprint. Sales in Latin America increased 16.7% on a like-for-like basis, led by high single to strong double-digit volume growth in Brazil, Argentina, Mexico, and Colombia. Sales in Europe increased by 11.1% on a like-for-like basis. The mature markets of Spain, Germany, and Italy achieved double-digit growth followed mid-to-high single-digit growth in the U.K. and France. In the high growth markets of Europe, there was excellent business momentum, especially driven by Poland. Sales in Asia Pacific increased by 5.3% on a like-for-like basis. Growth in Asia Pacific was strong, despite COVID-19 impacting performance in China in 2022. In the high growth markets, Indonesia, the Philippines, and Vietnam delivered the strongest performance. And finally, in the mature markets of Asia Pacific, the growth was driven by Korea. On a like-for-like basis, sales in North America decreased by 6.4% after growing a strong 5.8% in 2021. In addition to the strong comparative, this situation can be explained by customers destocking and more cautious inventory planning following the safety stock building as supply chain disruption and high [indiscernible] prevailed, especially in the first half of the year. Let's turn now to Slide 9. As you all know, our company [profit is above creation] [ph]. The cornerstone of which is innovation. Innovation is what our customers expect from us. The core of our innovation is about working on the more than 300,000 briefs per year and winning more than our fair share of those multiple rigs is the only way to compensate more than the average 10% erosion of our business so that we can deliver our average sales growth promise of 4% to 5% on the long-term. We continually seek new ways to anticipate consumer needs and help solve our â their customers challenges, and create value for them, while developing creations that contribute to happier and healthier life, which is our purpose. And this is whilst reducing the impact that we have on the environment. Our research and development activities allowed to provide our teams working on those multiple rigs with novel technologies, differentiating ingredients, which will make those [bespoke solutions] [ph] we develop with our customers, win the [indiscernible], but also add more importantly, win the consumer. In 2022, we invested CHF 522 million in R&D in-line with what we had spent in 2021, but let me give you some of the key outcome examples that stand-out of our research programs. In Taste and Wellbeing, it's about shaping the future of food and creating food experiences that consumers love. Our new Primelock, a natural vegan-friendly solution that mimics animal fat cells encapsulates, protects and locks in both flavor and fat in plant-based meat substitutes. This integrated technology enables companies to enhance the food experience of plant-based meat products, while cutting 75% less fat and 30% less calories when compared to a full fat, full protein plant-based product. A good example of how a plant-based protein can not only provide the benefit of being more sustainable that's also being healthier than the animal version. BioNootkatone, a breakthrough ingredient that responds to the demand for sustainable natural clean label citrus flavor without the cost and supply volatility of traditional citrus extracts, made from a non-GMO sugar source as the starting material. The ingredients does not require the use of any citrus ingredients and originates from a renewable natural starting material. This material is used in thousands of flavor applications. In the other division, in Fragrance & Beauty, sustainability is a key driver for creativity and innovation as well. We launched Patchoul, [an eco-design] [ph] upcycled active for hair and scalp. It is sourced responsibly in Indonesia and is crafted through green fractionation from distilled patchouli leaves after they use as a raw material in fragrance creation. This is a very good example of how we can use waste and upcycle. In the field of delivery systems, a major breakthrough with the launch of PlanetCaps, the first biodegradable and bio-sourced fragrance [indiscernible] technology for fabric softness, laundry sanitizers, and scent boosters. And finally, AmbreXolide, a sustainable alternative to the widely used musk Ambrettolide. This biodegradable and naturally derived molecule is exclusively available for Givaudan [consumers] [ph] is obtained by an innovative process using noble price within technology. Finally, in terms of artificial intelligence, we developed customer foresight, a proprietary digital engine, leveraging big data, artificial intelligence, and Givaudanâs deep expertise to detect signals and emerging trends to anticipate future potential food solutions, opening opportunity to advance the current development processes. With this, I'd like now to hand over Tom who will give you more granularity on our financial results. Tom, please. Thank you, Gilles. I would also like to welcome you all to the call. As always, as Gilles has taken you through the business performance of the group, as well as the main aspects of the market and regional development. On the following slides, I would like to focus on the group's operating performance and those of the two divisions. Let me start with the performance highlights on Slide 11. Group sales increased this year to CHF 7.1 billion, an increase of 5.3% on a like-for-like basis and 6.5% in Swiss francs. This result includes the full-year impact of DDW and Custom Essence, the two companies that we acquired in December 2021. The group's EBITDA is CHF 1.476 billion, compared to [CHF 1.482 billion] [ph] in the prior year, and the reported EBITDA margin is 20.7% in 2022, compared to 22.2% in 2021. The underlying EBITDA is [CHF 1486 million] [ph] , a margin of 20.9% in 2022, compared to 22.5% in 2021. The net income increased to CHF 856 million, an increase of 4.2%, compared to 2021 and the net income margin was 12% of sales. The group achieved a free cash flow of CHF 479 million or 6.7% of sales. The group's net debt-to-EBITDA was 3.1x at the end of 2022, compared to 2.97x at the end of December 2021. Please turn to Slide 12, which shows the exchange rate development. As always, this slide shows the comparison of the exchange rates in 2022 versus the average in 2021. In the current year, mainly due to the geopolitical instability and economic uncertainties, we have seen major fluctuations in the main currencies that the group operates in, especially in the development of the U.S. dollar, GBP sterling, and the euro against the Swiss francs. Although the movement in currency can have an impact on the various lines of the income statement, the net impact on the EBITDA margin is fairly limited given the operational and geographical spread, which provides good natural hedges to our business. Please turn to Slide 13 for an overview of the operating performance of the group. The gross margin decreased from 42.7% in 2021 to 38.8% this year. Due to, on the one hand, a mechanical margin dilution effect of the pricing, as well as the timing of the price increases, to offset higher raw material, energy, and freight costs. On the EBITDA level, the impact of the higher raw material, energy and freight costs was mostly offset by price increases and a lower operating expense due to the strict cost discipline resulting in an EBITDA of CHF 1,476 million in 2022, compared to CHF 1,482 million in 2021. We had a number of one-off items in the year amounting to CHF 10 million all relating to the integration of the acquired companies and the optimization of our manufacturing footprint. As such, the underlying EBITDA margin was 20.9% this year, compared to 22.5% in 2021. The operating income increased to [CHF 1.112 billion] [ph] in 2022, compared to [CHF 1.089 billion] [ph] in 2021. A small increase versus the year, a good performance considering a very challenging operating environment. On the next two slides, I would like to spend a few minutes on the operating performance of the two divisions. If you turn to Slide 14, we will start with Fragrance & Beauty. Fragrance & Beauty recorded a sales increase of 5.5% on a like-for-like basis and 5.3% in Swiss francs, mainly driven by the sustained good growth of Fine Fragrances and of the Fragrance Ingredients business during the year. EBITDA for the division was CHF 698 million in 2022, compared to CHF 696 million in 2021. The underlying EBITDA margin was 21.6% in the year, compared to 22.6% in 2021. The decrease in the margin is a result of the higher input costs, partially compensated by price increases. If you now turn to Page 15, we will cover the performance of Taste & Wellbeing. Taste & Wellbeing recorded a sales increase 5.2% on a like-for-like basis and an increase of 7.5% in Swiss francs. With excellent sales growth recorded in Europe, Southeast Asia, Middle East, Africa, as well as Latin America. The division was particularly impacted by higher raw materials, energy and freight costs, and recorded an EBITDA of CHF 778 million, compared to CHF 786 million in the prior year. On a comparable basis, the underlying EBITDA margin was 20.3%, compared to 22.4% in the prior year. Again, the decrease in the margin is as a result of the higher input costs, partially offset by price increase with clients. Please turn to Slide 16 for the net income. The net income before tax was CHF 928 million in the year, compared to CHF 965 million in 2021 with the decrease caused by higher non-operating expenses, compared to 2021. Although interest expenses remained stable, the group incurred higher realized and unrealized losses from fair value fluctuations of its financial instruments caused by the economic uncertainty in the financial markets, particularly during the first half of 2022. The effective tax rate decreased to 8% in 2022, compared to 15% in 2021. The net income was up to CHF 856 million in the year, which is a solid increase of 4.2%. The net income margin was 12% in 2022 and basic earnings per share was CHF 92.83, compared to CHF 89.03 in the prior year. Please turn to the next slide, which shows the free cash flow. In 2022 we had a free cash flow of 6.7%, compared to 12.6% in 2021. The decrease is mostly explained by the higher cash investment in working capital, driven by the need to manage the in-bound supply chain disruptions that the group has been facing throughout the year in order to continue to deliver and to satisfy the needs of its customers. During the year, the group generated an absolute free cash flow of CHF 479 million, compared to CHF 843 million in the prior year. Total net investment was CHF 289 million, and as a percentage of sales, net investments were 4.1% of sales, compared to 3.7% in the prior year as the group continues to invest in growth. Working capital was 26.8% of sales, compared to 24% in 2021. Please turn to Slide 18. This slide has been updated to include the final acquisition values of DDW and Custom Essence acquired in 2021 and it gives you a perspective of the future expected amortization. I would like to remind you that on Page 101 of the annual report, we provide a split of the changes in amortization on the various income statement lines. As an example, amortization of intangibles decreased by nearly CHF 20 million in R&D between 2021 and 2022. Please turn to Slide 19. Over the last 22 years, the company has generated a cumulative CHF 10.7 billion of free cash flow. Including the proposed dividend for 2022, Givaudan has returned CHF 7 billion to shareholders in the form of either dividends or share buybacks since its spin-off in 2000. As mentioned in previous years, this clearly underlines the strong commitment of Givaudan to return surplus cash to its shareholders. Based on the strong resilient business model of Givaudan, it is with confidence that the Board of Directors will propose a further increase of the dividend to CHF 67 per share in 2022 from CHF 66 in 2021, an increase of 1.5%. Please turn to Slide 20 to look at the debt profile of the group. This slide shows a well-balanced and stable debt profile, compared to the prior year with interest rates, which have been locked in at attractive rates. At the end of the year, the net debt was CHF 4.5 billion, with a weighted average interest rate of 1.7%, compared to 1.4% in 2021. Finally, please turn to Slide 21, which shows the net debt-to-EBITDA ratio. At the end of the year, the net debt-to-EBITDA ratio was 3.07x relatively stable, compared to the 2.97x at the end of 2021. Thank you, Tom. So, let me now come back to our 2025 strategy and the outlook for 2023, which I will comment further in the coming slides. Turn now to Slide 23. So, let me quickly remind the main features of our 2025 strategy. The company's 2025 ambition is to deliver sustainable value creation for all stakeholders. Givaudanâs 2025 strategy is fully in-line with our purpose, while placing customers at the heart of our business, supporting them to grow and creating products that are loved by consumers. The 2025 strategy is focused on three growth drivers. The first one, expanding our portfolio. The second is expanding our customer reach. And the third one is having a focused market strategy. All supported by four growth enablers, which are aligned with the company's purpose, namely creations, nature, people, and communities. These three growth drivers and four enablers are all underpinned by a commitment to excellence, innovation, and simplicity in everything we do. Let's turn now to Slide 24. Ambitious targets are an integral part of Givaudanâs 2025 strategy, with the company aiming to achieve organic sales growth of 4% to 5% on a like-for-like basis and a free cash flow of at least 12%, both measured as an average over the five-year period strategy cycle until 2025. In addition, the company aims to deliver on key non-financial targets around sustainability, diversity, and safety, linked to Givaudanâs purpose. Let's move now to Slide 25, [on our] [ph] 2023 outlook. We are confident in our capabilities, the quality of our portfolio, our creative strengths, and our ability to build on the strong start of this strategic cycle. For 2023, let me share with you our priorities and focus areas. We remain very well-positioned with our capabilities and our 2025 strategy. We have a strong brief pipeline to support the growth with our customers as they innovate. Our input costs are expected to increase 5% in 2023. We will continue to be focused on delivering pricing actions to compensate for higher input costs. In terms of operational priorities, a performance improvement program is about to be launched aiming at structurally improving our gross margin and our EBITDA margin over the course of this strategic cycle. It includes keeping our strong focus on operational excellence to the manufacturing and the supply chain footprint. It also includes an organizational simplification and further reducing the inventory levels through process optimization and continue cost and cash discipline across the business. This will imply restructuring costs of up to CHF 60 million to be expected in 2023, out of which CHF 40 million in cash and 20 million in non-cash. And we expect from this initiative savings of 60 million on an annualized basis with 40 million to come through in 2023 and fully in 2024. With that, we have arrived at the end of our 2022 full-year presentation. I'd like to thank you for your attention. And now we look forward [indiscernible] to your questions. Good afternoon. So, I have a first question on organic growth. I know you don't give annual guidance, but given the very low visibility out there for most of us listening to this call, could you help us with any hints or thoughts on volume growth in 2023 please? And then as a related question, could you talk more about what happened in Taste & Wellbeing North America, please, because it seems to be down double-digit? It's quite unusual to see that from Givaudan. What sort of categories in customer types were affected? And is this volume decline likely to continue? Is that happening in Q1? And then lastly, perhaps your current thinking on M&A, please? And do you have large potential targets? Thank you. Many questions, Heidi. Thank you. So, organic growth essentially to have â as you know, we commit on an average growth for five years, and we don't give any specific guidance on the given year. Not that we are hiding anything, it's just that the visibility not just in 2023, but always in every year is limited. The only thing we can control is the pricing actions that we have in place. And the other part that we control is the amount of new wins that we win in a given year, which will have a positive effect on the volume growth the following year. But the third element, which is the erosion of the existing business, which essentially is the result of how good our customers are doing around the world, there is no crystal ball to do that. The only way to do that is actually to look at the historic sales that the historic volume growth of Givaudan, which in fact if you look at 3 years, 5 years, 10 years, 15 years, whatever the horizon you take is actually quite steady because we contribute to products, which are consumed on a very regular basis around the world. And Givaudan has always delivered on the continuous volume growth. So, that's basically my best answer to you, Heidi. So, on the price increase, I can be a bit more specific. First, I mentioned that in 2022, we have encountered in the P&L an additional total CHF 360 million of input costs, which include CHF 270 million of additional [indiscernible] and 90 million of everything, logistics, freight, and energy. What we have always said is that we are in a good position to actually recover tw0-thirds of those 360, which we actually did because that's part of the 5.3% growth that we have recorded in 2022. So, you have roughly 4% of price increase in 2022, which amounts to 270. So, that means the remaining 90 million or 100 million have been already negotiated because it was part of the negotiations in 2022 and that will come in 2023 in full. The second pricing element has to do with the guidance we are giving on the input costs that we forecasting a 5% increase of raw material for the group in 2023 and that all actually have been already negotiated entirely and that will kick for the full-year in 2023. So, that's going to be another 160 million. So, basically, you have already 260 million of price increase in 2023, which is roughly exactly the same amount actually as 2022 in absolute terms. Then in terms of new wins, we track that especially for Fine Fragrance consumer products and Taste & Wellbeing. And we have a very good inflow of new wins, which will come into 2023. The only thing I can say about the volume, the remaining volume growth is to talk more about the natural hedges of Givaudan. We are â and it's in three dimensions, as you know, Heidi. From a geographic standpoint, we are everywhere. And you can see, again, the natural hedges across Europe is playing in 2022 because yes, everybody has been focusing on the decline in North America, but I actually had no question about why we have 11% growth in Europe. So, one is actually more than compensating the other. And it's also for high growth markets versus mature markets. So, yes, we have the confidence level in 2023, but to give an exact figure is not easy. The second hedge, natural hedge is that we are across clients. So, now we have 55% of our sales, which are with the local and regional clients that you don't have any figures because they don't usually are publishing their numbers since they are usually family-owned companies. So, this part, most people don't see, but we see it in our figures and I can testify for the strong growth that we have again delivered with this segment of clients in 2022, which are compensated for the actual volume decline that most of our global clients have published over 2022. So, that's another natural hedge dimension that is important to remind. And then across segments, across segments that's essentially â we are across all types of applications, but also all types of price points, whether you have an expensive [indiscernible], a more affordable soap or the affordable snack versus the premium product in food, we are on all sides. So, wherever consumers go down trading or are going for more affordable and so forth, we are on both sides. So, that's also the natural hedge that it creates. So that's the best answer I can give you. Givaudan is the best protected across whatever happens up or down, but difficult to get an exact growth figure for the volume. Lastly, yes, all those products actually 80% to 90% of all the things that we do are consumed every day for basic essential needs as you know that consumers have. Then specifically about Taste & Wellbeing North America, so overall, we have roughly a 6% decline for Taste & Wellbeing. It's true that â it's because â that shows because obviously Taste & Wellbeing we report by region. But what you don't actually see is that the consumer product start of fragrance, which we don't report by region, also include sales in North America, which have also shown a decline. So, a decline overall for the year, which is more or less in the same range as Taste & Wellbeing. So, what it shows is that, yes, there is â it is a combination and difficult again to give an exact â itâs not an exact science, but certainly a combination of consumers having consumed less at the end of the day on the back of a good growth in 2021, but as it relates to the comparable growth quarter-by-quarter where, yes, in the fourth quarter, the decline was stronger than in the early part the year, especially for Taste & Wellbeing that certainly has to do with the fact that as supply chains were incurring disruptions and clients were quite nervous to actually not miss sales, maybe there's been a certainly a bit of safety start building in the course of 20211 into 2022, which as consumers consuming less, those inventories were driven down by our clients. So, yes, there's a fair amount of building up and building down in terms of inventories, but what's the split between de-stocking and consumption, nobody knows, including our clients. So, on a long-term basis, the U.S. will grow. The question is basically by what amount and when. Finally, on acquisitions, essentially, we are always looking at opportunities. We're looking at â we're active on every opportunity. The number of opportunities has certainly declined, because most of the valuations have also declined, so maybe people are waiting for better time, but we are still actively looking in an opportunistic way. I hope it covered your three big questions, Heidi, but you can always come back. Hi, good afternoon. Thanks for taking my questions. Just a quick follow-up on the volume question and I fully appreciate your help or comment to that. But just in terms of Q1, I know we've only had maybe three weeks of trading, but is there a sign to destocking is done in North America? I guess given how quickly you've managed to get the full-year results out for us that you've got fairly live systems on the order tracking. So, any comments around that would be helpful. And then secondly on margins for 2023, I understand the 5% raw material inflation and also the arithmetic impact from pricing [pass-through] [ph]? But could you also discuss how you see some of the other major cost buckets like freight, energy, and wages developing this year? Maybe that's a question for Tom. And then very quick, sort of follow-up on the restructuring program, which I assume also results in some job cuts, are you able to sort of comment on where these job cuts are coming from? Is it sales personnel, R&D, head office staff or based across all of those buckets? Thank you. So, on the volume questions, one, I can't really disclose where we stand in January for two reasons: one because I'm not allowed, and two because it's only, as you say, two or three weeks, so very difficult to see. And again, the best way to predict Givaudan, if you look more on a multiple month basis. So there, I can't answer this question. And the second one, on the margin â on the margin profile. I mean, I just will pass over to Tom, but I think in very simplistic, but high level way, which I think is the best way to read our financial figures. As I said in 2022, the total input cost included almost 10% [raw material] [ph] increase, which is roughly CHF 270 million, plus a CHF 90 million, which includes the, sort of almost abnormal increase in logistics, freight, and energy, which came in and impacted 2022. So, that's a total 360 million, which again we compensated with pricing increase, which amounted by EUR 270 million and EUR 90 million of frugality essentially without as people might have asked the question without [cutting] [ph] on our research and development capabilities. As it relates to 2023, we basically have â I will let Tom add to that, but essentially to talk on the restructuring program. So, essentially, this is because obviously I can't give details. That has to be obviously discussed, validated with the different employee representative in the different countries, but will go actually quite fast. And this is really across the different divisions and support functions, but not impairing significantly our ability to grow with and to innovate with our commercial research and development resources. But Tom, maybe you want to add? Yes. Thanks, Gilles. Charles, on the â if you look on the long-term margin and I think we've discussed this many times together, our free cash flow, our long-term guidance is free cash flow as a percentage of sales, more than 12%. You know the numbers as well as I and that that requires a certain EBITDA level. If you look historically where we've been, we've been somewhere between 22% and 24% and that's the, sort of expectation that we would have if we talk about our 2025 guidance. So, of course, the restructuring or the reorganization that Gilles just referred to is part of that getting back to where we've been historically. Of course, we've talked about the pricing actions that we've taken. And as the supply chain has started to ease, we see that we are now able to accelerate the integration of the acquired companies. You see it already in our 2022 numbers in terms of the investments that we've been making on the digital side. And as we just announced today, we have some restructuring costs, which is non-cash, which is actually related to supply chain and footprint optimization. So, I would see really a two to three year journey in terms of recovery of what we would call our fair share of both gross margin and EBITDA margin. Hi, good afternoon. I just have two left please. Your R&D and admin costs are meaningfully down in the second half, Tom you also mentioned on the amortization slide a little bit, but could you elaborate more on that? Is this a level that is sustainable that we should think of going forward? And the second one is, on the restructuring costs, in general, you guided us that for the acquisitions that you have made recently, we should assume a 50 million integration costs on the special items line? Is this 60 million coming on top of that or does it include also the integration charges? Thank you. Yes. So just Isha on the R&D, which is the number that I have top of mind, I think overall, there's about a 40 million reduction, if you look at the face of the P&L in R&D, 20 million of that or nearly 20 million is amortization. Actually about 10 million is currency. Again, we show the currency slide just to remind you that we are a global business and it depends very much on where our R&D facilities located. Just as a reminder, we have a large R&D facility in the UK and in Ashford. And of course, with the weakening pound that has an impact on the reported R&D, but not on the underlying structure of the business. And that's about another 10 million. And then we have various smaller cost savings on R&D, but we are not, and Gilles has referred to it a couple of times, and you see again the innovation pipeline and the number of projects that are coming through. We are absolutely convinced that we need to invest a certain amount of R&D, so that we can differentiate in the market and our clients can differentiate in the market as well. So, no cut on the underlying research and development. So, that was the first question. Sorry on the second question, can you justâ¦Yes. On the implementation, sorry, on the implementation cost. Most of the implementation cost this year is on the people side as we mentioned. So, then we have about 20 million of non-cash, which is related to site closures. Right. I was just wondering if the acquisition in the integration costs that you incur in general close to 40 million, 50 million is that something that you're going to postpone for later or how does that? That will probably come into 2024, to be honest Isha. What we've talked about so far this year is the reorganization that Gilles referred to. Hey, good afternoon, gentlemen. We touched on this a bit already, but really star contrast in your taste performance between Europe and America. I think you've explained the American impact in terms of customer destocking. Just curious why we haven't necessarily seen that in Europe? Well were buffer stocks never built up to begin with or is that still to come in the coming quarters? And then maybe this one's for Tom, just around the cash flow, you said you chose to strategically invest in working capital to support the customers, which obviously makes sense, but I was a bit surprised by the 15% decline in payables. I was wondering if you could just explain that a little bit and whether that means you're sitting on excess inventory within Givaudan at the moment? Yes. Thank you. So, yes, the performance of Taste & Wellbeing is as unusual in Europe as it is in the U.S. I must say. And actually it's not something actually specific to Givaudan because if you look at the space of ingredients in total, the growth in Europe has been strong. So, it's not just about Givaudan, even if we are performing very well and gaining shares and so forth. And yes, you could argue that why is Europe not slowing down? Actually the outlook in Europe from an economic standpoint now turns out to be positive again. So, the only thing I can say is that we've been growing across all clients, across both segments. So, there is nothing specific about types of products or types of clients. And I would say that even if they would have been â the building stock cannot expand 11% and certainly we have not seen destocking. So, that's my best answer. Essentially, it's a great result. We believe that even if there's been a bit of stock piling up, maybe. Even if there is destocking, the impact will be minimal. The big question is, will the consumption at the retail continue to be strong. That's more the bigger question. Any destocking or up-stocking is only temporary, but â and reflects basically the consumer demand, what's happening at the retail side. So, that's more of the bigger question. Are we going to see a sustained volume as it relates to consumption in Europe? The only difference between Europe and the U.S. though is that in Europe, we include obviously a certain amount of high growth markets in there that you don't have in the U.S., which obviously are always operating at high growth rates, like Eastern Europe, like the Middle East and so. Yes. And Matthew, on the working capital, we can go through the technical aspects of it when inventory is received and accrued and paid and so on or we can just, sort of stay at the high level, which I think is probably the simplest. Fundamentally, we had high levels in 2022. It's as we both, both Gilles and I have mentioned in order to support our clients as the supply chain was so disrupted. Our total working capital is at the end of the year 26.8% of sales. There is absolutely no issue on the underlying accounts receivable under â on the underlying accounts payable. It's really a question of inventory. And if you look overall at where we would expect to be over the next two to three years and Gilles in particular referred to the supply chain, let's say, optimization now. We would target somewhere between 23% and 24% of sales for working capital over the next two to three years. So, we're 26.8% at the end of the year. We want to get back to that 23% to 24% over the next two to three years, and that is fundamentally reduction in inventory levels. Hi. Good afternoon, and thank you for taking my question, Gilles and Tom. So, I leave it to one. So, can you please share what your customers' appetite is at â is going for innovation and new launches? I mean the last one to two years may have been in some cases innovation or new launches may have been held back by a variety of supply chain challenges on your level and on the customer level. So, would you please share what you're seeing at your customers today and how you expect the launch cycle, sort of to ramp up over the next 12 months? Thank you very much. Yes. Thank you. So, I think we don't â we cannot have a single, the same answer for all product categories. Because it all depends, you know usually the rate of new launches depends on how the market is actually doing. So, if you take obviously Fine Fragrances, actually there's been many, many new launches in which actually Givaudan was always very happy to contribute with great perfume. So, actually the number of launches is correlated to the [buoyancy] [ph] of the market and that's true for Fine Fragrances. And the reverse is true. When there was a pandemic, you had almost actually no launches or new fragrances. And then when there was an economic downturn in 2008, that was the same. So, you see that for Fine, you see that for actually Beauty, which is doing very well on skincare and so on. A fair amount of â if you look across Taste & Wellbeing, obviously, a lot of promising launches around beverages, which continue to be a strong category, around plant-based proteins with new food solutions. So, essentially, we have an aggregated good number of new launches, but in any case, if you have less new launches, usually, you also have less erosion because obviously new launches replace erosion. So, at the end of the day, what matters is how much consumers consume and whether that's through existing businesses, existing products or new products, that's the net consumption, which matters. So, that's really what we can say, but essentially, we are not in a position to say that across geographies, clients are becoming reluctant to launch new products. We don't see that. Okay. So, that was the last question. I thank you everyone for your attention, for your questions. I'd like to remind you that we publish our Q1 2023 sales results, the first quarter sales results on 13 of April, and you are welcome to register to our Annual Investor Conference, which will be held in-person, finally back in-person in [indiscernible] Geneva and Switzerland. Thank you very much. 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.
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EarningCall_1215
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Good morning, and welcome to the Carpenter Technology Corporation Second Quarter 2023 Conference 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 this event is being recorded. Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2023 second quarter ended December 31, 2022. This call is also being broadcast over the internet, along with presentation slides. Please note, for those of you listening by phone, you may experience a time delay in slide movement. Speakers on the call today are Tony Thene, President and Chief Executive Officer; and Tim Lain, Senior Vice President and Chief Financial Officer. Statements made by management during this earnings presentation that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from these forward-looking statements can be found in Carpenter Technology's most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2022, and Form 10-Q for the quarter ended September 30, 2022 and the exhibits attached to those filings. Please also note that in the following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When referring to operating margins, that is based on adjusted operating income, excluding special items and sales, excluding surcharge. Thanks, Brad, and good morning to everyone on the call today. Let's begin on Slide 4 and a review of our safety performance. Through the second quarter of fiscal year 2023, our total case incident rate was 1.5. We did see improved performance in the second quarter, lowering the year-to-date rate. The year-over-year rate increase is largely due to the increase of employees undertaking new tasks, either as new hires or transfers into new roles. To address this, we have enhanced and expanded training procedures for any employee new to a job or task with frequent monitoring and follow-up. Our ultimate goal continues to be a zero injury workplace. We believe it is possible, and we will continue to work towards that goal. Now let's turn to Slide 5 and a review of the second quarter. Second quarter performance was driven by the strong demand environment in each of our end-use markets and the increase in productivity across our operating facilities. We continue to see solid demand conditions in each of our end-use markets, with our backlog up 9% sequentially and 107% year-over-year. This marks the eighth consecutive quarter of backlog growth. Most notably, we see the aerospace and defense end-use market ramp accelerating. As a result of the strong demand environment across our end-use markets, we continue to realize price gains. We announced another price increase on our transactional business in November and continue to raise prices through our regular contract negotiations. In order to satisfy demand, we are focused on accelerating the productivity of our labor force across our facilities, most notably by safely onboarding new employees across all our production centers. And we are working closely with our customers to deliver more material sooner. For the quarter, the SAO segment delivered operating income of $30.3 million, in line with our expectations. The improved performance was driven by the growing market demand in the aerospace and defense and medical end-use markets and continued operational improvements. The PEP segment turned in another strong performance with $9.3 million in operating income for the recent quarter. In particular, we saw strong demand for titanium products for the medical end-use market. Finally, our liquidity remains healthy as we finished the quarter with $237 million in total liquidity. Now let's move to Slide 6 and the end-use market update. All of our end-use markets were up sequentially, and with the exception of transportation, all were up year-over-year, reflecting the strong demand environment. Our near-term and long-term outlook for each of our end-use markets remains positive, and record backlog levels provide strong evidence for this bullish market outlook. Our aerospace and defense end-use market, sales were up 9% sequentially and 50% year-over-year. Global aerospace traffic continues its recovery, pushing the supply chain to continue to ramp production for new planes. As a result, we saw a strong demand in each of the commercial aerospace submarkets, in particular, the aerospace engine submarket. The defense submarket is down sequentially and year-over-year, primarily driven by the uncertain government budget horizons and extended lead times. We see this as a short-term issue as there is continued interest in our advanced alloys for next-generation platforms. Excluding defense, aerospace sales were up 12% sequentially and 57% year-over-year. More specifically, sales in the aerospace engine submarket were up 19% sequentially and up 78% year-over-year. As a result of the continued increases in demand, lead times across the industry have extended and our backlog continues to rise. Specifically, our aerospace and defense end-use market backlog is up 10% sequentially and 136% year-over-year. Notably, our backlog value remains at record levels, reflecting price increases and customer urgency to secure material. In the medical end-use market, sales were up 26% sequentially and 55% year-over-year. The higher results reflect ongoing growth in elective surgeries. Customers are increasing manufacturing activity and required stocking levels to meet demand. The overall outlook continues to be positive as medical procedures are expected to rise throughout calendar year 2023. We are seeing evidence of this replenishment in the supply chain as our medical end-use market backlog is up 11% sequentially and 150% year-over-year. In the transportation end-use market, sales were up 15% sequentially and down 4% compared to last year. Light-duty vehicle demand remains high even with the industry supply chain issues, limiting inventories. With strong demand and low inventories, build rates are expected to increase throughout calendar year 2023. In addition, we expect to see heavy-duty vehicle build rates rise in calendar year 2023, primarily driven by the increasing demand in China. In the energy end-use market, sales were up 23% sequentially and up 41% compared to last year. In the oil and gas submarket, demand continues to outpace supply, driving growth and capital investment. In addition, we are seeing growing demand for our advanced premium alloy solutions for drilling and completions activities in harsh environments. In the industrial and consumer end-use market, sales were up 15% sequentially and up 18% year-over-year. Sales growth was driven by demand for our alloys used in semiconductor fabrication and in our electronics submarket. Specifically in the electronic submarket, we continue to see growing demand in new applications for materials from our hot strip mill in Reading. Thanks, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Net sales in the second quarter were $579.1 million, and sales, excluding surcharge, totaled $420.8 million. Sales excluding surcharge increased 34% from the same period a year ago, on 17% higher volume. Sequentially, sales were up 12% on 12% higher volume. Gross profit was $70 million in the current quarter compared to $13.1 million in the same quarter of last year and $54.8 million in the first quarter of fiscal year 2023. Gross profit is up substantially compared to the same quarter last year and up 28% sequentially. The improvement in gross profit is primarily driven by higher sales and improving product mix and increased selling prices, partially offset by inflationary cost increases. SG&A expenses were $47.4 million in the second quarter, up about $3 million from the same period a year ago. Note that the SG&A line includes corporate costs, which totaled $16.4 million in the recent second quarter. The reported corporate costs increased about $2 million from the same quarter last year and are largely in line sequentially. As we look ahead to the balance of fiscal year 2023, we expect corporate cost to be $19 million to $20 million per quarter. Operating income was $22.6 million in the current quarter. When excluding the impact of special items in the prior year quarter, adjusted operating loss was $29.8 million in the same quarter last year, and operating income was $8.3 million in our recent first quarter. Our effective tax rate for the second quarter was 19.5%. As we said last quarter, as pretax levels increased throughout the fiscal year, we expect that the full year effective tax rate will be approximately 22% to 24%, but may continue to have variability on a quarterly basis. Earnings per share for the current quarter was $0.13 per share. The results demonstrate our continued momentum supported by a strong demand environment. Now turning to Slide 9 and our SAO segment results. Net sales for the second quarter were $495.8 million or $346.2 million excluding surcharge. Compared to the same period last year, net sales, excluding surcharge, increased 38% on 14% higher volumes. Sequentially, net sales excluding surcharge increased 13% on 11% higher volumes. The year-over-year improvement in net sales was driven by increased volume and higher prices as well as an improving product mix across our key end-use markets that Tony reviewed on the market slide. Moving to operating results. SAO reported operating income of $30.3 million in our recent second quarter, a significant improvement versus our recent first quarter and prior year second quarter results. The improving operating income results reflect continued progress towards returning to our fiscal year 2019 run rates. On a year-over-year basis, SAO adjusted operating income improved $49 million largely due to higher sales, coupled with an improving mix. On a sequential basis, operating income improved $10.4 million, which is in line with the expectations we set last quarter and driven by increased volumes as we continue to ramp our operations to meet the strong demand that we are seeing across our end-use markets. Looking ahead, our backlog grew sequentially again this quarter with steady order rates across all of our key end-use markets. As we have highlighted, we continue to see increased activity in the aerospace supply chain to meet anticipated increases in build rates by the OEMs. Our teams remain focused on ensuring that we accelerate activity levels and production flow to meet the needs of our customers for the foreseeable future. Based on current expectations, we anticipate SAO will generate operating income in the range of $41 million to $45 million in the upcoming third quarter of fiscal year 2023. Now turning to Slide 10 and our PEP segment results. Net sales in the second quarter of fiscal year 2023 were $106.7 million or $98 million excluding surcharge. Net sales, excluding surcharge, increased 17% from the same quarter last year and were up 12% sequentially. The year-over-year growth in net sales reflects increased demand primarily in our Dynamet Titanium and additive businesses. In our Dynamet Titanium business, net sales increased in both the aerospace and defense and medical end-use markets from the same quarter a year ago. We've also seen a significant improvement in year-over-year sales in our Additive business driven primarily by aerospace and defense market applications. The sequential increase in net sales reflects increases in Dynamet Titanium sales to the medical end-use market as well as Additive sales to the aerospace and defense and industrial consumer end-use markets. In the current quarter, PEP reported operating income of $9.3 million. This compares to adjusted operating income of $3.2 million in the same quarter a year ago, and operating income of $6.3 million in the first quarter of fiscal year 2023. The operating income improvement year-over-year and sequentially is primarily the result of increased net sales driven by strong market demand conditions. As we look ahead, we remain confident that overall demand conditions will remain strong in the coming quarters. We currently anticipate that the PEP segment will deliver operating income in the range of $9.5 million to $11 million for the upcoming third quarter of fiscal year 2023. Now turning to Slide 11 and a review of free cash flow. In the current quarter, we used $86 million of cash for operating activities. The cash used for operations in the current quarter was driven by increasing inventory. During the quarter, we increased inventory by $106 million. The increased inventory is a result of ramping up production activities to satisfy the growing demand, namely the targeted shipments for the second half of fiscal year 2023. We anticipate that as we move through the balance of fiscal year 2023, we will reduce inventories from the current levels. The reduction will be driven by increased shipments and a more balanced flow of materials across the operations. In the second quarter of fiscal year 2023, we spent $18 million on capital expenditures. Given the timing of certain projects and ongoing delays due to extended lead times, we expect fiscal year 2023 capital expenditures to be in the range of $85 million to $90 million, which is down slightly from our previous guidance of $100 million. Lastly, as I've highlighted before, we continue to fund a constant dividend to our shareholders, which we consider as part of free cash flow and an important part of our overall shareholder return. With those details in mind, we used $114 million of free cash flow in the second quarter of fiscal year 2023. Our liquidity remains healthy, and we ended the current quarter with total liquidity of $237 million, including $20 million of cash and $217 million of available borrowings under our credit facility. As I mentioned, we expect to reduce inventory in the second half of the fiscal year. The inventory reduction, combined with our expectations for continued earnings momentum, are anticipated to drive free cash flow generation in the upcoming second half of our fiscal year 2023. Thanks, Tim. Now to recap our second quarter of fiscal year 2023. We are operating in a strong demand environment with positive near-term and long-term outlooks in each of our end-use markets. Notably, the aerospace submarkets continue to accelerate their recovery. As a result, our backlog continues to grow, and we expect it to remain strong for the foreseeable future. We will continue to offset inflationary pressures through our raw material surcharge mechanism and our ability to increase prices on both our contractual and transactional business. As I noted earlier, we are focused on increasing the productivity of our labor force across the facility by safely onboarding a significant influx of new employees across all of our production centers. By increasing volumes, improving mix, increasing prices and improving productivity, we will continue to see margin expansion. As a result, we will continue to maintain a healthy liquidity position. We did build inventory at certain stages of the production flow in the first half of the fiscal year to make sure we have the necessary resources to serve our customers. As Tim mentioned earlier, we expect the inventory balance will come down as we move through the second half of the fiscal year. And looking ahead, we are positioned to achieve our goal of delivering operating income at the fiscal year 2019 run rate range in the fourth quarter of fiscal year 2023. Let's turn to the next slide and take a closer look at our full fiscal year 2023 outlook. On the last two earnings calls, we talked about our goal of achieving the fiscal year 2019 operating income run rate by the fourth quarter of this fiscal year. Let me provide more insight into how we see the next two quarters playing out. Demand remains strong across all of our end-use markets as evidenced by growing backlogs and extending lead times. We participate at the high end of attractive markets, which are driven by positive macro trends. Therefore, in terms of demand, we see minimal risk in our fiscal year 2023 projections. Specifically, over the next two quarters, we anticipate sales excluding surcharge to grow at approximately 12% to 13% per quarter, driven by increased productivity through production rate increases. The most critical variable in our continued effort to increase production rates is the pace at which we can safely train and develop the workforce, many of whom are new to their role in the last 12 months. With this in mind, we have provided operating income projection ranges for the third and fourth quarters of fiscal year 2023. Earlier, Tim communicated the SAO and PEP segment third quarter operating income outlook. Those combined with estimated corporate costs, results in a total company projected operating income range of $30.5 million to $37 million for the third quarter, a strong sequential increase. For the fourth quarter, taking into account the variables I just noted, we project total company operating income to be in the range of $54 million to $60 million, a relatively small window in total dollars. It is worth noting that this represents at least 140% operating income increase over the current second quarter results. And not to get too far ahead, but we expect the first quarter of fiscal year 2024 to have another meaningful increase in operating income compared to the fourth quarter range just given. We will give you more color on that over the coming quarters. It is an exciting time for Carpenter Technology as we are not only poised to return to pre-pandemic earning levels in the near term, but also have a path to significantly increase earnings over the coming years. Thank you. We will now begin the question-and-answer session. [Operator Instructions] First question comes from Gautam Khanna from Cowen. Please go ahead. Thanks, guys. I just want to make sure I have this right, first on the guidance comments. Did you say 12% to 13% ex surcharge sales growth in Q3 and Q4? Did I hear that right? No. You take the second quarter sales. Third quarter will be 12% to 13% higher and then take another 12% to 13% on that. You meant sequentially. I apologize. Okay. I just want to make sure wasn't year-over-year. The commentary on Q4, now the range of $54 million to $60 million, previously, it was around $60 million. Is there anything specific that explains the slightly lower midpoint or low end? No, it's not corporate cost. It's not demand. It's really our workforce and training them safely and effectively to produce those rates to run at the rates. That's really the gating factor right now. And I've heard that from many other companies in the industry as well. If you remember, our workforce decreased significantly during COVID and now we're building that back up. So it takes some time to get them trained. Now I'm a quarter closer. I just want to give a little bit of range. If we hit what we say we're going to hit, we'll be closer to the 60% in terms of the training. Got it. And then the Q1 comment, did you mean to suggest it will be higher than the $54 million to $60 million, so way better than normal seasonality? Yes, because I think -- keep in mind, inflection where our shareholders or people that might -- that needs a little bit more runway as far as what they see us doing. So I'm always trying to be a couple of quarters out there. Now I might not give all the color that someone like yourself might like, but at least trying to give some directional guidance, assuming there's always your normal risk factors. But assuming that it goes the way we see it. But yes, we would see the first quarter then take another step up from that 50-40-60. And then I was just curious on the cash use in the first half. The cash balances quite low at ending the quarter and then the leverage is a bit up. What do you think will happen with respect to free cash flow in the second half? Do you guys have an updated forecast for that? Well, I'll tell you this, Tim mentioned it on the call. I think I mentioned it as well that we intend to take inventory down in the second half. And we're not going to do that randomly. I mean the demand is going to be higher, so it's going to pull that inventory. And then the earnings are going to be significantly higher as well, right? I mean that 54% to 60%. If you hit that, that's -- as I said, it's 140% higher than what we just did. So your free cash flow will follow those two items. I think you'll have pretty healthy free cash flow, obviously, compared to the first half. Okay. And just stepping back on backlog, you mentioned a 9% increase. Could you just talk a little bit about engines versus fasteners versus other structural components in aero? And then maybe just give some flavor for where you're seeing the order strength maybe sustain and improve, and if you're seeing any areas that are a little bit softer? Well, right now, I'm not seeing any areas that are soft. I mean all of our customers are asking for more sooner. I mean to answer your question specifically, year-over-year, engines backlog is up 180%-plus, faster than 160%. If you look sequentially, it's up 8%, 9%. So big increases in all the backlog. And you're getting to a point where the backlog isn't as meaningful. In other words, we're over 52 weeks. And there's plenty of demand out there. So we're at -- I think we're at 2x the backlog we had even back in FY '19 when you had the type of demand you had back then. Good morning. As we think of that labor influx now to support that step up into the fourth quarter, will you need additional labor inputs to get to the Q1 numbers and beyond? Or is there a leveling off at some point in headcount? Yeah, it's a good question. So -- and I'm glad -- I appreciate you asking it. Let me give a couple of bullets around that. I just -- that might be helpful for you. I mean, certainly, as I just mentioned to Gautam, like most companies during the COVID pandemic, we allowed our maintenance production workforce to decrease significantly through attrition. We had a higher rate of retirements during that period of time. Now over the last year, we've had an accelerated pace in bringing back employees across all of our locations. So of course, that gives you a less experienced workforce. And I jotted down a little stat here. If you look at some of our critical work centers at our largest facility, you could have anywhere range from 30% to 35% of employees at that workstation have less than a year. So you know your way around a manufacturing site. That is a significant amount to be able to produce it through rates you want to produce that. Now certainly, there's a tight labor market. I believe our -- we're making very good progress. We have very fulfilling jobs. We have competitive wages, attractive benefit plans. So we're right there. I would say we're probably 85% to 90% as far as the work staff -- workforce that we need. There's some more that we want to hire in a couple of critical work centers. Now to give you some comfort, that's not a couple of thousand, that's maybe 200 or 300 more on roughly 2,500 person our workforce in SAO. Got it. And then any commentary out of the aerospace supply chain, they can't get enough engine-related materials. But from Carpenter's perspective, what takes aerospace sales incrementally higher from here? Is it increased capacity on your end? Or is it increased pull from customers just given where you guys supply chain? Yeah. Three things, not in any particular order. One, yeah, we increase our productivity. And remember, part of that increased productivity is our Athens facility. So we have that. So we know demand is going to go higher. We have organic productivity at our existing plants, and then we have Athens. We have mixed management, as you see some of these markets like aerospace and medical get stronger and stronger. You'll see us move more towards those markets and cut off the tail, if you will, even more than we have in the past. And then the third big driver is price. We've been able to increase price significantly. And even if you do some math, quick math and SAO with -- take the sales and we give you shipments by pound, do the math, you're probably a pound higher than you were in FY '19, which was one of our best financial years ever. So pricing is a big item that a lot of people tend to forget about because they all want to know how are you going to get more productivity, where is the capacity, the price and the mix management is a big factor in that. Yeah. And then just on the defense impact you mentioned, can you just highlight some of the dynamics there? What types of alloys or defense products is that impacting? And then how might we see that rebound? Sometimes, it's such a small piece, you sometimes wonder whether that's even really relevant in the whole scheme of our earnings release. I don't see any issues there. You know the areas that we that we provide in defense were more on the munition side than armament, but we have a variety of alloys that we sell into defense. And quite frankly, we see defense as a growth area for us going forward. But because of the dynamics, you'll see some variability up and down every quarter. It was only a couple of quarters ago, I think that it was a big increase in defense, and I said not to get too excited about that, that's just the normal variability inside the defense submarket. This concludes our question-and-answer session. I would like to turn the conference back over to Brad Edwards for any closing remarks. Thanks, Jason. I appreciate it. Thanks, everyone, for joining us today for our fiscal 2023 second quarter conference call. We appreciate your time and support and look forward to connecting with all of you in the near future. Thanks again, and have a great rest of your day.
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Greetings, and welcome to the Axos Financial Second Quarter 2023 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] Please note that this conference is being recorded. I will now turn the conference over to our host, Johnny Lai, Senior Vice President, Corporate Development and Investor Relations. Thank you. You may begin. Thanks, Diego. And good afternoon, everyone. Thanks for your interest in Axos. Joining us today for our second quarter 2023 financial results conference call are the company's President and Chief Executive Officer, Greg Garrabrants; and Executive Vice President and Chief Financial Officer, Derrick Walsh; and Executive Vice President of Finance, Andy Micheletti. Greg and Derrick will review and comment on the financial and operational results for the three and six months ended December 31, 2022, and we will be available to answer questions after the prepared remarks. Before I begin, I would like to remind listeners that prepared remarks made on this call may contain forward-looking statements that are subject to risks and uncertainties, and that management may make additional forward-looking statements in response to your questions. These forward-looking statements are made on the basis of current views and assumptions of management regarding future events and performance. Actual results could differ materially from those expressed or implied in such forward-looking statements as a result of risks and uncertainties. Therefore, the company claims the safe harbor protection pertaining to forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. This call is being webcast, and there will be an audio replay available in the Investor Relations section of the company's website located at axosfinancial.com for 30 days. Details for this call were provided on the conference call announcement and in today's earnings press release. Before handing over the call to Greg, I'd like to remind our listeners that in addition to the earnings press release and 10-Q, we also issued an earnings supplement for this call. All of these documents can be found on our axosfinancial.com website. Thank you, Johnny. Good afternoon, everyone, and thank you for joining us. I'd like to welcome everyone to Axos Financial's conference call for the second fiscal quarter ended December 31, 2022. I thank you for your interest in Axos Financial and Axos Bank. We delivered double digit year-over-year growth in earnings per share, book value per share, ending loan and deposit balances. Our strong results were broad based with increasing net interest margins and double digit net interest income growth. We grew deposits by approximately 28% year-over-year despite an expected normalization in cash sorting deposits from our custody business. The diversity and optionality of our deposit franchise is a valuable differentiator that will allow us to maintain a strong net interest margin in a highly competitive market for deposits. We reported net income of $82 million and earnings per share of $1.35 for the three months ended December 31, 2022, representing year-over-year growth of 34% and 35$, respectively. Our book value per share was $29.79 at December 31, 2022, up 16% from December 31, 2021. The highlights for this quarter include the following: Deposits increased 3% linked quarter and 28% year-over-year to $15.7 billion. Checking and saving deposits increased 5% linked quarter and 33% year-over-year, representing 93% of total deposits at December 31, 2022. Ending net loans for investment balance were $15.5 billion up 2% linked quarter or 7% annualized. Average loans were up 4.7% or 19% annualized. Solid loan originations were partially offset by higher than expected payoffs in certain C&I lending categories. Excluding single family warehouse ending net loans increased by approximately $300 million in the three months ended December 31, 2022. Net interest margin was 4.49% for the second quarter, up 23 basis points from 4.26% in the quarter ended September 30, 2022 and up 39 basis points from 4.1% in the quarter ended December 31, 2021. Net interest margin for the banking business unit was 4.65% compared to 4.5% in the quarter ended September 30, 2022, and 4.3% in the quarter ended December 31, 2021. Higher loan yields more than offset the increase in funding cost. The gap between our consolidated bank only net interest margin decreased this quarter to 16 basis points from 24 basis points in the prior quarter. The primary reason for this dynamic was that our loan portfolio increased and our securities lending and customer margin balances fell by 33% and 20%, respectively linked quarter. Axos Security comprised primarily of custody and clearing businesses made positive contributions to our fee and net income. Total deposits from Axos Securities were approximately $2.3 billion at December 31, 2022 compared to the elevated $3.3 billion at September 30, 2022. Quarterly pretax income for our securities business improved by $6.7 million linked quarter to $15.6 million due primarily to higher interest rates. Our efficiency ratio for the three months ended December 31, 2022 was 47.11% compared to 55.9% in the first quarter of 2023. The efficiency ratio for the banking business segment was 46.1% for the second quarter of 2023 versus 52.9% in the first quarter of 2023. Capital levels remained strong with Tier 1 leverage of 10.1% at the bank and 9.1% at the holding company, both well above our regulatory requirements. Our credit quality remains strong with net annualized charge offs to average loans of 5 basis points versus 1 basis point in the second quarter of fiscal 2022. The slight uptick in our net charge offs from very low levels was principally due to losses in our personal unsecured and auto loan portfolios. Of the 5 basis points of net charge offs this quarter, 3 basis points were from auto loans that are covered by insurance policies which on average have paid 85% of the principal balance of these charged off loans. We added $3.5 million our loan loss provision this quarter to support loan growth. Total allowance for credit losses was $157 million on December 31, 2022, representing 22 times our annualized net charge offs and 1% of ending total loans. With the vast majority of our loans having strong collateral protection from low leverage, we feel extremely confident about our ability to manage through an economic downturn. Loan originations for investment for the quarter ended December 31, 2022 were $2 billion, down approximately 22% from the $2.6 billion in the comparable quarter a year ago. Q2, 2023 fiscal year originations were as follows: $175 million of single family jumbo portfolio production, $110 million of multifamily production, $64 million of commercial real estate production, $59 million of auto and unsecured consumer loan production and $1.6 billion of C&I loan production resulting in a net increase in ending C&I loan balances of $204 million. Ending loan balances in our jumbo single family mortgage business increased by $11 million to $3.8 billion. We generated $175 million of loan production in the second quarter of 2023, taking some market share in the significantly smaller market for purchase and refinance transactions. Payments in our jumbo single family mortgage business was $164 million in the three months ended December 31, 2022, down from $184 million of prepayments in the prior quarter. Although we are not seeing any stress in our jumbo single family mortgage book, we continue to maintain conservative lending standards and low loan to values. Our jumbo single family mortgage pipeline was approximately $29 million on January 23, 2023. C&I lending had another good quarter. The $203 million of net loan growth in our C&I lending moderated from record highs achieved in the prior two quarters, strong originations in our commercial specialty real estate business and our lender finance business were partially offset by higher payoffs in the back half of the quarter. We will be able to maintain strong yields across most of our C&I lending businesses. We float originations in our auto and unsecured lending to reflect our cautious view of the broader economy. Our entire auto and personal unsecured lending portfolio is comprised of prime and super prime borrowers, except for select auto loan customers where the bank purchases insurance that reimburses the bank for approximately 85% of its losses -- potential losses. The $632 million of ending balances in the auto and personal unsecured book combined represents less than 5% of our $15.5 billion loan portfolio. Our credit quality remains healthy and we're not seeing any signs that our borrowers are struggling to finance their debt obligations with us. Net charge offs to total loans remained low, and our asset based low LTV lending makes us extremely comfortable about our credit outlook even in an adverse economic scenario. Nonperforming assets to total assets ratio was 54 basis points for the quarter ended December 31, 2022, down from 68 basis points for the quarter ended September 30, 2022. Of our nonperforming loans, approximately 41% are single family first mortgages where we've had historically very low realized losses. Of our nonperforming single family mortgage loans at December 31, 2022, approximately 81% had an estimated current loan to value at or below 70% and approximately 82% or below 80% of our best estimate of current loan to value. Given the low loan to values of our asset back loans, we remain confident that we will incur credit losses that are manageable, if any, on any of the assets that are underperforming. Our loan pipeline remains solid with approximately $1.4 billion of consolidated loans in our pipeline at January 23, 2023, consisting approximately of $22 million of single family agency gain on sale mortgages, $292 million of single family jumbo mortgages, $185 million of multifamily and small balance commercial real estate term loans, $833 million of C&I and commercial specialty real estate loans and $65 million of auto and consumer unsecured loans. After two consecutive quarters of record net loan growth, we've moderated the pace of growth in the second quarter of fiscal 2023. Average loans increased by 6.7% and 7.7% linked quarter or 27% and 31% annualized in the June and September 2022 quarters compared to 4.7% linked quarter or 19% annualized in the December 2022 quarter. We remain confident that we will have achieved our mid-teens loan growth target in the second half of our fiscal 2023 as payoffs decreased from elevated levels and new originations stay strong. Deposits increased 3% linked quarter and 28% year-over-year. Growth in small business and consumer deposits were offset by declines in certain commercial banking channels and clearing and custody deposits from elevated levels at the end of the prior quarter. Competition for deposits has increased across most of our deposit verticals and our deposit betas vary from 0% in our Axos Fiduciary Service deposit business to 50% in our high yield savings and [1031] (ph) exchange deposit business. We have been successful retaining and growing consumer checking, savings and money market deposits through cross sell and relationship pricing initiatives. In our commercial banking, our low cost nationwide deposit gathering and specialized servicing approach has allowed us to be more competitive in retaining and growing deposits from existing clients through earnings credits and other price adjustments. Our investments in cash and treasury management capabilities and teams have also increased the pipeline of prospective new treasury management clients. Axos Fiduciary Services, our bankruptcy trustee business total deposits were approximately $1.1 billion at the end of the second quarter. We expect a gradual pickup in Chapter 7 and non-Chapter 7 cases and deposits over the next 12 months as the economy decelerates and bankruptcy filings rebound from decades low. Axos Clearing continues to generate a significant source of low cost deposits. We had approximately $2.3 billion of clearing and custody deposits as of December 31, 2022, including $1.5 billion that was on our balance sheet and $800 million that was placed at partner banks. The average custody deposits were $1.5 billion in the quarter ended December 31, 2022 compared to $1.9 billion in the prior quarter. Cash sorting by RIAs has increased across the industry and ending cash balances held at Axos Advisory Services fell from 11% of total assets under custody at September 30, 2022 to approximately 7% at December 31, 2022. Deposits in our clearing business declined slightly to approximately $650 million. The weighted average cost of our clearing and custody deposits remains low even with a rapid rise in the Fed funds rate. We have a healthy pipeline of new custody and clearing clients that will partially offset the normalization and client cash balance at Access Advisory Services. We remain slightly asset sensitive with 43% of our loans comprised of five year hybrid single family jumbo mortgages and multifamily term loans and 48% of our loans comprised primarily of floating rate C&I loans. An overwhelming majority of our C&I loans are adjustable rate with current rates above their floors. 45% of our variable rate C&I loans are just for LIBOR and the other 55% are just for SOFR Ameribor and other indexes. Net interest margin was elevated this quarter with consolidated and bank only net interest margin of 4.49% and 4.65%, respectively. Our consolidated and bank only net interest margins were boosted by several factors this quarter some of which are unlikely to have the same level of benefits in future quarters. First, loan growth for the June and September 2022 quarters were exceptionally strong, which allowed us to reprice the large portion of our loan portfolio with new loans at higher yields. Second, net interest income benefited from a pre-payment of one of our equipment lease borrowers in the December 31, 2022 quarter. This provided a onetime boost to our previous -- this quarter's net interest income of approximately $2 million and increased the net interest margin by 5 basis points. Third, average deposits at Axos Advisory Services were elevated in the past two quarters before normalizing toward the end of the December 2022 quarter. Average deposits as a percentage of assets under custody over the last 12 months in our clearing and custody business were approximately 9.1%. This is elevated compared to the long term average of 6% to 7% prior to our purchase of the custody business. In the first quarter of fiscal 2023 ended September 30, 2022, the average deposit balance in the securities business was $3.1 billion. Currently, the total deposits in the Security business are approximately $2.3 billion comprised of $1.7 billion of Axos Advisory Services and $600 million at Axos Clearing. Being able to fund a portion of our loan growth with low cost clearing and custody deposits has an outside benefit to our consolidated and bank only net interest margin in the first half of fiscal 2023. Finally, our loan balances grew while our securities lending and margin lending balances declined. This dynamic boosted our consolidated net interest margin this quarter because fee and interest income from securities and margin lending generally have lower yields than our loan yields. New loan yields during the quarter were as follows: Jumbo single family, 6.99%; multifamily mortgages, 6.91%; auto 9.65%; and commercial and industrial 9.32%. With new C&I loans coming in with a spread between 4.25% and 4.75% above the index rate, the continuation of cash sorting by custody clients and increasing deposit competition for many of our deposit businesses, we expect our consolidated net interest margin to normalize to between 4.25% and 4.35% in the next few quarters. While we expect a rebound in loan growth to our mid-teens target given timing of loan growth coming out of the holiday season, we expect our Q3, 2023 fiscal net interest income to be flat or slightly down on a dollar basis from this quarter levels before increasing in the fourth quarter of fiscal 2023. A level of cash deposits at Axos Advisory Service and the pace of loan growth are the biggest drivers of our net interest margin and net interest income. Axos Securities, which includes our securities clearing and custody, software to trading and managed portfolio business, ended the quarter with approximately $22.5 billion of assets under custody and $9.8 billion of assets under administration. The securities business generated $17 million of pretax income excluding noncash amortization expenses in the second quarter of fiscal 2023, an improvement from adjusted pretax income of $10 million in the prior quarter. Our securities business continues to benefit from rising rates despite volatility in the average ending client cash balances. Our custody business also had asset and transaction based fee income that countered some of the changes in the deposit balances. Axos Advisory Services is seeing good momentum adding approximately $31 million of net new assets in the quarter ended December 31, 2022, and our pipeline of eight new advisors or $625 million of new assets under custody that have committed to Axos over the next 12 months. The pipeline for Axos Advisory Services remains robust with active discussions with several multi billion dollars firms who are looking to move portions of their assets from their existing custodian. We are making good progress with the various operational and infrastructure initiatives in our clearing and custody business. We have started to automate manual front and back end processes and accelerated the transition of low value tasks to lower cost near shore and offshore teams. These efforts combined with the full rollout of a proprietary securities core system and successful implementation of various internal straight through processing and other operational efficient initiatives in the next 12 to 18 months will fundamentally improve the cost structure of our securities business and allow us to generate much better operating leverage. We continue to invest across our other businesses as well. In consumer banking, we are working hard to launch the next version of our consumer app in the summer of 2023. This new version adds a planning tab to the consumer app that will offer a variety of services such as financial planning journeys, investment content, enhanced personal and financial management features and better system and data integration with third party service providers. The revised platform moves from a banking centric focus to a more integrated set of financial products, including enhancements of the self-directed trading and automated model based investment platform. The platform will also enhance our ability to bundle at account opening securities and bank accounts. We believe these enhancements will be an important upgrade that will reduce customer acquisition cost and increase user engagement and cross sell to our large and expanding base of affluent and high net worth consumer deposit and lending clients. In commercial banking, we are adding new API integrations for clients in existing and new verticals by making our cash management and payments easier to use, we should be able to generate incremental fee income and deposits. In our securities business, one of the key initiatives is a white label banking platform for independent advisors and broker dealers, which we expect to launch in the summer of 2023. This platform integrates our banking and lending products with the securities accounts we hold for advisors and brokers. Based on conversation with existing advisors, brokers and prospective clients, interest in having access to a robust set of banking and lending products for their end clients is extremely high. As Charles Schwab begins the first phase of their technological transition later this year as a result of the acquisition of TD Ameritrade, our white label banking platform in addition to our strong custody technology and high touch service offerings positions us as a compelling custody alternative. But before I hand the call over to Derrick, I'd like to highlight several reasons why we believe Axos is well positioned to maintain strong profitable growth. First, we have a diverse set of businesses that provide balance and optionality. For example, while higher rates dampened mortgage banking gain on sale and jumbo SFR lending growth, higher rates are extremely accretive to the profitability of our clearing and custody business. Our fee income deposit and lending businesses are much more diverse than they've been in the past. Second, we have a strong balance sheet and ample excess liquidity to weather a prolonged economic downturn. Our low loan to value strategy in single family and multifamily has been battle tested to the great financial crisis and our asset backed commercial specialty real estate and lending finance books are well secured with senior positions, well capitalized partners and multiple exit strategies. Third, our securities book with an outstanding balance of only $250 million as of December 31, 2022 is a short duration and small and absolute in relative terms and has resulted in de minimis impaired value despite higher interest rates. We have a clean capital structure and ample access to funding and liquidity should we need it. Fourth, we don't have any exposure to crypto related activity or deposits or any other highly cyclical source of funding. To the contrary, an extended economic downturn would likely generate significant growth in our low cost bankruptcy and fiduciary deposit business. Finally, we have a proven track record of opportunistically strengthening and growing existing and new businesses during periods of market dislocation. We are ready and able to capitalize on opportunities that will enhance shareholder value. Thanks, Greg. To begin, I'd like to highlight that in addition to our press release, an 8-K with supplemental schedules was filed with the SEC today and is available online through EDGAR or through our website at axosfinancial.com. I will provide some brief comments on a few topics. Please refer to our press release, our SEC filings and our website for additional detail. Noninterest income for the three months ended December 31, 2022 was $28.3 million compared to $30.8 million in the corresponding three months a year ago. Broker dealer fee income increased from $6.3 million in Q2, 2022 to $9.8 million in Q2 2023, due primarily to higher interest rates. While mortgage banking was down by approximately $4 million year-over-year to $0.6 million as a result of the industry wide downturn in single family agency mortgage refinancing activity. Prepayment penalty fee income was also down by $2.5 million to $0.8 million as the increased interest rate environment led to decreased levels of prepayments on multifamily and commercial loans. Our noninterest expense for the quarter ended December 31, 2022 was $107.5 million down from $116 million in the prior quarter. Salaries and related expenses for the quarter were $49.7 million up $2.7 million from the $47 million linked quarter and up approximately $10 million from the year ago quarter. The linked quarter and year-over-year increases are primarily attributable to our annual salary compensation increases that occurred at the end of the first fiscal quarter and increased headcount to support loan and deposit growth. Advertising and promotional expenses increased to $10.9 million from $6.4 million in the prior quarter to support the growth in our deposit businesses. Given the competitive landscape for deposits, we expect to maintain a higher level of spending on marketing to grow our consumer and commercial deposit. Professional services for the quarter ended December 31, 2022 was $8.5 million, an increase of $0.4 million from the $8.1 million for the three months ended September 30, 2022. And a $2.6 million increase from the $5.9 million for the quarter ended December 2021. The primary drivers of the increases were consulting expenses related to technology investments and legal expenses. Going forward, we expect our efficiency ratio for the banking business to be in the mid to high 40% level for the second half of our fiscal 2023. We expect to moderate the pace of new hires and the level of growth related investment spending to be roughly the same as the current run rate in the first half of fiscal 2023. Lastly, with our return on equity increasing to 18.7% in the fiscal second quarter from 13.9% in the prior quarter and loan growth decelerating to 7% annualized from the 32% annualized in the September quarter, we were able to increase our capital ratios this quarter. Tier 1 capital to risk weighted assets for Axos Bank was 11.3% at the end of the December quarter, up from 10.9% in the prior quarter. Net capital at Axos Clearing increased 23% linked quarter, due primarily to higher profitability in our securities business. We have excess capital at the holding company available to contribute to our subsidiaries if needed with asset growth projected to be in the mid-teens in the second half of fiscal 2023 and an ROE well north of 15%, we expect to maintain strong capital levels throughout the enterprise. Thank you. And ladies and gentlemen, at this time, we'll conduct our question-and-answer session. [Operator Instructions] Our first question comes from Andrew Liesch with Piper Sandler. Please state your question. Just want to -- look at the margin, it sounds like it's going to normalize a little bit lower, because there are some maybe some items affecting it here this last quarter. But if we're looking at the margin, say, a quarter from now and we've had a couple more rate increases, is there room for it to go higher or this funding cost pressure that seems like it'd be pretty meaningful. So you think it could ever go back above this range that you highlighted for the third quarter? I think it's good to look at that range as appropriate guidance for the next several quarters. We think we're kind of at more the bottom of within a couple of million dollars of the cash sorting element, but that makes a difference. And then it's -- I think it's prudent to stick within that range. There's always some potential for upside, but I think that's why we tried to give it just based on what we're seeing now just with respect to where we are in the quarter now and where we are on the deposit side with respect to the clearing and custody deposits. Got it. That was my next question on the cash sorting. So thank you for that. And then Derrick, just your commentary on the efficiency ratio. Did I hear that correctly, bank level 45%, the securities business, I think, is usually with 6% or 7% points on top of that. So to the efficiency ratio in the 50% range in aggregate. I'm just curious how that's going to flow through? No, with the -- with what we're just highlighting, the cash sorting deposits, there's some intercompany there because there's a level that we keep at the bank, right? So as those deposits are paid to clearing that efficiency ratio increases on the bank side, but decreases on the -- the income obviously helps decrease it on the clearing side. So it actually brings the efficiency ratios closer together. So I think what you saw this quarter in terms of the efficiency ratios will be more of what to expect kind of as a run rate going forward. Thanks. Good afternoon. Couple of points of clarification, Greg. Did you say that you thought you'd be in the mid-teens on loan growth for the back half of the fiscal year or for the full fiscal year including the last couple of quarters? I annualized on the back half. Yes, we -- if you look at how much loan growth we had, yes, assuming that we're having -- as we expect to normalize more in the 600, 700ish range roughly next quarter or something like that, certainly lower than we had in the prior quarters, but above where we are now. And itâs hard say, things can move around, but that's kind of what we're seeing right now and decent visibility into it. And I think that will be true with that or a little higher in the subsequent quarter as well. I think the key [Multiple Speakers] the one thing is that the average balances when you come out of the holiday seasons. This quarter got started a little more slowly, so you often end up with a little more back end loaded. So that's why we gave guidance on the net interest income for next quarter just given the cash sorting and then also the timing of loan growth we expect to be pushed out a little bit more. Okay. And then likely, CRESL and kind of lender finance being the primary drivers in the back half or he second -- for the half of the calendar year? Yes, I think that's right. We are seeing some jumbo mortgage loan growth, but it's not so huge to speak more than this quarter, but not -- probably not in the $100 million plus range. Okay, thanks. And then just regarding the auto charge offs and the insurance received, is there is there a lag to when that comes in and where on the income statement is the recovery to be recorded? Yes, it's about a six to nine month process to go through. So we've actually had a decent jump coming in, not big numbers, but it's growing over the last several quarters. And it's coming in through banking service fees and other income. That's the line item that is coming in. But it's not huge, huge dollars, but there is a six to nine month lag because of the processing the application to the insurance company and working through that process. And just the way the accounting works in this period, the 5 basis points in charge offs, 60% of them were from those loans, those auto loans that are insured. It's obviously a small number, but it just sort of comes in a little bit differently. So it isn't -- if not that not just 5 basis points as much charge off, but even that is enhanced by the nature of the accounting for that insurance. Thank you. And our next question comes from Michael Perito with KBW. Please state your question. Michael, your line is open, go ahead. Unmute yourself. Okay. We'll move on to the next question. [Operator Instructions] Our next question comes from Edward Hemmelgarn with Shaker Investments. Please go ahead. Yes. The question -- back in the financial crisis, I mean, in 2007, 2009, when you took over and later on, even after that, you seem to do a very good job of taking advantage of the reluctance on the part of some of your competitors perhaps to be making loans. Are you finding any additional that your -- banks are really pulling back because not showing some of the surveys and stuff certainly indicate that they are, but I'm just curious what kind of an environment you're seeing? Yes. It's interesting. It depends on each area. I think on the jumbo mortgage side, a lot of the competition that had come up over the last couple of years were from these conduits that had securitization exits. And those have clearly been challenged, but the market is so slow, both from a purchase and a refinance side and it's hard to see there. And we do see decent loan growth. But there are certain areas where banks have become a little less active for sure. We're able to take a little more rate, tightened credit, things like that. It's not completely frozen though. It certainly doesn't have â like, single family had that feel in 2010 when we started doing a lot more, for example, of it just everybody -- all of us -- everybody went to the same thing thought that if you did a 40% LTV mortgage loan after housing prices fell 50% that was a horrible thing. And so there was that massive, massive dislocation. It's not quite like that now. I think you see some of the securitization exits blowing out a little bit. So it's more -- it's more -- there's a little more spread. There's I think a higher value uncertainty of execution, because I think that these type of environments are people like to work with people they've worked with before. Because they understand the nature of what kind of execution we provide, which I think has been valuable for our repeat clients. So yes, but itâs -- I feel pretty good about this environment. Actually, I like where we are here. I think we've done a good job preparing on the liquidity side, the loan portfolio is looking very strong. Even in areas that I think we made -- not that we're seeing much, I think we made good decisions around the auto side ensuring a lower tier products and things like that. So yes, I think it's pretty good. Obviously, I know where you're going with this, you would always like to see the higher growth. I think you've -- weâve got to be thoughtful about capital ratios, we've got to be thoughtful about the fact that the stock isn't where you want to issue it, right? And then any kind of sub debt or other capital is also quite a bit more expensive that same benefit of the spreads on the side when you're the lender impact you when you're the borrower. So I think the good part for us is that with a high ROE and strong earnings that we are able to grow organically. And I think we just have to make sure we're staying in that range to ensure that we're building capital, keeping it relatively consistent and not relying on any capital markets right now until the stock market better reflects the value that we believe we should get for the company. Great. And I actually did mean that as a compliment. I thought you really managed this for us as well. So I'm not -- as a shareholder, I wasn't hopeful for more. I thought that you did a very good job. All right. Sorry about that. I got disconnected. So I missed a few of the questions. So I'll just wrap it up with just a big picture one for Greg. You know, this isn't the first time you guys have hit this level of ROE, but it does feel a little different. I think structurally the NIM is a lot stronger than it was maybe a handful of years ago. Do you have the AAS business which is starting to contribute more meaningfully on the bottom line? So I'm just curious, Greg, like how do you think about the ROE of this business evolving? You've been in this 18% -- plus or 18% 19% range for quite a long time. But is there kind of the box in place for that to maybe structurally move higher here understanding that there are some elements that might normalize, but just curious how you're thinking about it? Yes, I think in a much longer time frame, and I mean, let's say, two years plus, I think we have some really neat plans with respect to that. For example, I think the cost structure of the securities business will be fundamentally evolved by what we're doing on the core development side by way of example. That business does have the potential to scale at higher returns on equity if we are able to scale it and make that business grow and I think we have that capacity over the longer term. I would be a little cautious as much as I'd like to be optimistic just given what we've said for margin guidance here that that will be coming down a bit. We did have those onetime benefits associated with the significant elevation of the securities deposits, which -- that's a $1 billion of zero cost deposits is a nice boost. And if that's not there, then that obviously impacts things. So I think we have to be a little cautious about that. But, yes, look, it's kind of -- I think that you can see that happening, but there's just a lot of unknowns with respect to where spreads go in the capital markets, all those different kind of things kind of impact that. But I feel good about where we are. And I think we've got a lot of -- I feel like the investments that we're making are all geared in the right way towards that continued improvement. And some of them are pretty -- it's significant to build your own securities core, for example, right? But it's going really, really well. So I think those kind of things are the type of things that can come together to generate a continued enhanced return on equity. Great. And then just secondly and if you guys addressed this, well I got kicked off, feel free to just pull me to the transcript. But just on the partnership with [indiscernible] and some of the digital asset stuff that you guys were focusing on. Can you maybe give us an update of where that strategically is at this point? I mean, obviously, it was a volatile handful a month in that business. And I'm just curious what your updated thoughts are there and anything else you're willing to offer would be great. Yes. I think where we are with respect to that right now is, we're kind of letting the situation evolve a little bit and watching what's happening in the market. It's moving a lot. We've obviously done some technological investments, but I think there's going to be regulatory scrutiny, regulatory guidance and we want to prepare ourselves to participate, but not necessarily get ahead of it either. So I think, frankly, just obviously watching what's happened with the market for participants there even with the deposit basis and things like that. I think it certainly has impacted our views on the level of strategic importance that we're going to be placing on those elements. Now I think -- it'll be interesting to see how the space evolves over time in the longer term. And I think what we need to do is be ready to participate. And we do have -- we've built technology, we signed with [indiscernible] and things like that. And we're going to continue to sort of watch where this goes right now. I think frankly there's a significantly enhanced regulatory scrutiny on these products right now and regulators are nervous and I can't say that that is necessarily unjustified. And I also think that some regulatory clarity around certain other elements of the business would be helpful as well. So we're continuing to just look at that and then be thoughtful about it. For example, we don't think we had created a process where we would have -- we built our own platform to be able to launch our own AX stable coin for example. And as near as we can tell from a regulatory perspective, no bank has been granted the ability to do that nor do I foresee the regulatory environment being receptive to that for a while until there's a lot of clarity. So you know what, look, that's fine. It'll be ready if there is regulatory clarity, if there's not, I think I think even on the self-directed trading side where we thought we would be able -- to be able to utilize some of that crypto asset trading as a way of generating customer business. I think that that may be something over the longer term that we pursue. But right now, I think the level of consumer interest has also diminished significantly as well and so other kind of elements are driving that. So frankly, we're turning more to thinking about how we can talk to our clients about fixed income, for example, which has become a lot more interesting. We still obviously will take an open deposit accounts in the -- thoughtfully in the right way there, but we also have to be cautious about just what's going on in that space right now because there's just so many movements and changes. So yes, so I think that probably gives you a flavor of where we're thinking. Thank you. And there are no further questions at this time. I'll hand the floor back to management for any closing remarks. Thank you.
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EarningCall_1217
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Welcome to the Community Bank System Fourth Quarter and Full Year 2022 Earnings Conference Call. Please note that this presentation contains forward-looking statements within the provisions of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry, markets and economic environment in which the company operates. Such statements involve risk and uncertainties that could cause actual results to differ materially from the results discussed in these statements. These risks are detailed in the company's Annual Report and Form 10-K filed with the Securities and Exchange Commission. [Operator Instructions] Please also note that this call is being recorded today. Today's call presenters are Mark Tryniski, President and Chief Executive Officer; and Joseph Sutaris, Executive Vice President and Chief Financial Officer. They will also be joined by Dimitar Karaivanov, Executive Vice President and Chief Operating Officer for the question-and-answer session. Gentlemen, you may begin the call. Thank you Joe. Good morning everyone and thank you for joining our year-end conference call. We hope everyone is well. Earnings for the quarter were very good, infact our best quarter ever ex-reserve releases last year. We reported record revenues, record PPNR and record GAAP EPS ex acquisition expenses. Loan growth was very strong across all our portfolio up 12% annualized over the third quarter and the deposit base remains sound with respect to retention and rate. Joe will comment further on the quarter, but it was a good one. Looking at the whole of 2022, we likewise had a record year not just financially but for our commercial mortgage and instalment lending businesses as well. Investments we made over the past 18 months particularly in our commercial and mortgage businesses have proven fruitful. The commercial business grew organically 18% in 2022, the mortgage business was up 7% and the instalment grew at 28%. Our non-banking businesses also had significant organic growth but were negatively impacted by the market declines with the exception of OneGroup our insurance business whose revenues were up 17%. Our wealth business which is entirely levered to the market was only down 4% against the market that was down 19.5% and our Benefits business which is about half levered to the market actually grew 1%. So these businesses had a fabulous year, despite the market and at this point, are a coiled spring for the future. Looking ahead to the remainder of the year, we expect to execute well across all of our businesses, a significant focus will be on funding. We have $800 million of overnight borrowings, which is not ideally where we want to be when we also have $5 billion in lower yielding securities. So we have some thoughts on dressing that going forward into 2023. And beyond some of which Joe will touch on further. We'll continue to invest in digital and rationalize analog as we did this past year with a consolidation of 12 retail branches, bringing the total over the past three years to 15% of our total net worth. Excluding acquisitions, we have fewer FTEs than we did in 2021. We implemented new commercial and cash management platforms. Our operations teams are working to implement workflow automation that is expected to save up to 60,000 hours of manual effort. So we are focused across the company on technology solutions for our customers and for our operating efficiency. Lastly, and most important, we have the best talent this company has ever had and so we'll continue to get better and everything we do. Particularly as we also now have the products technology and service capacity to compete very effectively with the larger banks across our markets. This has created significant new organic market opportunity for us that we have not previously possessed. In summary, it was a great quarter. It was a great year. We're exceptionally well positioned, and we look forward to 2023. Joe? Thank you, Mark. And good morning everyone. As Mark noted, the company's fourth quarter earnings results were solid with fully diluted GAAP earnings per share of $0.97 and fully diluted operating earnings per share of $0.96. GAAP earnings per share were up $0.17 or 21.3% over the fourth quarter of 2021, while operating earnings per share were up $0.15, or 18.5% over the same period. The improvement in operating results was largely driven by a significant improvement in the company's net interest income and a decrease in weighted average shares outstanding between the periods offset in part by a small decrease in non-interest revenues and increases in operating expenses the provision for credit losses and income taxes. On a full year basis, fully diluted GAAP earnings per share were down $0.02 per share or less than 1% while operating earnings per share were up $0.09, or 2.6% despite a $23.6 million, or $0.34 per share increase in the provision for credit losses, and a $15.4 million or $0.22 per share, decrease in PPP related revenues. Adjusted pretax pre-provision net revenue or adjusted PPNR per share, which excludes from net income the provision for credit losses acquisition related expenses, other non-operating revenues and expenses and income taxes was $1.29 in the fourth quarter of 2022 up $0.20 or 18.3% over the prior year's fourth quarter. Adjusted PPNR per share was also up $0.04 or 3.2% over the linked third quarter result of $1.25. On a full year basis, adjusted pretax pre-provision and revenue was up $0.50 or 11.7% from $4.28 in 2021 to $4.78 in 2022. The Company recorded total revenues of $175.9 million in the fourth quarter of 2022. This was up $16.3 million or 10.2% over the prior years fourth quarter and established a new quarterly record for the company. Net interest income increased $16.5 million or 17.2% over the prior yearâs fourth quarter due to market interest related tailwinds, strong loan growth and investment security purchases between the periods while non-interest revenues decreased $0.2 million or 0.4%. The company's average interest earning assets increased $905.5 million or 6.5%, while the tax net interest margin increased 28 basis points from 2.74% in the fourth quarter of 2021 to 3.02% in the fourth quarter of 2022. Net interest income was also up $1.8 million, or 1.7% over the linked third quarter results while the tax equivalent net interest margin decreased one basis point. Although interest expense was up $8.8 million over the prior year's fourth quarter, the company's average cost of funds was up just 24 basis points from nine basis points in the fourth quarter of 2021 to 33 basis points in the fourth quarter of 2022, given a 425 basis point cycle to date increase in the federal funds rate. This represents a total funding beta of 6%. Similarly, the company's average cost of deposits for the quarter remain low at 18 basis points representing a cycle to date deposit date of 2%. The $0.2 million 0.4% decrease in non-interest revenues between the comparable annual quarters was driven by a $2.6 million or 5.6% decrease in the financial services, business revenues offset and in part by $2.4 million or 14.5% increase in banking management's revenues. Despite organic customer growth in 2022, Employee Benefits Services revenues were down $1.4 million or 4.5% due to a decrease in asset-based employee benefit trust and custodial fees. Wealth Management Insurance Services revenues were down $1.2 million or 7.5% due to primarily the challenging investment market conditions. The increase in banking non-interest revenues was driven by an increase in deposit service fees. The company recorded $2.8 million in the provision for credit losses in the fourth quarter reflective of strong loan growth and a weaker economic forecast. This compares to a $2.2 million provision for credit losses recorded in the fourth quarter of 2021. On a full year basis the company reported $14.8 million in the provision for credit losses reflective of $1.44 billion of loan growth in 2022, the Elmira Savings Bank acquisition and weaker economic forecasts. By comparison, the company reported an $8.8 million net benefit in the provision for credit losses in 2021 due to an improving economic outlook as the country rebounded from the pandemic. The Company recorded $105.9 million in total operating expenses in the fourth quarter of 2022, compared to $100.9 million in total operating expenses in the prior yearâs fourth quarter. The $4.9 million 4.9% increase in operating expenses was driven by increases in salaries, employee benefits, data processing, communication expenses, occupancy and equipment expenses and other expenses offset in part by lower acquisition related expenses. The $1 million 1.6% increase in salaries and employee benefits expenses driven by increases in merit related employee wages, acquisition related additions to staff and higher payroll taxes, offset in part by lower incentive compensation and employee benefit related expenses. The $0.8 million 5.9% increase in data processing communication expenses with the company's continued investment in customer facing and back office digital technologies between the comparable periods. Occupancy and equipment expense increased $0.9 million, or 8.9% due to inflationary pressures the Elmira Acquisition in the second quarter of 2022 offset in part by branch consolidation activities between the periods. Other expenses were up $3.4 million, or 31.7% due to the acquisitions and general increase in the level of business activities between the periods including business development, marketing expenses and travel related expenses. In comparison, the company reported $108.2 million of total operating expenses in the third quarter of 2022. The $2.3 million 2.2% sequential decrease in quarterly operating expenses was largely attributable to a $2.1 million decrease in salaries and employee benefits. The effective tax rate for the fourth quarter of 2022 was 22%. The company's average earnings and assets increased $905.5 million or 6.5% over the prior year, from $13.96 billion in the fourth quarter of 2021 to $14.87 billion in the fourth quarter of 2022. This included a $1.29 billion or 26.5% increase in the average book value of the investment securities and a $1.41 billion or 19.3% increase in average loans outstanding partially offset by $1.79 billion decrease in average cash equivalents. Average deposit balances were up $348.4 million, or 2.7% over the same period, which included $522.3 million of deposits acquired in the Elmira Acquisition. On a linked-quarter basis, average earning assets increased $254.6 million or 1.7%, while average deposits decreased $154.4 million or 1.2%. Ending loans increased $265.8 million or 3.1% during the fourth quarter and $1.44 billion, or 19.5% over the prior 12-month period. Exclusive of $437 million of loans acquired in connection with the second quarter acquisition of Elmira, ending loans outstanding increased $998.7 million or 13.5% over the prior 12-month period. During the fourth quarter, the company originated almost $560 million of new loans at a weighted average rate of just under 6%. Comparatively the book yield on the company's loan portfolio was 4.39% during the fourth quarter. Asset quality remains strong in the fourth quarter at December 31, 2022 non-performing loans were $33.4 million, or 0.38% of total loans outstanding. This compares to $32.5 million, or 0.38% of total loans outstanding at the end of the linked quarter 2022 and $45.5 million, or 0.62% of total loans outstanding one year earlier. The decrease in non-performing loans as compared to the prior year's fourth quarter was primarily due to the reclassification of certain pandemic impact that hotel loans from nonaccrual status back to accruing status. Loans 30 to 89 days delinquent were 0.51% of total loans outstanding at December 31, 2022, up from 33 basis points at the end of the third quarter of 2022 and 38 basis points one year earlier. The company recorded $3.3 million or 4 basis points annualized of net charge-offs during 2022. The company's regulatory capital ratios remain strong in the fourth quarter, the company's tier one leverage ratio was 8.79%, which significantly exceeded the well capitalized regulatory standard of 5%. In addition, the company's net tangible equity and net tangible assets ratio increased 56 basis points during the quarter from 4.08% at the end of the third quarter to 4.64% at the end of the fourth quarter. During the fourth quarter, the company reclassified certain U.S. Treasury securities with a book value of $1.42 billion and a market value of $1.08 billion from its available for sale investment securities portfolio to its held to maturity investment securities portfolio, while the reclassification has no economic earnings or regulatory impact, enables the company to be more to more effectively manage overall capital levels if interest rates rise above year-end levels in the coming quarters. The company continues to maintain a strong liquidity profile, the combination of the company's cash and cash equivalents borrowing capacity at the Federal Reserve Bank, borrowing availability at the Federal Home Loan Bank and unpledged investment securities provided the company with approximately $4.9 billion of immediately available source of liquidity at the end of the fourth quarter. The company's loan to deposit ratio at the end of the fourth quarter was 67.7% providing future opportunity to migrate lower yield investment security balances into higher yield loans. During 2023 the company anticipates receiving over $600 million of investment security principal cash flows to support its funding needs. Looking forward, we are encouraged by the momentum in our business; the company generates strong organic loan growth over the prior six quarters. Asset quality remains solid. In addition, new business opportunities in the financial services businesses remain strong. In 2023 we remain focused on new loan generation managing the company's funding strategies in a rapidly changing interest rate environment while continuing to pursue accretive low risk and strategically valuable merger and acquisition opportunities. We will now begin the question-and-answer session. [Operator Instructions] And our first question here will come from Alex Twerdahl with Piper Sandler. Please go ahead. First off, just wanted to ask about, what you guys are seeing, or maybe expect to see over the next couple of months with respect to deposits. I know the first quarter typically see some inflows from municipal deposits. I'm just curious if you're expecting similar levels to what we saw last year. And kind of if you have any sort of line in sight line of sight, on to other expected deposit flows, so we can sort of manage expectations for that relative to borrowings along with etcetera. Sure, Alex, it's Dimitar. Youâre right. Typically in the first quarter, we get some seasonal inflows in our deposit base. It's usually a couple of 100 million bucks. With that said, I think we're kind of in an unprecedented time on the funding side. And we started seeing that kind of late in the summer, early in the fourth quarter and it's accelerated I think for everybody in the industry. When you're Europe as the Federal Reserve with an infinite balance sheet who has decided to take out liquidity, we all got to take notice of that. So with that said, I think I'm not sure we're going to be netting up in the first quarter we hope we will. But we're putting in place our strategists to make sure that we are able to manage our funding. So as we sit here today, I would personally probably bet on, closer to flat and up in terms of our deposit base. Okay, and then within the deposit base in the last tightening cycle, you guys did a spectacular job of keeping your cost of deposits lower, I'm just curious if there's a change in customer mentality, just given how quickly rates have risen. And I think certainly many of us have, have noticed it, and they're doing it in our personal accounts. I'm just curious if how we should think about the deposit costs and you sort of the customer behavior that you guys are seeing over the next couple of quarters? Alex, this is Joe. I would just say that, when you look at our composition of our deposit base, about 75%, of our deposit base is in deposits that are not typically rate sensitive. That's not to suggest that, some of that some of those funds could not be drawn out into higher yielding type assets. But, relative to the rest of the industry, I think that our, our deposit bases is, is very core, but there's kind of a larger sort of picture here with respect to what Dimitar referenced on, on the Fed, and what's happening to the money supply. But generally speaking, I think, weâll outperform but yes, I would expect that our funding, beta will increase over the next couple of quarters. There's always a bit of a delay between the Fed changes, and then ultimately changes in the funding costs for financial institutions, including us. In some of the rate moves that the Fed made, we're in, in in the fourth quarter. And, those fully haven't been haven't been fully baked into all of the financial institutions costs of funds. So I think there will be some increase in the funding beta over the over the coming quarters. No, it's Mark. The only thing I would add, just as it relates to funding overall, in the first quarter of the first half of the year, we'll have $400 million or $500 million of the securities portfolio maturing at fairly low yields, which we will likely use to pay down our overnight borrowings with a probably 300 basis point delta on costs. So just so -- that's reasonably significant in the context of what the funding side of our balance sheet will look like, headed here over the next two quarters. Okay. And then I think in your prepared remarks, Mark, or maybe Joe, you talked about managing the company's funding strategies, is that what you're referring to as if the 600 million of securities that are coming due? Yes, I think there's there's two pieces, which is that the maturing securities, but also just generally trying to be strategic in terms of identifying markets where, where we can pick up deposits. It's really deposit strategies. We've got $5 billion of securities. Are there any strategies around that, which makes sense for us to think about? So there's, there's a number of elements to our thought process around funding strategies here, which we're thinking about. Okay. And then just the other question that I had is, you guys talked about deteriorating economic or macroeconomic outlook, yet the ACL dropped by 2 basis points. I was hoping maybe you could just put that into context and explain the moving parts of the ACL and why it actually declined, given, given the commentary that the macro outlook is deteriorating. Yes, Alex, this is Joe. I can, I can take that question. So there's a couple of components in our CECL model. One is kind of the loss history. The other is the economic outlook, which we refer to in the press release. The third piece is also what's been trending internally in terms of non-performing assets. And classified and criticized assets and delinquency and we tend to look at kind of a four quarter trailing average on those non-economic qualitative factors, simply to smooth out if you will, any sort of seasonal aspects around the portfolio, and effectively as we rolled the quote, quarter forward, those four quarter trailing metrics improved. We dropped effectively the fourth quarter of 2021 whether a little higher NPAs and risk ratings were a little bit a little bit higher on the classified in criticized and effectively that improved. So that was the offset to the economic outlook. Good morning, gentlemen. My name is Mark [Indiscernible] filling in for Manuel. I have a few questions to ask. What are your loan growth expectations for next year? And in terms of mix, would it be more commercial weighted, just wanted some color on that? It's Dimitar. So I think we've been talking about mid-single digit growth rate for our business, kind of on a go-forward basis, which is higher for us than historical averages because of all the investments and the retooling of the company in a way. Clearly, it's going to be a slower economic environmental, that's the expectation at least. So maybe we're a tad below mid-single digits rather than a tad up. But we're still kind of in that probably 4% to 6% range expectation in terms of loan growth. As it relates to mix, right now, the commercial pipeline is pretty good. The car business is doing well. Mortgages are slowing down the same way with everybody else. So, we've been kind of running at a 50:50 mix in general. Maybe it's a little bit more commercial this year. But that's a very early guess. So, it could easily be kind of 50:50. Thank you for that. And in terms of NIM trajectory near term, given thereâs pressures on funding, what's your Outlook going forward? So we did flatten a bit in Q4 versus Q3, however, the net interest income didn't increase, which is kind of in line with our, with our expectations. When we talked on the third quarter conference call, however we look forward, I think in the in the first quarter, you could see potentially us go a bit backwards in terms of the NIM just because of the increase in funding costs. And on NII, we potentially go backwards. We lose effectively 2 days of net interest income on a short, shorter quarter in the first quarter. With that said, as Mark was referring to in the in the second quarter, we start to see some significant cash flows off the securities portfolio. And so the expectation, then we would also typically have some seasonal loan growth, kicking in the second quarter. So based on what we can see now, assuming, funding is somewhat stabilized, we would expect some, some expansion and kind of through the second and third quarters of next year, and obviously, the fourth quarters away is a ways out, but the expectations are we see increasing net interest income, kind of in the back half of the year. Thanks for that. One last question and then I'll hand it over. You're talking about the securities books, what is the duration of the security books at the end of the quarter? And does that timeframe correlate with the recapture of AOCI? Yes, so the duration is just under 7 years on a combined basis when you look at the Federal Securities portfolio, which is kind of in line with where it was. We talked about it in the in the prior quarter. And what was the -- I'm sorry, the second part of the question? Yes, to an extent if I'm if I'm following the question, but in fact, what we did when we reclassified the securities, that they are roughly billion dollars in market value of securities into HTM is really to reduce volatility, if you will, around our tangible equity and tangible book value. We also have about $1 billion, $1.3 billion in municipal deposits that require pledging, require securities. And so we're effectively required to hold securities for a long period of time to secure those deposits and, in effect, the amounts that we reclassified are similar to the amount of that we typically carry their municipal securities. Yes. And maybe if itâs helpful, just to add to that, the duration of the AFS portfolio today is just about 5 years, which is what we're going to predominantly use for our balance sheet, remixing going forward as we transition from securities into loans. So we've got those 5 year duration cash flows and believe about 4 billion of securities in that bucket. Good morning. I wanted to continue on the securities discussion. You had mentioned that you expect I think, $400 million to $500 million of securities maturing in the first half of the year. What does that schedule look like for the back half of the year? And could you give us some frame of reference for on that mix shift over the next call it, 12 to 24 months where you want to bring that securities portfolio down to as a percentage of assets? Yes. Well, Matt, this is Joe. So the the expectations for the full year on the securities is about $600 million. We just have to have a significant amount of that about $350 million or so coming off kind of in the middle of the second, second quarter, $400 million in the first half of the year. But the totals about $600 million in the full year. I think over time, we certainly would like to see our transition from a securities largely, securities, concentrated, average earning assets base to one of loans. I think we now have the organic growth components that we need, we tooled up and so over time, we'd like to see that roughly $5 million portfolio to move down to on a relative basis to move down. We'd like to see a loan-to-deposit ratio that trends up. Right now, I think about 67%, ideally, weâd be down more balanced at 75% to 80% loan-to-deposit ratio. So I think that will just trend over time and you'll see kind of on a relative basis the securities book drop. Okay. Understood. And how much of the securities portfolio is unencumbered or tied to municipal deposits where you have to keep some portion in securities? Perfect. So just would love a sense for indirect auto. Obviously, there's a lot of just inbound questions and scuttle around, you know, deteriorating consumer health. Could you just remind us of FICOs there and whether or not you're seeing any sort of deterioration underneath the hood part and the pond? Sure. Matt this is Dimitar. So our portfolio on the car businesses average FICO of 750, roughly. And that's where the originations continue to be -- we're writing business now, kind of in the 7% range, on a gross basis. So that's kind of six net. So it's still pretty good business. We have seen in terms of credit, normalization, I would call it still I would call it normalization towards the lower end of the historical averages. So we've been averaging losses, they're kind of between 25 and 35 basis points, historically, we're kind of right. But about the lower end of that. Again the FICOs are very strong. Debt to income of the portfolio and originations is 27%. So, we feel pretty good about the credit profile. I think as we've disclosed previously 80% is used cars, our loan to value are less than the average for the industry. We write based on actual dealer invoice not based on the inflated sometimes markups that we've seen over the past couple of years. So we feel pretty good about that. Weâre going to normalize a little bit more towards the midpoint of the 25 to 30 basis points, 35 basis points and losses probably is still great business and the rates we're writing it, yes, it is. So that's kind of how we look at it right now. Okay, understood. Thank you. Next one was just in regards to fee income Joe. I'm sorry, Mark. I think you had mentioned that there's some new business opportunities within financial services. So I was curious, wholesale just kind of thoughts on fee income in 2023 more specific commentary on employee benefits, wealth insurance. And then for those opportunities, just curious what you meant in terms of -- is there a more robust pipeline in terms of deals or organic opportunities that you could talk about? Yes, I'll just kind of brief and let Dimitar jump into it further. But if you look at the summary financial results, it doesn't look like those businesses had a tremendous year with the exception of insurance. As I said, that was up 17% in revenues. The wealth business was down a little bit against a market that's down almost 20%. The benefits business, which is half lever to the market, as I said, was up, even though the market was down 20%. So the organic performance of those businesses in 2022, might have been the best year we've ever had. They all grew organically, and some of them grew a lot. But it got clouded by the market, because they're on different levels levered to the market. So there's a lot of momentum in those businesses right now, which I think is going to continue. And I'll let Dimitar provide any further commentary he might want to add to that. I think that's pretty good summary. I would just say if you kind of think about historical growth rates in those businesses in the high single digits. If the market recovers, we feel very confident we're going to get there. If the markets kind of stays where it is, we think we're still going to have a pretty decent year might not be high single digits, but low to mid single digits is definitely achievable. Because again, we put on a lot of a lot of new units and clients, especially in the second half of the year, and we did not get the benefit of most of those. So we feel pretty good about the outlook, barring the market going down another 20%. Matt, this is Joe. With respect to your prior question about unplugged [Ph] securities about $3.2 billion at the end of the year. We also have, you know, a blanket availability at the Federal Home Loan Bank that's secured by our mortgage portfolio, which is about another $1.1 billion. And then we also have some securities pledged at the FRV, which creates another $500 million. So that's how we get to kind of $4.9 million, but $3.2 million of which is the unplugged [Ph]? Got it. Okay. Last one was, I saw this the calculated tangible book value in the earnings release a bit higher. And the one component I don't have is the deferred tax liability. So I was curious what that updated balance was and if there was any meaningful change quarter-over-quarter? So I'll break it down at the end of the end of the year, Matt. So, on a book, book value basis, the available for sale securities portfolio, about $4.7 billion, about $500 million of market value adjustment for about 4.2, is kind of the carrying value. And the held-to-maturity portfolio, about $1.1 billion. At the time, we did the transfer -- excuse me, the book value is about $1.42 billion. There's about $340 million effectively in gross market value adjustment on that held-to-maturity portfolio, and about 24% or 25% of that is effectively in a deferred tax asset of about $80 million. So leaving behind effectively net AOCI of about $250 million. Hey, good morning. I may have missed it in the opening comments, but was there any commentary regarding the overall expense outlook for 2023? And I guess if not, can you guys talk a little bit about that? Yes, Chris, we we've had -- this is Joe. We had a history of kind of low single digits, call it 3% on operating expense increases year-over-year. Obviously the market has changed. There's been you know, stronger, kind of call it wage-related inflation and other inflationary elements that do make their way into our expense base or operating expense base. So we kind of think that mid-single digits is a more realistic expectation excluding acquisitions on a going-forward basis, just because of those kinds of wage and other sort of inflationary pressures. With that said, Mark alluded to, in his comments, all of the back office type efficiencies that we're investing in. That will take a while for that to kick in to really get the efficiencies from all of those automation activities in the back office. So on a more of a kind of shorter term basis, we think, mid-single digits, but our efforts here are to kind of control those operating expenses on a longer term basis through automation and efficiency. Got it. Thatâs helpful. And circling back to some of the deposit discussion from earlier. I think if I read your commentary, right, near term expectations, we're for deposits to remain, somewhat flat versus up. Is that inclusive of the muni flows? Or do you expect kind of ex the municipal deposit fluctuations that there could still be some downward pressure in the near term on the overall deposits. Chris, this is Dimitar. I think we would expect them the first quarter to be net up on municipal deposits and net down personal deposits, and commercial deposits. Where that ultimately ends up on a net basis is, is a guess. Funding is the biggest question for everybody this year. So we don't know, we're planning for certainly lower than historical experience on the deposit side, probably lower than some of our bottom quartile experience, frankly, if you look over 10 years, where we've been. So with that in mind, hence the comment that historically, we would have been up in the first quarter and this quarter weâre unlikely to be up as we sit here today. Just one more topic here on my list that wasn't discussed in earlier questions or comments, Just looking at the tax rates, my notes are right from last year, about a year ago, you're expecting a tax rate of kind of 22.5% to 23.5%. It looks like you came in below that this year. So one first question, just curious if you utilize any kind of tax strategies throughout the year that brought it in lower the mix of revenue was just different. And the second part of the question would be, what's a good expectation for 2023 at this point? Yes. Chris, excuse me. Erik, with respect to on a going-forward basis, I still think that, plus or minus a half a point around 22% is probably a reasonable expectation as we as we look ahead. We do occasionally buy tax credits and other items that are helpful for the overall rate, and we do have a municipal securities booked municipal loans that keep the effective tax rate down a bit. So, I wouldn't expect much change over 2023 or really the future where our current tax rate unless there's a change in the tax code. With no remaining questions, this will conclude our question-and-answer session. I'd like to turn the conference back over to Mr. Tryniski for any closing remarks. Thank you, Joe. Thanks, everyone for joining the call and we will talk to you again after the end of the first quarter. Thank you.
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EarningCall_1218
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Good afternoon, and welcome to Forestarâs First Quarter 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. [Operator Instructions] Thank you, John, and good afternoon, everyone and welcome to the call to discuss Forestarâs first quarter results. Thank you for joining us. Before we get started, todayâs call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although Forestar believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to Forestar on the date of this conference call, and we do not undertake any obligation to update or revise any forward-looking statements publicly. Additional information about factors that could lead to material changes and performance is contained in Forestarâs annual report on Form 10-K. Our earnings release is on our website at investor.forestar.com and we plan to file our 10-Q tomorrow. After this call, we will post an updated Investor Presentation to our Investor Relations site under Events & Presentations for your reference. Thank you, Katie. Good afternoon, everyone. As always, we appreciate your interest in Forestar and taking the time to discuss our first quarter results. In addition to Katie, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer and Mark Walker, our Chief Operating Officer. Mortgage rates rose at a record pace during 2022, as a result housing affordability has been severely impacted. New home sales fell 15% in November from a year ago and December housing starts were down 25% from a year ago. Despite those headwinds resulting in a revenue decline of nearly 50%. Our gross profit margin increased 390 basis points to 21.9%, and our pre-tax profit margin was 12.9%. The real story here is the transformation that Forestar has undergone over the past five years. We have become the largest pure play residential lot manufacturing company in the United States. We have built a platform and assembled a team that is flexible and focused. We have further strengthened our balance sheet and look to be opportunistic in ways that will continue to build shareholder value. We have a strategic relationship with D.R. Horton, America's largest builder, and we have positioned ourselves to expand our customer base as we consolidate market share. The housing market is going through a period of transition. We are disciplined and have been proactively reducing land acquisition over the past 18-months. We have been staging development activity at our projects to be prepared for when the plan for residential lots increases. Our flexibility enables us to quickly adjust to meet the needs of our customers. We continue to strive to maximize returns, while we plan and prepare to return to periods of rapid growth. Having a growth plan is one thing, but we have the capital structure, the operational flexibility, a strong customer relationship, and most importantly, the team execute that plan. Forestar is better positioned than ever to serve current and new customers and consolidate market share. Thank you, Dan. In the first quarter, net income attributable to Forestar was $20.8 million or $0.42 per diluted share, compared to $40.5 million or $0.81 per diluted share in the prior year quarter. Consolidated revenues for the quarter totaled $216.7 million, compared to $407.6 million during the first quarter of 2022. We sold 2,263 lots during the quarter with an average sales price of $90,100. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot size mix of our deliveries. We expect demand for residential lots will continue to be impacted in the coming months as homebuilders align starts to a new sales pace. Our pre-tax income for the quarter totaled $27.9 million, compared to $53.5 million in the first quarter of last year. Our pre-tax profit margin of 12.9% was 20 basis points lower than last year, driven by reduced operating leverage. Our gross profit margin was 21.9%, representing an improvement of 390 basis points over the prior year period. In the first quarter, SG&A expense was $22.9 million or 10.6% as a percentage of revenues, compared to $21.5 million in the prior year quarter. While our SG&A expense as a percentage of revenue was higher than we would like, the absolute dollars were down 3% sequentially and has decreased for the last three quarters. We will continue to focus on controlling our SG&A costs, while ensuring that our infrastructure supports our business. Mark? As for current market conditions, we are starting to see greater contractor availability with front-end trades and continue to stage development on a project-by-project basis. Despite single family home starts falling, roughly 25% in December from a year ago, our cost to develop a residential lot continued to decline. Materials like Concrete, Cement and Transformers are still challenging to secure. However, our teams are relentless problem solvers and they continue to navigate this environment exceptionally well. We will continue to be proactive and work with our trade partners to develop cost -- control development costs. We evaluate each project and the surrounding market conditions as we determine the appropriate pricing and sales pace to maximize returns. We remain focused on developing lots for homes at affordable price points demonstrated by our average sale price of roughly $90,000. Over the past 12 months, our inventory balance has grown only 5%. Despite elongated development timelines, and inflationary pressures further demonstrating discipline and strategic inventory management. Jim? 7% of our first quarter deliveries were sold to customers other than D.R. Horton, compared to 11% in the prior year quarter. In the trailing 12-months 16% of our deliveries were sold to other customers and we continue to target selling 30% of our lots to customers other than D.R. Horton over the intermediate term. Additionally, Forestarâs lots sold to D.R. Horton continue to grow as a percentage of D.R. Horton starts year-over-year and sequentially. Approximately one out of every five homes that D.R. Horton starts is on a lot developed by Forestar. Our mutually stated goal is for one out of every three homes that D.R. Horton sells to be built on a lot developed by us. Katie? Forestarâs underwriting criteria for new development projects including minimum 15% pre-tax return on average inventory and a return of the initial cash investment within 36-months. During the first quarter, we invested $237 million in land and land development, a reduction of 38%, compared to the prior year quarter. $205 million was for land development and $32 million was for land. As land prices continue to increase across most of our footprint during 18-months, we proactively started to reduce our land investment in anticipation of the slower housing market and primarily focus on the phase development of land that we already own. We are working with land sellers to extend closing dates and in certain cases we have opted to terminate contracts. Our unique operating model allows us to adjust the pace of development based on market conditions and we remain intensely focused on managing our development in phases as we strive to deliver finished blocks at a pace that matches market demand consistent with our emphasis on capital efficiency. Mark? Forestar's loss position as of December 31 was 82,300 lots, of which 61,500 lots are owned and 20,800 are controlled through purchase contracts. Our lot position decreased by 7,800 lots or 9% sequentially and by 21,000 lots or 20% year-over-year. We incurred $2.4 million of option deposits and due diligence write-offs in the quarter. At quarter end, we had 7,600 finished lots on hand. The majority of our owned lots were placed under contract to purchase from land sellers prior to 2021, resulting in an attractive cost basis and we had no inventory impairments during the quarter. We are continuing to target a three to four-year owned inventory of land and lots. 30% of our owned lots are under contract to sell, representing approximately $1.5 billion of future revenue. These contracts of $148 million of hard earnest money deposits associated with them. Another 29% of our owned lots are subject to a right of first offer to D.R. Horton based off executive purchase and sale agreements. Jim? We are maintaining a strong balance sheet with significant liquidity and modest leverage and we plan to maintain our disciplined approach when investing capital to enhance the long-term value of Forestar. We ended the quarter with over $580 million of liquidity, including approximately $215 million of unrestricted cash and $365 million of available capacity on our revolving credit facility after the reduction for outstanding letters of credit. Total debt at December 31 was $706 million with no senior note maturities until fiscal 2026. Our net debt to capital ratio at December 31 was 28.7%, down from 33.9% in the prior year period. We ended the year with $1.2 billion of stockholders' equity and our book value per share increased to $24.50, up 15% from a year ago. Forestarâs capital structure is one of our biggest competitive advantages. Most traditional land developers are encumbered by project level financing, which makes it more difficult to react to the market, while also adding complexity and administrative costs. Our strong liquidity and corporate level financing enable us to operate effectively through changing economic conditions and positions us to be strategic when attractive opportunities present themselves. We have significant flexibility to navigate the upcoming year. Katie? Consistent with our last earnings call and as a result of the current market certainties, we are not providing guidance for fiscal 2023 at this time. We will reevaluate providing annual guidance when we have sufficient visibility into market conditions. We have been very strategic and disciplined and we are well positioned to adapt quickly to the short-term challenges that are before us and the housing industry. Thank you, Katie. Forestar will continue facing difficult comparisons to our fiscal 2022 results as the housing industry adjusts throughout 2023. We have made remarkable progress building Forestarâs platform, which enabled us to maintain strong returns and margins during a challenging quarter. While we cannot control the macroeconomic backdrop or directly influence the demand for housing, we can and will stay focused on strengthening our platform and increasing operational efficiencies to drive future growth. We are closely monitoring each market submarket and project as we strive to balance pace and price to maximize returns. We are the market leader in a highly fragmented and undercapitalized industry and are optimistic about Forestarâs ability to continue to execute well, consolidate market share in any operating environment. I would like to add on to Jim's earlier comment about our capital structure being a big competitive advantage, because it is our team that is our biggest advantage. I could not be more proud than to be a part of this team. Their knowledge and experience and the way that they have dealt with the challenges of this past year are truly remarkable. Looking forward, we continue to believe that D.R. Horton and many other homebuilders will shift their focus towards buying finished lots from third-party developers. Instead of self-developing. With our broad geographic footprint, attractive land positions, strong balance sheet, and most importantly, our experienced team. Forestar is well positioned to be the last supplier of choice to homebuilders. We are planning for the long-term and have a track record of solid execution. We proactively and methodically started to implement our downturn playbook over 18-months ago by adjusting our pace of new land acquisition in preparation for today's current environment. When appropriate, we will leverage our platform and balance sheet to take advantage of opportunities to build shareholder value. Our flexibility enables us to quickly adjust to meet the needs of our customers. Our team has managed through market cycles before and we are well positioned to navigate these challenging market conditions. Hey, good afternoon, everyone and thanks for taking my questions. First, you all been trending close to 20% of Horton starts or orders over the past year? You mentioned your stated goal of supplying about a third of their lot needs. Do you think you all continue to increase that percentage throughout 2023? Or given the current housing backdrop, do you kind of run into a steady state, digest the current environment, see where home and lot prices ultimately settle? Yes. Thanks, Truman. Thanks for the question. It will be an interesting year. I think everybody is looking forward to seeing how it plays out. I don't expect that our market share within Horton will decrease. I expect that it will increase, but is that going to be going from one out of five homes to one out of four during this year, that would probably be pretty aggressive. But I do expect to continue to see some increase in our market share within Horton. Okay, okay, got you. And then are you all actually seeing any opportunities to buy discounted land or distressed deals? Or is it still just a bit too early? I got the impression on the call that perhaps you're not ready to deploy capital yet and maybe there's some further downside? Yes. We're starting to see opportunities more particularly though in deals that we may have either passed on before or where somebody outbidderâs and now those deals are coming back around when they've been dropped. But as far as seeing anything that I would call distressed or severely discounted, I haven't really seen that yet, but we're looking hard for them. Got you. Understood. And then one final from me, which markets do you think have the greatest lock constraints and we'll just say are lease acceptable, the potential impairments in the industry in which markets are maybe more oversupplied and more at risk. I'm asking because right now new home pricing we just made is kind of down about 10% from the peak nationwide? I don't really see that any market is oversupplied. Again, nothing at all compared to what we saw back in â07, â08 timeframe. So I think it's still really hard to get lots entitled and they get lots developed. So again, I don't see anything being oversupplied. I think as far as riskiest markets, I think it's the ones that ran up the most and are probably going to be a little slower to bounce back. And the ones I would point to would be, I think the ones that you hear on everybody talk about, right, which is Arizona, Denver. And we kind of got out of the Northwest, so we kind of missed some of the stuff that happened up in in Salt Lake and Washington in Boise. But I'd say for us, probably the two that we look at most carefully are Arizona and Colorado. Thanks. Good afternoon, everybody. Thanks for taking my question. I just wanted to follow-up on Trumanâs. You have $90,000 on a sort of average revenue per lot rate this quarter. Obviously, the markets change to some degree, the Southeast has remained reasonably decent Texas has been good, the West has slowed a lot. As you're thinking about your mix of deliveries in 2023, recognizing you're not giving guidance? Do you think it's going to adjust appreciably from what it was in â22 geographically speaking? It's always challenging that what product mix is going to sell and what dates $90,000 I think is probably the highest we've hit on a quarter, but we also had some sales in the West. We sold our last lots up in the Seattle market. Again, we might reenter that market when it's more attractively priced again. And then we had some other Western type sales that maybe skewed that number a little higher than usual So I would expect overall our ASP will probably not increase from $90,000, but will probably trend down a little bit this year. All right. Thanks, Dan. And then regarding your comments on the potential for opportunities, you talked about some builders may be looking more at finished lot transactions as opposed to doing self-development. Besides deals that you passed on before that are now coming back to the market. Is there any sense that you're seeing now some of those vertically integrated builders want to move towards not developing their own given they sort of need it for margin? And are you seeing other developers out there not looking at new deals? So not only dropping deals, but just effectively disappearing from the market at all. That kind of firm level distress yet? Yes. I think, I clearly, I've seen that the smaller developers are having a hard time getting new financing on new projects. And are probably negotiating with their banks on their existing deals, that's my sense. We are seeing some developers that have put a couple packages together, but again, I don't feel it. I don't think they're feeling overly stressed yet. That may happen. I think, I guess, we'll see what happens here with the spring selling season about to begin. But we are definitely seeing a slow up in transactions by developers. As far as builders, the conversations over the last couple of months have been interesting. People are looking for positions in areas that they're not in yet. But I think everybody is getting ready to pull the trigger. Again, I think we're going to really see over the next eight to 12 weeks what happens with sales and therefore builders desire to ramp up starts again. Hi, this is Asher Sohnen on for Anthony. Thanks for taking my question. So ASP per lot rose 2% quarter-over-quarter, which seems somewhat out of line with what we're seeing in terms of home prices of what they're doing? So is that largely due to delivery of loss with prior pricing, kind of, already put under contract in the time of those deliveries? And then if so, was there any renegotiation of prices between you and builders baked into that number? And then if not, should we start to expect like renegotiations to be a price headwind over the balance of the year? Well. This is Jim Allen. With respect to the $90,100 ASP for the quarter, I think the increase there probably had more to do with mix than anything as Dan mentioned. I guess with respect to renegotiating and what [Multiple Speakers] Renegotiating, we're seeing builders come to us looking for some flexibility with terms, not so much pricing, but maybe their takedown. So pricing right now has held pretty steady. The other thing that we mentioned is $90,100 for an ASP, it puts us in a sweet spot we think for affordable pricing where builders want to be with highest demand is in the marketplace. So we had not seen that yet on the pricing side, but we have that builders come back to us and want to talk about terms. This is Dave. I'd add on to that too, when a builder comes to us and wants to renegotiate a takedown, we're typically getting something in return for that. So whether it be a larger earnest money deposit or a higher escalator on those lots. So there is a little bit of an offset, as far as price whenever we do decide to extend a takedown schedule. Great. That's really helpful. And then just sort of following up on that Dan, so as you sort of write up new contracts for lots that are sort of coming through the pipeline that haven't been contracted yet. What has pricing look like trending there? Is it sort of still stable, kind of, following underlying land prices not yet coming down? Or are you starting to have to give up a little bit price there? I think we look at that project-by-project, market-by-market. They all have unique characteristics. So when we set pricing for finished lots, we're looking at all the intangibles for each market, but right now our pricing is up steady. Hi guys, Doug Wardlaw on for Mike. Last quarter you guys mentioned that you weren't any closer to any potential impairments after the quarter. And I was just curious after this most recent quarter of that mindset has changed? And if not, how do you envision the rest of the year going in terms of maybe getting to, kind of, the warnings on a potential impairment? Well, we regularly review and monitor projects for indicators of impairment. We had no impairments for the quarter. We did write-off some due diligence costs and earnest money related to deals that we decided not to close on. At this point, as Mark said, our margins and our pricing has held up pretty well. We've seen a little bit of compression in margin, which we expected. Probably a little bit early to say what to expect for the rest of the year that will be in a more contingent on general market conditions and what happens with rates. But at this point, we don't see widespread impairments. We may have isolated impairments as we go through the year, but we don't see it at this point on a widespread basis. Great, thanks. And with that, I'm just following up on what you said in terms of margins. So relative to your expectations at the end of 4Q, you haven't seen more and less of the margin compression you expected? Sequentially, gross margin came down a little bit this quarter, but it's held up pretty well. Our pricing has held up well. We have lost operating leverage due to reduced volume. So we've certainly, have a higher SG&A as a percentage of revenue than we'd like. But as I said earlier, our SG&A expense was down 3% sequentially and has decreased for the last three quarters. We have reached the end of the question-and-answer session. And I will now turn the call over to Dan Bartok for closing remarks. Thank you, John. Thank you to everyone on the Forestar team for your focus and hard work. I'm proud of the results the team achieved this quarter. We will stay disciplined, flexible and opportunistic as we continue to consolidate market share in fiscal 2023. We appreciate everyone's time on the call today and look forward to speaking with you again in April to share our second quarter results. Thank you.
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EarningCall_1219
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Good morning or good afternoon all and welcome to the Dime Community Bancshares, Inc. Fourth Quarter Earnings Call. My name is Adam, and I'll be your operator for today. [Operator Instructions] 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 and set forth in todayâs press release and the company filings with the U.S. Securities and Exchange Commission to which weâll refer 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 the U.S. GAAP. The information about these non-GAAP measures and for reconciliation to GAAP, please refer todayâs earnings release. Good morning. Thank you, Adam, and thank you all for joining us this morning. With me today are Stu Lubow, President and Chief Operating Officer; and Avi Reddy, our CFO. We are pleased to report another strong quarter for Dime. But before we get into the quarter results, I want to take a moment to comment on our full year performance. 2022 was a very successful year for Dime. And our strong and consistent performance throughout the year reflects the power of our commercially focused community bank model and our dominant market share on Greater Long Island. For the full year, we reported over $145 million in net income and EPS of $3.73 dollars per share. Our return on assets for the four quarters of 2022 were 1.13%, 1.27%, 1.26% and 1.23%. Stable results during this rapidly rising and unprecedented interest rate environment. We were able to achieve strong returns by keeping our operating expenses controlled and our NIM averaged 3.25% for 2022 compared to 3.14% for the fourth quarter, consistent with our stated posture of operating a moderately asset sensitive balance sheet. We supported our customers and grew loans by approximately $1.3 billion and put in place the talent and infrastructure to grow our C&I business to the next level. I must give full credit to each of our 800 plus employees on delivering record growth and profitability. Turning to our results for the fourth quarter. We generated net income of $38.2 million or EPS of $0.99 a share, a year-over-year increase of 19%. We had another impressive quarter of net loan growth and again focused on prudent cost control. Loan growth for this quarter was well balanced across various asset classes. Importantly, and the key strategic priority for us, this quarter we grew business loan balances by $215 million and continue to have a strong pipeline in this area. Stu, Iâm sure will provide more color on our current pipeline and the mix in the Q&A. As you heard from our peers and consistent with the banking industry at large, the environment for deposit gathering is extremely competitive. Not just competition from other banks, but also from market related products such as U.S. treasuries and money market funds. Despite these headwinds, we were able to maintain average DDA at around 36% of deposits. We continue to expect some level of migration from DDA to interest bearing accounts, but our laser focused on this, and our incentive compensation plans from top to bottom are designed on prioritizing DDA. We have a strong group of commercial bankers and we had the luxury over the past years of using excess liquidity on our balance. Obviously, their goals and objectives this year will be heavily weighted and refocused even more on deposit generation. In addition to our commercial bankers, we have a specialized treasury management team with a robust product set. Working in tandem with our commercial bankers and retail branches, we have all the right people and systems in place to deliver on 2023 goals. We were not very competitive on consumer deposit front over the past few years. However, starting in late 2022 and into 2023, we like many others are being more competitive in this segment as well. We think 2023 deposit growth will come from various sources. Some component will be DDA, but will also include a mix of less price sensitive interest bearing accounts and even some market sensitive accounts. Our cycle to date deposit beta for this round of tightening has been approximately 19.7%, 74 basis points versus the increase in cost of -- 74 basis point increase in cost of deposits versus 375 basis points of Fed hikes up to mid-December. Our performance on this front compares favorably to our Metro New York competitors. Again, our relatively low betas have been driven by the significant level of DDA in our balance sheet. This remains a clear differentiator for Dime versus other competitive banks in our footprint. As you know, historically the Metro New York area has been a more competitive market for deposit gathering, while affording robust loan growth opportunities and more stable asset quality performance in other parts of the country. Avi will get into our expectations of betas and NIM in his remarks. Moving to asset quality. Our NPAs and loans 90 days past due were down 22% versus the linked quarter. During the pandemic, we also took a fairly conservative stance on migrating loans to classified status and we've seen a significant decline in classified assets this year. Our net charge offs in the fourth quarter were only 1 basis point. Avi will again provide more detail on loan provisioning for this quarter. Suffice to say we feel comfortable with the level of reserve and the overall health of our balance sheet. Thus far, we have not seen any meaningful early warning indicators of credit deterioration. As you know, Dimeâs credit losses have been well below the bank index over multiple cycles. Underpinning our strong historical competitive credit performance has been our bulletproof multifamily portfolio that has an LTV of only 57%. We continue to believe this portfolio will outperform any potential recessionary environment. Also, as this has been a fairly topical question on other earnings calls, a quick update on our office exposure in Manhattan. As mentioned previously, we only have $229 million of loans with an LTV of approximately 53%. Finally, as the AOCI and the balance sheet stable this quarter, we were able to grow tangible book value per share by $0.86 for the quarter or 15.4%. We had a strong quarter end year. Our balance sheet is positioned to produce strong returns in any economic environment as evidenced by our quarterly and year to date ROAs of over 1.2%. We remain focused on managing our margins in a difficult inverted yield curve environment and we are focused on growing core deposit relationships, which have value in any rate environment. We remain excited to deliver on the opportunities in front of us as a true community commercial bank and are highly focused on being responsive to market conditions and customers' needs. Our goals for 2023 remain consistent, managing our cost of funds and prioritizing NIM in an inverted yield curve environment, prudently managing expenses and is always maintaining solid asset quality. At this point, I'd like to turn the conference call over to Avi who will provide some additional color on our quarterly results and thoughts around 2023. Thank you, Kevin. For the fourth quarter, our reported net income to common was $38.2 million. The reported NIM for the quarter was 3.15%. As Kevin mentioned, our full year 2022 NIM was higher than the 2021 fourth quarter base, reflecting a moderately asset sensitive position. Over the course of the third and fourth quarters, we supported loan demand through the addition of approximately $1 billion of FHLB borrowings. While we have the ability to borrow longer at a lower cost, we intentionally kept the duration of these borrowings to one month or less so that we can benefit from a full repricing in the event that the forward interest rate curve materializes and the Federal Reserve does indeed lower rates starting in late 2023 into 2024. Similar to how many companies kept excess cash during the pandemic and benefited from rising rates we're following a similar strategy on the liability side where we are intentionally staying short and hope to benefit from a full repricing if and when rates do go down. Couple of housekeeping items. Net accredible balance from purchase accounting currently stands at approximately $1.5 million and purchase accounting accretion was fairly immaterial this quarter. Included in the 3.15% margin was 3 basis points of prepayment related income. Average total deposits for the quarter were down 2% and our cost of total deposits increased by 46 basis points. We were again pleased with our deposit betas lagging the level of Fed funds increases in the fourth quarter. That said, given the rapid pace of rate increases and the absolute level of market rates, we do expect deposit betas to continue to increase from the levels seen this cycle. We continue to have a significant repricing opportunity on our loan portfolio and we continue to proactively manage our loan pricing. The rate on our total pipeline is approximately 6.25%. This is significantly higher than our existing loan portfolio rate of approximately 4.75%. The clear medium to longer term opportunity for us is to reprice our loan portfolio at new origination rates which are approximately 150 basis points to 175 basis points above the overall portfolio rate. Core cash operating expenses excluding intangible amortization and loss on extinguishment of debt for 2022 was $198 million, which was within our full year guidance. We remain highly focused on expense discipline, while making necessary investments in our franchise and have built this into our culture on a very granular level. Core cash operating expense for the fourth quarter excluding intangible amortization came in at approximately $50 million. Our core efficiency ratio this quarter was 47% and for the full year 2022, we also operated at approximately 47%. Noninterest income for the fourth quarter was approximately $9.5 million or a 19% increase versus core noninterest income from third quarter, excluding the branch sale gain in the third quarter. As we have predicted, revenue from our back to back customer loan swap program and our SBA business picked up in the fourth quarter compared to third quarter levels. Moving on to credit quality. Our provision for the quarter was $335,000, while we did have approximately $450 million of loan growth in the fourth quarter, we also saw a reduction in results on various individually analyze loans that moved from substandard and doubtful categories into better risk ratings, driving a release in reserves for our individually analyzed portfolios. Needless to say, we are comfortable to leverage results on our balance sheet. Our existing allowance for credit losses of 79 basis points is still above the historical pre-pandemic combined levels of the legacy institutions. During the fourth quarter, our capital levels remained relatively stable despite supporting $450 million of loan growth. As we've guided to previously, supporting loan growth and our clients is the first and best use of our capital base. We will continue to manage our balance sheet efficiently and our tangible equity ratio of 7.76%, including the full impact of AOCI and 8.40% excluding the impact of AOCI is within our comfort zone. Next, I'll provide some guidance for 2023. We expect loan growth for the first half of 2023 to be in the mid-single digits on an annualized basis. We've clearly demonstrated strong loan originations with sequential growth every quarter in 2022. Our focus is on growing solid business relationships, while keeping our multi-family portfolio relatively flat. Given the economic environment and uncertainty around how customers will react to additional Federal Reserve rate hikes, we will update you on our growth goals for the second half of the year on subsequent earnings calls. As you know, we don't provide quarterly quantitative NIM guidance. We're operating in a significantly inverted yield curve with intense competition on the deposit side. As Kevin mentioned, our deposit beta to date has been 19.7%, fairly accredible for a 375 basis point rate shock to the system. Even with some future deposit cost lag, if rate increases have stopped at these levels, we would have been within our previous cumulative cycle guidance for deposit betas of 25%, which was based on around 300 basis points to 325 basis points of rate hikes. However, given the fact that the Federal Reserve is going to the 5% area on rates, we're now expecting higher cumulative betas as the last 100 basis points to 150 basis points has had a more heightened impact on customer behavior versus the first 100 basis points to 250 basis points. Given the level of Fed funds increases in the competitive environment in general, there'll be a lingering impact of deposit cost catch up over the course of 2023. Our best estimate right now is that cumulative betas end up in the 30% area for total deposit costs and deposit costs peak towards the back half of this year. The loan to deposit ratio ended the year at 103% up from 97% in the prior quarter and slightly above our target range of 95% to 100%%. Going forward, we will exercise price discipline and pace deposit growth to approximate the growth in well-priced lending opportunities. We're keenly focused on deposit gathering to our seasoned relationship bankers, treasury management teams and competitively priced consumer deposits. Our goal is to operate over the course of 2023 with a loan to deposit ratio below 108%. Should rates decline in future years, 2024 and beyond, we do expect prepayments in the multifamily portfolio to pick up, which will lead to a natural normalizing of the loan to deposit ratio over time. As mentioned previously, our core cash operating expense base excluding intangible amortization was $50 million for the fourth quarter or $200 million annualized. We expect core cash operating expenses for 2023 to be between $206 million and $209 million. Included in this guidance is approximately $2 million of additional expenses related to the industry wide FDIC surcharge and also $2 million of additional expenses for our pension plans for 2023, which is related to the poor performance of the equity markets in 2022. Obviously, both these items are outside of our control. Absent these items, the expense guide would have been closer to $202 million to $205 million. Be that as it may, we remain focused on controlling the things we can and we will do everything in our part to beat the guidance of this year and we continue to evaluate opportunities for expense reductions across the bank. We expect non-interest income to be within the range of $35 million to $37 million. This guidance take into account the full year impact of the Durbin amendment on interchange. We expect to manage our capital ratios efficiently and are very comfortable operating the company at our current capital levels. We are very active on the share repurchase front in 2021 and 2022 and should our capital levels build for any reason we will not be shy to enter the market via repurchases, given the value we see in our stock. Finally, with respect to the tax rate for 2023, we expect it to be approximately 28%. Thank you. [Operator Instructions] And our first question today comes from Mark Fitzgibbon from Piper Sandler. Mark, please go ahead. Your line is open. Hey, good morning guys. First, wondered -- Avi, I could just -- could you just go through your fee income guidance again? I didn't catch all that? Sure. Yes, so the guide for this year Mark is $35 million to $37 million on fee income. This is the first year that we're going to have a full impact of build. And if you remember, starting July 1 we did have an impact for the second half of this year. Seasonally, Q4 is a little higher with certain fees that we recognize in the fourth quarter. So the guidance for next year is really $35 million to $37 million. We're really expecting good income on the loan swap program that we have and on the SBA side and our treasury management business really is kicking in on all cylinders at this point. So that's going to offset the full year decline for the interchange income there. So really $35 million to $37 million for next year. Okay. And I heard your comments on the margin, Avi, but could you help us think at a high level when you think that perhaps the margin kind of bottoms out? Does that relative to when the Fed has done raising rates or some other metric? Yes, I think so. What we said in the prepared remarks Mark was, we do think deposit costs are going to continue to increase over the course of the year and probably stabilized by the back half of this year. What I would point out is, when you look at our front book and our back book in terms of loan originations, the front book is coming on in the low 6s and the stuff that's amortizing is around 4.40% for this prior quarter. So it's going to -- that's going to benefit us going forward, obviously. But the one quarter the Fed does stop hiking, you're going to see then the impact of repricing stop and deposit costs over power for a quarter or two. So I'd say, towards the back half of this year, we're highly focused on stabilizing the NIM. And obviously, we believe this company should have a NIM in the 320 to 330 area in the medium to longer term. Again, it kept DDA at 36%, we're happy with that. And we're still growing our customer base at this point in time. So yes, I think really just a function of deposit costs catching up a little bit and a little bit laggard in the first half of this year. Okay, great. And then I guess just strategically thinking about it, given the funding challenges out there and the fact that you guys aren't wildly overcapitalized, would it make sense to kind of slow loan growth even more just kind of slowed down the growth in the balance sheet and kind of protect margin, if you will? I think -- Hi, Mark, it's Stu Lubow. I think we're talking about mid-single digit growth this year. The last 18 months have been significantly higher than that. We are seeing a moderation in our pipeline. But a big part of our growth in the early part of this year was the multifamily portfolio. And that portfolio weâre really just servicing our existing customers and doing swap deals on that portfolio. We don't expect to see any real growth in that portfolio at all for the year. So just a natural remixing of the portfolio and our focus on C&I and owner occupied CRE is going to result in a moderation in terms of growth. I mean, today we have about a $1.5 billion pipeline at an average yield of $628 million, but only about $200 million of that is multifamily. And even at that rate, those rates are in the high fives. So we're really not in the market in terms of pricing in that portfolio. And so, we do believe we're going to have some nice growth with the C&I business and the owner occupied CRE deposit balances, we're really focused on that. And so the funding on that is important and we think growing good solid business relationship, DDA balances within the C&I and owner occupied sectors of our product mix are very important. So we want to continue to grow that part of the business. But suffice to say, we don't expect to see this significant growth that we had over this year. Yes, Mark, I just want to reiterate one of the comments we made upfront was if you go back a year, we had significant payoffs in the multi-family portfolio, right? So if you just follow the forward rate curve, 12 to 18 months from now, you could again see significant payoffs in that portfolio, which is going to help with stabilization of the loan-to-deposit ratio over time. We're not seeing it right now because, obviously, rates are elevated, but we could see that portfolio pay off at a fast level in 2024. Well, we're going to continue to do -- from the standpoint of the value of this franchise is building relationships. So we're going to take this opportunity to continue to do that. Good morning. Maybe just starting with -- just maybe starting with [indiscernible] here. You mentioned that there was an improvement in terms of criticized and classified assets quarter-over-quarter. Just wondering if you could quantify that and maybe just help us think about the reserve here -- the reserve ratio going forward? Yes. So this quarter what happen with the reserve was, as part of the merger accounting we had set aside various results or various loans at that point. And some of them were in the criticized/classified category upfront. And over time, we've seen a steady improvement in that. So that drove a part of the release this particular quarter. The other thing that we saw was, one of our biggest nonaccrual loans which was on the C&I side actually moved to accruing status this quarter and there's probably $1 million of reserve release associated with that. I mean, with our substandard loans, we typically provide disclosures of that in our 10-K, which will come up in a month time, but preliminary numbers right now on those portfolios indicate continued improvement in those. I mean, we're down significantly since the start of the year. What we did, when you go back and look at our old 10-Ks and 10-Qs, we were very conservative over the course of the pandemic where we moved a lot of loans that had deferrals in them and a lot of that's getting a lot better. So really back to the peer group median, if not below the peer group median on criticized cost side. But really this quarter, it was a couple of specific loans that came out that had specific reserves associated with them. I think just going forward on the reserve, just general rule of thumb is on real estate loans. We probably have a reserve on investor free and owner occupied free of around 60 basis points plus or minus on new loan growth. And on the C&I side, it's between one and 125 basis. So on a blended basis, it's probably around 80 basis points in terms of the result, which is pretty similar to our overall result right now, which is 80 basis points. So absent any improvement or worsening of economic conditions and absent any changes in our individually analyze portfolios. The way you should think about it is that, we have loan growth in the future, the provisioning on that should be around 80 basis points given our mix. Okay, great. That's helpful. And then, excuse me, maybe just following up on funding here. Just curious, obviously, marginal funding cost is pretty high here. Just wondering, the longer the curve has moved lower at what point maybe would you consider balance sheet restructuring with your securities portfolio, if at all? Yes. I mean, I think we look at all uses of capital at all times. I think we're very comfortable with where we are. Supporting customer growth right now is important for us, but we look at it all the time. When you look at our securities portfolio, the yield on the securities portfolio is around $180 million. It's a fairly short duration portfolio. It's probably three to four years over there. I mean in our math ahead, Steve, is that, if we reprice that whole portfolio to market rates to $180 million and the market rate for securities right now is $425 million to $450 million, that's a 35 basis point pick up on the NIM once that whole portfolio reprice. So itâs something we think about in conjunction with the buyback and conjunction with loan growth. And we feel pretty good about our capital levels at this point. So we do have this flexibility to do various things. Good morning. Avi, I just wanted to stay on that point on the securities portfolio. You mentioned the duration. And at least in my model, I'm expecting some role from securities into loans to help funding. Could you just give me a sense for kind of the quarterly runoff of securities? The duration implies it's a little bit sharper than what I have modeled. Yes. So we got around $120 million, $130 million of cash flows coming in, in 2023, Matt. But when we sold our PPP loans a couple of years back, we really put that stuff into treasuries. And those treasuries are obviously bullet maturities, two to three years out. So we got some big maturities in 2025 and 2026, probably around $300 million over there. So it is pretty short on the AFS side just because of the fact of the treasuries we have. So to answer it differently, the cash flows aren't coming in because they're treasuries, but they're all going to mature two years out. So there's not a lot left there in terms of extension risk on that particular portfolio. And obviously, we have a held-to-maturity bucket, which we moved some securities into that late last year and into Q1 to help protect tangible book. So -- and the portfolio is fairly well balanced. 40% held to maturity, 60% AFS, which gives us the ability to consider various things over time. Okay. And then you had mentioned that demand deposits you expect to kind of settle out in the 30% range, you're at 34% today. So obviously, there's some implied pressure there. As we think about matching loan growth with deposit⦠Matt, we didn't say that. We said that our total deposit beta over the cycle would be 30%. I mean our average DDA was 36% for the fourth quarter. So we don't really expect that or we're not really saying it's going to go down to 30%. So that's not what we said. I'm sorry, I misquoted you. Could you give me some idea where you expect demand deposits to settle out? What's your best guess with that 30% deposit beta? Yes. I mean, I think Q4 is a little seasonal for us. At the end of Q4, typically, we have municipal deposits come in. This time around is a little bit of a delay in the municipal deposits come in. We've seen a strong January in terms of some of the municipal checking accounts come in, which are related to tax receiver money. So look, we're going to have some pressure on that ratio. But at the same time, we've got various opportunities at the bank, big customers, small customers. And as Kevin said, our lending teams, this particular year are going to be highly focused on gathering deposits and treasury management teams are going to be focused on that. So I think like everybody else in the industry, we had some excess deposits the last couple of years and put that to work and growing the balance sheet was important. But yes, I mean, it's going to go down maybe a little bit. It's really hard to predict where it's going to go down, but we do feel we have a pretty granular customer base and everything is relationship-based. So that should help us stay well above the peer group in terms of this ratio going forward. And then right now, where are you most competitive in terms of higher rate offers? Is it money market, CDs, high percentage of savings accounts? So we got a CD product out there for new customers and new money, which is a 4.5% rate. It's a 13 month CD at that point. That's the highest rate that we have out there. So really on the consumer side, we're competitive. On the business side, it's really customer-by-customer, relationship-by-relationship and looking at profitability. Okay. And then I wanted to get a sense for whether or not -- look, I know your -- all your non-accruals, your criticized/classified are all solid. But as you kind of step back, are there any kind of underneath the hood credit cracks materializing across any of the portfolios? It just feels rather [indiscernible] for us to go through this level of interest rate hike and then mix shift in cap rates without really any material credit deterioration. Matt, I hear what you're saying and we are laser-focused and we've had this conversation, I guess, over the last three quarters as to -- do we think there's going to be a crack in credit, and we're very watchful of it. At this point, we're not seeing it. I mean, I think the positive side of our portfolio, we talked about the multifamily being -- having a low LTV of 57%. The average debt service coverage on that portfolio is about 1.43. But the total CRE, Investor CRE for LTV is also 57% with an average debt service coverage of 1.78. So I think from a credit standpoint, while we're always concerned and certainly, as rates have gone up, we're concerned about stress on different parts of the portfolio. I would say we're really not seeing any significant material stress in any product line. I would say probably the only area that some of the customers will be the SBA business, all right? And that's a small part of our book. But those customers are -- some of those customers will struggle with floating rates getting to the level they are today. Matt. [Multiple Speakers] One area I'd point out is, as you know, when we put the companies together, we were able to really look at individual credits. And I think the one difference with our reserves that we've always said versus the peer group is, there's a significant portion of it that's described to individually analyze loans. So within the $83-odd million that we have, there's probably $31 million, that's for individual credit. So we know what credits are on the weaker side, and we've got significant reserves associated with them, and we're able to do that as part of the merger accounting. So I think we've -- as opposed to people who have everything in the pooled reserve, I think the difference with them is, if something goes bad, then they're going to have to start putting up reserves to those. I think we try to identify everything that may or could have an issue, be conservative around it and already [indiscernible]. And that's what you saw this quarter, right? You saw some stuff improve, and that's why the reserve was close -- the provision was close to zero, even though we had significant loan growth. So this is just something else to think about when you do the modeling. And virtually everything that we have charged off this year was previously identified as a part of the merger and we took the mark. So the due diligence we did early on prove to be correct. And so we really haven't seen any new credits -- significant new credits come to us as a problem. Hey, good morning. With your outlook of kind of stay below 108% loan to deposit ratio, what's kind of like the thinking on how quickly you might approach that? Would that be something that could happen next quarter or just kind of any color there? No. So I think what we're trying to say with that is, pipeline, like Stu said is really strong at this point, right? I mean, we've built a lot of business over the course of 2022 so we have a line of sight here on the loan portfolio in the first half of the year. And at any point in time, again, I mean, people think about loan to deposit as a period end number, right? So we've got some seasonality in the deposits like escrow deposits, for example, that could stay for the whole quarter, but then go out at the end of the quarter. So I think we just want to add some guardrails around which we operate. Loan growth is probably going to be stronger in the first half of the year than the second half of the year. But I think, again, we're focused -- and Kevin said this too, we're back in the consumer market for competitive repriced deposits. So it's not a per quarter per month thing, but we just want to stay under that threshold for this year. Yes. And I also think it's important to understand that we're going to continue to remix the portfolio out of the multi-family business and into the areas where we've really grown capabilities in terms of the middle market C&I, owner occupied CRE. So you should expect and could expect to see multifamily as a percentage of the total, significantly reduced over the next several years. Obviously, what that does is, improve our NIM because we're getting 50 basis points to 100 basis points better yield on the non-multifamily part of the portfolio. And of course, deposits come along with the C&I and relationship business. I appreciate that. I think that's going to be my next question about mix and growth. So it's going to be definitely more C&I. Did you give what proportion of the pipeline of C&I at the moment? I appreciate that color. Is there -- I know that you don't like to give kind of near-term NIM expectations, but anything you can give on like directionality and kind of success of your current offers in the marketplace to help stabilize funding? Yes, sure. So in terms of consumer deposits, we've -- we have some offers out there at the start of this year, and we've already raised $75 million of deposits on that. So you think falling back to the loan to deposit ratio question, I mean, that's a market that we can access. We have seen a lot of banks do it. It's going to be a mix between CDs and competitive savings of products. I think the one disclosure we always like pointing the analysts to is, if you look at our prior 10-Ks and 10-Qs, Manuel, on the economic value of equity, and you go back to the start of the year, look at our 10-K, our EVE was around $1.2 billion at that point in time. And you look at what we had in our September disclosures, it was around $1.7 billion to $1.8 billion. And so what that's really telling you is that, the present value of the cash flows of the assets and liabilities, once they go through that full cycle, which is over a DCF model over three to five years, our own models are saying the bank is worth $400 million to $500 million more, right? That doesn't show up in a quarterly NIM number because your NIM can go up and down in any particular quarter. So I think looking at those EVE numbers, provide you some directional analysis of the franchise value in the company. And obviously, in our next 10-K, you'll see the next EVE number come out. What do you assume are the ranges for your noninterest bearing deposit balance in that calculation? Because that could shift that pretty widely, correct? Yes. No, absolutely, but it's a projection over the course of five years, right? So we see attrition then when we modeled that based on recent history of what we're seeing. But like Kevin said, our noninterest bearing -- our average noninterest bearing deposits for the fourth quarter was 36%. I mean, we have escrow deposits that we pay out at the end of the year. So the spot balance is always kind of misleading. But we were 37% when we went into the cycle and weâre 36% right now. So we've done a really nice job keeping it there. And I think like Kevin said, all our goals are really focused on deposits and growing deposits this year. So some level of that, we obviously model a certain level of betas in there. And as I said, we always do our IRR modeling with around 30% betas, and that's kind of what's in there. But I think in the near term, yes, sure, you could see people move out of DDA into interest bearing deposits. But then over time, once the Fed starts cutting rates again, you could see a migration back into DDA there as well. Hey, good morning. I appreciate the expense guide. I was hoping to just get a little bit of color given the first quarter seasonality, especially in the comp line with some of the things you mentioned as to maybe where the starting point is for the year and then how the cadence kind of progresses from there? Yes. Chris, I think we typically shouldn't see too much seasonality with our numbers. We try to accrue and pretty much true up towards the end of the year. So I know that some banks that have a significant amount of seasonality probably a little bit less for us. I would say, in general, we kind of met all the goals we set out at the start of the year. So we should be okay on that. I think we try to focus on the full year number because, again, there could be movements up and down. I mean you are right, Q1 sometimes a little bit more, but not too much more for us. I think within the $206 million to $209 million, like I said, we got the FDIC and we got some items for the pension, which hopefully are not recurring for 2024, right? So 2023 is a little bit of an abnormal year. There's also some investments that we're making in our digital platforms that are part of that. And then in addition to that, there's employee costs and just the cost of running our business. So nothing too much out of the ordinary for us, but we hope to come in line or better than that $206 million to $209 million for the full year, like we did for the last two years. Got it. And so that tension comes in at $0.5 million to the quarterly run rate starting in the first quarter? Yes. I mean the way the pension works is, you get an estimate at the start of the year, you accrue for the whole year in a certain run rate, and then you do a true-up at the end of the year. So that would kind of be straight line, correct exactly. Okay. Great. And just given the updated outlook on the margin in the near term year for the first part of the year. How do you guys feel about the sub-50% efficiency ratio target? Yes. I mean, look, we can control the things we can, right? So when you focus on expense to assets, we were at 1.55% this past quarter. And I think being there or being better than that is a goal of the company and we're highly focused on that. I think when you think about the efficiency ratio, you go back to when we put the two companies together and our goal was to be at sub-50%. I think we'd be -- I mean, apart from the first quarter, I think we've beaten that every single quarter. Some quarters we operated at 44%. This past quarter was 47%, right? So look, every quarter, it may go up or down. But I think in the medium to longer term, we definitely want to be a sub-50% efficiency ratio bank, which we've definitely demonstrated over the course of the last 24 months. Great. And as far as just the loan growth, you guys seem to have a robust pipeline still, especially outlook for the first half of the year. Where are you guys seeing the biggest opportunity for growth? And are you getting any kickback from your customers on higher rates on the new originations? The real opportunity for us is and what we're really focused on, as I said, is the C&I and the owner occupied CRE, because those are relationship businesses. And we've really been able -- you saw significant growth in C&I. I mean, today, the weighted average rate on that part of the portfolio, the pipeline is [744] (ph). So the fact is, we're able to -- with our new teams bring on business at these rates, and we're still conservative underwriters. So on the CRE and the Investor CRE. We're maintaining our debt service coverage ratios even at these interest rates, which are basically our rack rates on Investor CRE is about [indiscernible] today. So again, we're very comfortable with where we are. We're able to develop new relationships and new business even within this higher rate environment. I think the fact that we are a local community commercial bank building relationships is the key. And the banks that we're taking in the business from are larger and provides us an opportunity to provide the personal service and the attention that these customers desire. And we can do it competitively with all the products and services that a larger commercial bank has. So, I mean, that's our opportunity. And to date, we've been able to accomplish that. I mean just in the fourth quarter alone, we -- while we had $450 million in net growth, we had $680 million in total originations at the high 5s in terms of yield. So the fact is, we've been able to really improve our yields and grow the business even during these higher rate times. Yes. Just two follow-ups for me. Maybe just going back to funding costs here. Just curious kind of what the maturity schedule is on the CD portfolio and kind of think about how we can grow up that rate pricing up here going forward? Yes. I mean, we used to provide some disclosure in our press release on the CD portfolio. Maybe we'll put that back. But there's around $600 million that we have. I'd say the biggest piece in the month of May, where we have around $100 million of CDs, the rate on that is around 3%. So I'd say $600 million of that is this year, and the rate on that is around $150 million to $155 million. So the item with that is generally on our CD portfolio, we see retention rates of around 65% to 70% based on current rack rates. And then the remaining 35% of it, you're going to have to go out in the market and fund at a higher rate. So in the near term, you're going to see some deposit cost increase because CDs are pricing up as stuff rolls off. But what we've done, and I've mentioned this in the script was, we're trying to keep everything fairly short so that when the Fed does drop rates, we're not stuck with 24, 36 month maturities over there. So everything is generally fairly short on the CD portfolio. Okay. That's helpful. And then maybe just on M&A here. Just kind of curious, any updated thoughts you guys may have in terms of level of discussions and your appetite for a transaction? I think we've been talking about this for the last several quarters. We are focused on the organic opportunities in front of us. This is certainly a challenging environment to think about that. But we have demonstrated that putting these two companies together, we're in a position to do something if it was available. But really, the focus for us is continuing to grow in this marketplace, taking advantage of our position here. And as Stu has shown you on the pipeline and that there's plenty of opportunity for us to continue grow our franchise organically. Yes. I just want to -- listen, I think we're proud of what we've accomplished in 2022. On behalf of the Board, I want to thank the whole Dime team for what they've done, the efforts and the focus. And I know there's a lot of questions about margin, but we believe the value of the business model that we have seeking customer, strong relationships, a conservative credit philosophy. It's a model that worked for Legacy Bridge, It worked for the team that still brought on from Dime and what we've done. The near-term challenges we managed as the entire balance sheet adjust to the current rate environment, organizations like ours, with superior funding basis will ultimately succeed. So again, I want to thank everybody for their interest and questions today and look forward to, if you have any follow-up, please give us a call.
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EarningCall_1220
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At this time, for opening remarks and introductions, Iâd like to turn the call over to the companyâs Executive Vice President and Chief Financial Officer, Mike Ruppert. Please go ahead, sir. Good afternoon and thank you for joining us. I hope you had a chance to review the press release we issued earlier this afternoon. If not you can find them on our website at mrcy.com The slide presentation that Mark and I will be referring to is posted on the Investor Relations section of the website under Events and Presentations. With me today is our President and Chief Executive Officer, Mark Aslett. I'm also very pleased to welcome Michelle McCarthy to the call. Serving as Mercury's Senior Vice President and Chief accounting officer for the past five years, Michelle has been an active and valuable member of our leadership team. I'm looking forward to working closely with Michelle in her new position as Interim Chief Financial Officer to ensure a seamless transition prior to my departure in February. Turning to Slide 2 in the presentation. I would like to remind you that today's presentation includes forward-looking statements, including information regarding Mercury's financial outlook, future plans, objectives, business prospects and anticipated financial performance. These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on Slide 2, in the earnings press release and the risk factors included in Mercury's SEC filings. I'd also like to mention that in addition to reporting financial results in accordance with generally accepted accounting principles or GAAP, during our call, we will also discuss several non-GAAP financial measures, specifically adjusted income, adjusted earnings per share, adjusted EBITDA, free cash flow, organic revenue and acquired revenue. A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release. Thanks, Mike. Good afternoon, everyone and thanks for joining us. Typically, I'd sign up prepared remarks with review about results for the quarter. However, given the other news we've announced today, I'll begin with key takeaways from those announcements. I will then review the business. Mike will cover our financial results and guidance, and then we'll open it up for questions. The board's decision to initiate a review of strategic alternatives underscores our commitment to exploring all available avenues to enhance shareholder value. We've engaged two leading investment banks to pursue a range of options including a potential sale. During the board's evaluation, we'll continue to execute on our strategic plan for growth in value creation. As you know, we need to let this process play out. And as such, we won't have further comment on it today. I want to emphasize that there can be no assurance that the transaction will result from the review. We also don't intend to disclose developments relating to this process unless and until the board has approved a specific agreement or transaction or is terminated its review. Now, let me say a few words about Mike. As you saw from our announcement, Mike has decided to step down from Mercury to accept an opportunity in a privately held company headquartered in Virginia, where he and his family reside. Mike has been a great partner for the past eight years. He's made significant contributions to Mercury including helping driver M&A strategy and many acquisitions. Mike on behalf of myself and the entire crew team we wish you all the best in your new role. We've initiated a search for a permanent successor with the assistance of a leading executive search firm. We're fortunate to have a deep bench of talent on our finance team during this transition period. In addition to Michelle McCarthy's appointment as Interim CFO, Nelson Erickson, Senior Vice President Strategy and Corporate development will formally assume responsibility for investor relations. Last week, we also announced that Vivek Upadhyaya who has joined mercury as our Vice President of financial planning and analysis, further bolstering our team. Over the coming weeks, Michael worked closely with Michelle Nelson, Vivek and I to ensure a seamless handoff. With that let's discuss our second quarter results. Turning to Slide 4. Mercury second quarter revenue was in line with our guidance growing 4% year-over-year. More importantly, we return to organic growth and generated positive cash flow in the quarter. GAAP net loss and loss per share as well as adjusted EBITDA and adjusted earnings per share fell short of guidance. This was primarily due to an unforeseen delay in funding to our customer for a large LTAMDs program. After this delay, which reduced Q2 revenue and margin by $10 million and $7 million respectively, our results would have been at or above the high end of our Q2 guidance [indiscernible] results in lower Q3 guidance also as an additional $10 million of revenue and $7 million margin moves to fiscal '24. We are obviously disappointed with the delay in the short term impacts anticipated for this fiscal year. This is large program and the time is outside of our immediate control. That said our customer is confident that their funding issues will ultimately be resolved, allowing us to recognize the entire $20 million in revenue and $14 million margin early in Mercury's new fiscal year. Working with the customer, we've rotated in other related opportunities that we expect will partially offset the impact of this delay in the second half of fiscal '23. As we consider the back half and our full fiscal year guidance, we're shifting our outlook to incorporate this program timing and the prolonged supply chain impacts, resulting in program delays and inefficiencies which are temporarily affecting margins. On the plus side, we believe that revenues currently trending above the midpoint of our fiscal '23 guidance while net income and adjusted EBITDA are now expected to be towards the low end. We're in our fourth fiscal year dealing with these impacts. In addition to program delays and related inefficiencies, we continue to face long semiconductor lead times, tight labor market and inflation. These challenges, however, are not related to end market demand, which remain strong. They're largely timing related, they're short term and they're not unique to Mercury. We continue to execute on our plan to control what we can in this environment, and we're optimistic about the future could not turn positioning. Mercury's bookings for Q2 increased 14% year-over-year, the largest been F-35, F-18 LTAMDs for the classified C2 program. It nearly $60 million the F-35 order for advanced microelectronics capabilities was the largest booking in the company's history. Driven by the growth and bookings are booked to build was $1.18 in the quarter and $1.16 over the last 12 months. Backlog grew 17% year-over-year to record $1.12 billion which provisions us well for future growth. Despite the FMS customer funding delay, our Q2 revenue increased 4% year-over-year. Organic revenue turned positive growing 1% versus a 13% decline in Q2 of fiscal '22. We expect to return to organic growth for the year as a whole as expected. Our largest revenue programs in the quarter were F-35, F-16 [NDSA trans tracking layer], P8 and [SAD] Q2 GAAP net income was negative and adjusted EBITDA declined year-over-year both with the low guidance primarily due to the FMS customer funding delay, although revenue is trending above our fiscal '23 guidance midpoint, other financial measures, including adjusted EBITDA are trending towards the low end as I said largely due to program delays and related inefficiencies. We believe these impacts are temporary in nature, we expect margins to increase the supply chain conditions begin to improve and as we realize further benefits from impact and the continued shift in our program mix from development to production. Operating free cash flow for Q2 was positive a substantial improvements sequentially. We expect to deliver breakeven to slightly positive free cash flow for FY '23, including the impact of the R&D tax legislation. Turning to Slide 5, the defense appropriations bill was approved after the midterm elections as expected, resulting in substantial spending increases in response to national security threats. That said the House GOP rules package adopted this month and the report a deal between speaker McCarthy and the Freedom focus create risk to government FY '24 discretionary spending including defense. And extended budget continuing resolution appears to be the base case scenario for GFY 24, including the potential for a full year CR. However, although risk does exist, we don't expect Congress to approve a reduction in DoD appropriations. Given the geopolitical challenges we face, there appears to be strong underlying bipartisan support to increase defense spending. Looking ahead longer term, we believe the defense spending outlook remains positive both domestically and internationally and that Mercury is well positioned to benefit in this environment. The growth in demand for the compute capability onboard military platform shows no sign of slowing. We also stand to benefit from the ongoing push for platform electronification. We believe that we're well positioned to continue to benefit from long term industry trends include supply chain delivery and assuring as well as increased outsourcing at the subsystem level. Our adjustable market has increased substantially, largely driven by strategic movement to mission systems and the potential to deliver innovative processing solutions at chip scale. Our model, certainly at the intersection of high tech and defense positions us well. Turning to Slide 6. The industry environment continues to be challenging in the short term. Despite incremental improvement in the second quarter supply chain constraints continue to affect program timing and efficiency. Locally sophisticated end to end processing platform passes the most critical end missions. High end processing represents about 70% of the business. This is where Mercury likely has the largest opportunity to grow over the next five years. Prior to the pandemic semiconductor process lead times were 10 to 12 weeks. They increased rapidly in the second part of fiscal '21 and now range from 36 to 72 weeks. Although current lead times on average a slightly shorter than in Q1, we don't expect to see a significant improvement until the second half of fiscal '24. Semiconductor inflationary pressures remain a challenge as well. Semiconductors equates 38% of our direct supplier spend far more than our peers we believe. We're making good progress in mitigating the impact with highest semiconductor costs. As part of our impact program, we established a centralized procurement organization. This enabled us to improve our purchasing efficiency, while helping us deal with the effects of supply chain disruption. We also established the pricing team reprise standard products and incorporated price adjustment mechanisms in our rates based businesses and multiyear proposals. In addition, we implemented across the board price increase in our microelectronics business. Through the pandemic, we've used the strength of our balance sheet to invest in the working capital necessary to mitigate supply chain risk as best we can. As a result, we positioned Mercury to deliver against customer commitments and generate stronger results over time. Turning to Slide 7. We believe that we've entered a multiyear period of accelerating growth and profitability. Demand is improving is evidenced by our strong LTM bookings and record backlog. The next several years could resemble the period post sequestration in 2013 absent a significant budget events and GFY '24. So most of the enhancements that we made in our business at that time, through impact was strengthening our fundamentals once again. It also impacted early in fiscal '22 and it's evolved substantially since then. We began by streamlining our organizational structure and strengthening the leadership team and continuing to do so. We also focus on margin expansion in this business and we're now pushing their execution deeper into the business. With the recent addition of Allen Couture as head of execution excellence and Mitch Stephenson taking over our mission business last quarter, we've doubled down on these efforts seeking to drive continuous improvement around supply chain, operations and program execution. These areas will have been affected by the cumulative impact of operating during the pandemic, with the resulting program delays and related inefficiencies temporarily impacting margins. We believe these headwinds will diminish the supply chain and labor market conditions continue to improve, leading to market and expansion. At the same time, we continue to focus on supply chain risk mitigation, working capital burned down and accelerated cash release. We believe that substantial cash will move off the balance sheets and supply chain related impacts on the business begin to unwind. Another initiative is R&D investment efficiency and returns. In addition on digital transformation ethics and engineering operations and the back office will help improve our cost structure and give us better productivity, scalability and efficiency over time. We're also moving on our manufacturing facility footprint strategy. We consolidate our Mesa Arizona facility into the Phoenix site in Q2 and release two additional facilities as planned. Thank you, Mark. And good afternoon again, everyone. Before I discuss our results, I do want to say a few words about my decision with Mercury. Mercury has been a big part of my life for the better part of a decade. Since I started at the company in 2014 we've grown the business organically, completed 15 acquisitions, and assembled a set of capabilities that uniquely positioned us in the defense industry. It's been a tremendous opportunity to be Mercuryâs CFO working alongside Mark and the rest of our talented leadership team during this time. A few months ago, I was approached by a company that had recently been taken private, base closer to my home in Virginia. This is not something I sought out. But when the opportunity was presented to me, I felt at this point in my career, it was something I had to explore. There's never a great time for a move like this, but I'm firmly committed to making this transition a success. Michelle and I have been in lockstep for years, and I've developed our finances team. So I know how much talent there is at Mercury. I wouldn't have made the decision to leave if I didn't have complete competence in this team and then the company's ability to enhance value for all shareholders, including me. To our investors and analysts it's been a pleasure getting to know all of you over the years. Now turning to Mercuryâs results. As always, I'll begin with our second quarter actuals and then move to our Q3 and fiscal '23 guidance. As Mark discuss Mercury delivered revenue in line with guidance, returning to organic growth and generating positive cash flow in Q2. Demand continues to be strong as we entered the second half. Our 12 months backlog was up 34% compared to Q2 last year, and up 10% compared to last quarter, providing a solid visibility into the remainder of the year. For fiscal '23, we expect to deliver increased bookings versus fiscal '22 a positive book to bill, a record $1 billion in revenues and positive organic growth. As Mark said we expect our performance to be heavily weighted to the fourth quarter. We believe that revenue is currently trending above the midpoint of our fiscal '23 guidance while adjusted EBITDA is trending towards the low end as all discuss. Demand remains strong supported by our position on well funded franchise programs. However, supply chain constraints, labor availability and inflation continue to contribute to program delays and inefficiencies. With the post pandemic impacts persisting through fiscal '23 we're experiencing shifts and high margin production programs, including FMS sales into Q4 and fiscal '24 impacting Q3 and fiscal '23 gross margin expansion as a result. Slide 8 covers the bookings booked the bill backlog and revenue growth results that Mark discussed. What's highlighted yet and is the large FMS program customer funding delay that had an impact of approximately $10 million on our Q2 revenue. Given the program's high margin profile, it also impacted profitability by approximately $7 million resulting in the adjusted EBITDA guidance list for the quarter. This delay in customer funding reflects the nature of FMS contracting, which requires alignment between the U.S. government and the foreign government as well as our direct customers. There's been an approved FMS deal to delay only relates to the award timing both our customer and Mercury. We now expect this program in our fiscal '24. As Mark mentioned, we expect us to have an approximate $20 million and $14 million revenue and adjusted EBITDA impact to fiscal '23 respectively. Gross margins for the second quarter were down 430 basis points year-over-year. As we expected coming into the quarter gross margins reflected a higher proportion of lower margin development revenue as well as material, labor inflation year-over-year. Gross margins were slightly lower than expectations driven by the FMS delay which had an approximately 140 basis point impact on gross margins. Q2 gross margin was also impacted by an incremental depreciation expense and lower absorption in the quarter primarily due to our site consolidation efforts. We expect to see higher gross margins in the second half of the fiscal year and especially in Q4. This is primarily a result of program mix chips due to the high margin FMF sale, as well as execution on several of our larger development programs taking a little longer than expected in the current environment. GAAP net loss was $10.9 million for the quarter, while adjusted EBITDA was $35.7 million down 6% from Q2 last year on lower gross margins. Our adjusted EBITDA margins were 15.5% for the quarter, down 180 basis points from 17.3% in Q2 fiscal '22. Again, the delay in the large FMS opportunity resulted in adjusted EBITDA and adjusted EBITDA margins being below our guidance range. Have we received this contract, adjusted EBITDA and adjusted EBITDA margins would have exceeded our Q2 guidance. Free cash flow for the second quarter was an inflow of approximately $22 million, despite delays in payments from our customers at the end of their fiscal years. Delayed payment behavior across our customer base was partially offset by receivables factoring which we discussed last quarter. Slide 9 presents Mercury's balance sheet for the last five quarters. Our balance sheet remains strong with significant capacity under our $1.1 billion revolving credit facilities. Driven by the anticipated strong cash flow generation in H2 we expect to be well positioned to deliver the balance sheet while continuing to invest in business. We ended Q2 with cash and cash equivalents of $77 million and approximately $512 million of debt funded under our revolver. At current leverage levels the interest rate under the revolver is approximately 5%, which positions Mercury to continue to allocate capital at attractive rates. From a working capital perspective, we've invested approximately $240 million since fiscal '21 potentially the start of the pandemic to support performance obligations to our customers and ensure delivery on critical programs. As these obligations are completed, we expect working capital especially unbilled receivables and inventory to convert to cash and decreased substantially as a percentage of annualized sales. Turning to cash flow on Slide 10. Last quarter, we forecasted breakeven to slightly positive free cash flow Q2. Free cash flow for the quarter was $22 million. In Q2 we did see delays of approximately $30 million in receipts from bill receivables from our customers at the end of their fiscal years. These were partially offset through factoring 20 million of receivables. At this point in Q3, we have received the $30 million of delay payments from our customers. Given our fiscal year timing, we did not see any impact related to the R&D tax legislation in H1. But we're now forecasting an impact in H2. I will now turn to our financial guidance, starting with Q3 on Slide 11. Forecasting in the current environment remains challenging. Our guidance incorporates to the extent we can potential impacts associated with the ongoing supply chain constraints and material and labor inflation headwinds. As a result of the high margin FMS program moving into fiscal '24 coupled with the headwinds contributing to program delays and inefficiencies H2 is more weighted to Q4 and Q3. For Q3, we currently expect revenue in the range of $245 million to $260 million. At the midpoint this is approximately flat growth compared to the third quarter last year, although we remain cautious with regard to award timing, program execution and the current industry headwinds, we expect gross margin to increase gradually in Q3 and more dramatically in Q4 as we complete execution across several of our lower margin development contracts. The revenue growth in H2 and especially Q4 is expected to be driven by higher margin production programs as well as license sales. We expect Q3 GAAP results to range from a net loss of $5.8 million to net income of $1 million. We expect adjusted EBITDA to be $40 million to $47 million, representing approximately 17% of revenue at the midpoint. And as I've said our Q3 adjusted EBITDA margin are being impacted by the delay in the FMS sale, as well as a higher proportion of development contracts. I will now turn to our guidance for full year fiscal '23 on Slide 12. The near term outlook across the industry remains far from certain. But the demand environment continues to be strong and it's highlighted by our continued bookings momentum. Balancing these two dynamics will maintain our previous guidance for the year revenue and adjusted EBITDA. From a total company revenue perspective, our guidance remains $1.01 billion to $1.0 5 billion in fiscal '23. This represents 2% to 6% growth year-over-year and approximately flat to 4%. organic growth. Based on our current demand environment, despite the approximate $20 million slip in FMS revenue, we still expect to see fiscal '23 revenue towards the high end of this range. GAAP net income for fiscal '23 is expected to be in the range of $13.9 million to $24.8 million with GAAP EPS of $0.24 to $0.44 per share. The reduction at the low end and midpoint is a function of the incremental depreciation expense in the second quarter, partially offset by lower expected stock based compensation. We're maintaining our fiscal '23 adjusted EBITDA guidance range of $202.5 million to $215 million, up 1% to 7% from fiscal '22. While we expect revenues at the high end of the range, we expect adjusted EBITDA to trend toward the lower end of the range. This is driven primarily by program mix including the FMS sale as well as supply chain related program delays and inefficiencies also impacting adjusted EBITDA margin. Adjusted EPS is expected to be in the range and $1.90 to $2.80 per share. The reduction from our prior guidance is also a function of the incremental depreciation expense in the second quarter. From a free cash flow perspective, we're now targeting breakeven to slightly positive free cash flow for the year. This includes approximately 36 million of cash outflows related to R&D tax legislation in H2 which we've now incorporated into our guidance. Turning to Slide 13. I want to briefly touch on Q4 which we expect to be a record quarter for Mercury across all key metrics. But we will not formally guide Q4 until next quarter. Based on H1 actuals and our Q3 and fiscal '23 guidance, we can arrive at an implied forecast for the fourth quarter. Looking at the midpoints of our fiscal '23 and Q3 guidance ranges, Q4 revenue at the midpoint would be approximately 320 million. This is an increase of approximately 11% from our record fourth quarter last year. Given our current backlog and anticipated bookings in Q3 we expect to enter Q4 with forward backlog coverage, which is the basis for our current guidance. GAAP net income and GAAP EPS will be approximately $47 million and $0.83 per share respectively at the midpoint. Q4 adjusted EBITDA would be approximately 98 million and adjusted EBITDA margins would be approximately 31%. These results are driven by gross margin expansion, reflecting the mix weighted toward higher margin production programs and licensing revenues. We also expect adjusted EBITDA margin improvement as a result of the operating leverage we've created in the business. From a free cash flow perspective, we expect to see a strong rebound in Q4. We have a clear path to achieve our guidance. Thanks, Mike. Turning now to Slide 14. Mercury delivered strong bookings in the second quarter. We returned to organic growth and generated positive cash flow and is still challenging environment. Demand is strong and getting stronger. Our robust H1 bookings, record backlog and substantial fall revenue coverage provide us with good visibility into the second half of fiscal '23. Timing, however, remains a risk in the short term as we win larger more complex subsystem deals. Given the impact of the delays associated with the FMS program, we have a larger fourth quarter than previously anticipated. We have a high level of confidence in our ability to recognize the associated revenue and margin in the first half of fiscal '24 and as a result of the additional opportunities we've rotated into the plan, we're maintaining our fiscal '23 revenue and adjusted EBITDA guidance. As I said earlier, while revenue is trending above the midpoint, adjusted EBITDA is likely to come in towards the low end of guidance as a result of next and supply chain driven program delays and inefficiencies. To the year we expected a lot of strong bookings waiting toward Q4. We expect the positive book to bill and return to organic growth, with revenue eclipsing 1 billion for the first time. It should position us well for fiscal '24 as a supply chain conditions begin to normalize. We expect to deliver strong organic growth, margin expansion and improved cash flows is released working capital, all of which should position us for further growth and value creation in future years. That said, the potential for disruption around the GFY '24 budget and the timing and level of a defense appropriation presents additional risk. Looking further ahead, our outlook to the next five years remained strong. We expect increased defense spending domestically and internationally. We are well-positioned strategically in the right part of the market but the right capabilities on the right programs. We believe that Mercury can and will grow organically its high single digits to low double digit rates. In addition to organic and M&A related growth our five year plan includes margin expansion, driven by better execution as the industry headwinds subside, improved program and content mix as well as impact. It should lead to stronger profitability as well as improved working capital efficiency and cash conversion. For more than a decade, we've successfully executed on our longer term strategy. We've improved margins by growing the business organically supplemented with disciplined M&A and full integration. As a result, we've created significant value for our shareholders and expect to continue doing so. In closing, I'd like to recognize the Mercury team's commitment to our success and strong performance in the second quarter. Our sincere thanks to all of you. Before we turn it over to Q&A, I ask you please keep your questions focused on our earnings results. With that, operator, please proceed with the Q&A. Thank you. [Operator Instructions] Your first question comes from the line of Peter Arment with Baird. Your line is now open. Yes. Good afternoon, Mark and Mike. The impact program that you've talked about quite a bit about on this call and previous calls, I think you've targeted net savings to be $30 million to $50 million when you look out to fiscal '25. Just wondering where that stands today. I know that you achieve to at least $22 million in your first fiscal year. Can that still grow just given all the efforts you've done? And then just as the follow up, I'll ask and now just your confidence around kind of is there much FMS mixed in the fourth quarter that could also slide out just given the kind of the impacts that you've had from customer shifts? Thanks. So thanks for the question, Peter. So I think we're absolutely on target for the impact savings. I think the program's doing extremely well. If anything, we're probably slightly ahead of schedule compared to where we thought we were going to be at this point in time. Unfortunately, I think a lot of the efforts and the results that we've delivered, aren't really showing up in our financials right now because they are simply offsetting some of the headwinds that we're facing, but the programs are on track and we think there's substantial upside associated with it going forward. As it relates to FMS, we do have some FMS in the fourth quarter, that as we rotated and the $20 million of revenue and $14 million of margin from Q2 and Q3 yes we were working with the customer able to rotate in additional revenue that partially offset some of the shortfall due to the delay in funding. So yes there is on revenue in the fourth quarter, Iâd be coming up the number off the top of my head. Mike do you? It's not something we break out specifically. But I would say, Peter, that the magnitude of the revenue we have is much lower than the $20 million of revenue and 14 million of gross margin that slipped out. Thanks very much. Good evening, guys. I guess, just on the topic of the availability of semiconductors and chips, I guess I'm wondering kind of what makes that take until the second half of year '24. We saw Intel's results last week, it seems like demand in the digital economy is really drying up. And you would think that maybe that would free up capacity more quickly for the defense industry. Or what makes that takes a long? Yes. So first of all, I think based upon the feedback that we're getting, specifically from some of those semiconductor companies based upon what they think is going to happen in terms of the capacity and their ability to supply. We did see some incremental improvements, Seth in the second quarter and last quarter, we were talking that the semiconductor lead times on the high end, in particular, the stuff that's coming out of TSMC, and have some of the high end Intel processing, the lead times were 52 to 99 weeks. This quarter, we did see the average come down 36 to 72 weeks. So it's still extremely long and far longer than what we saw pre-pandemic, which is in the 10 to 12 week range. So we are please see the improvement and see the average coming down, but it's still got a long way to go. All right. Okay. Thanks. And then, just as a follow up, when we look at the data that comes out in the filing, about the sales breakdown between different types of products, different customers, is there anything there that offers a little bit more insight into the gross margin, compression that we've seen, whether it's I mean, last quarter, kind of, we only have it as of the, I guess, as of the September quarter so far but fewer sales into radar applications I guess, fewer sales into components more sales to lock it, as we look through these different categories, is there anything about the mix that's changing, that we can be aware of in terms of thinking about the gross margin and the profitability of different types of sales? Not specifically the macro levels Seth. I think, if anything, what we are seeing is just the cumulative effects of operating under the pandemic and the delays that we've seen on programs and resulting inefficiencies. So things are taking longer. We've seen cost growth, and that clearly, is what is impacting the margin. As we look forward as we've said, is more of these programs kind of get out of the development phase and into production we'll start to see some mix shifts and some margin improvements there, coupled with some probably better efficiencies and supply chain. So less of a headwind, and then continued balance from impact is really what's going to drive the margins as we go forward. So I don't know, Mike, if you'd like to add anything to that? No, I mean, that you'll see the detail when the cue comes out in terms of subsystems components modules, I think what Mark said is correct, it's going to be not going to see anything there significant that's going to stand out as the driver of the margin degradation. It really is, these new programs starts that we've talked about, as the development programs transition over time to production, they're just taking a little longer in this environment. And then we expect that to transition in fiscal '24. So nothing's specifically going to in the cue, more just around the trend. Is that we're expecting in Q4 and in fiscal '24. Obviously Seth the FMS program that moved. That was pretty high margin based upon the capabilities that we're providing that includes IP licenses and royalties. And we do see a pickup of that as we're going into the second half as well. So the mix here in terms of capabilities, and the programs really do matter. And it's unfortunate that the customer has this funding delay that move the $20 million in revenue and $14 million out of the year. Hey Mark and Mike. I wanted to ask Mark on the free cash flow guidance I'm sorry, if I missed it. But as you think about sort of breakeven, a slightly positive call it $60 million in the second half of the year. How does that split between the third and fourth quarter? Or what's the guidance implied for the cadence of cash in the second half of the year? Yes. Ken I'll take that one, it's Mike. So when we look at the second half, it is going to be more weighted to Q4. We think Q3 prior to the R&D tax and I'll give you the split between those between Q3 and Q4 but prior to the R&D tax payments, we think Q3 is going to look a lot like Q2 which we expected coming in, prior to factoring to be breakeven to slightly positive. And that's what we're seeing in Q3 right now. Now, that's pre the R&D tax payment, which we estimate it's going to be $23 million in Q3, it's going to be 13 million in Q4 to get to the $36 million that we mentioned in the prepared remarks. So what we're looking at is a free cash outflow in Q3 and the magnitude of $20 million. And Q4 is going to make up the difference, as we see the higher net income, higher up income. And we actually expect working capital in Q4 to release especially in unbilled and inventory, which is driving the cash flow for the year. Yes, that's helpful. Thanks, Mike. And it sounds like for cash earnings, or cash and earnings, obviously a pretty significant ramp in the fourth quarter. Is there any program you'd specifically call out maybe around progress payments or anything like that, that we should keep in mind as significant or material swing factors in the fourth quarter or they could either be potential risk or that are obviously embedded in what's going to help sort of hit the full year number seems like a pretty aggressive ramp in the fourth quarter. I was just going to say it is definitely a large quarter Ken we do feel good. The good news, as we look at it is we have good backlog coverage right now going into two H2, and into Q4. We've got good visibility into the programs that aren't in backlog that make up the balance of our FY '23 and specifically the Q4. So we're entering with strong backlog coverage of majority the remaining are recurring programs, programs for which were designed in on. We also have and I think Mark touched on it briefly, we have improved visibility and coordination into the supply chain than we had in H1. So still risk around it, but we feel better about it. And then we've got line of sight into some key execution milestones that drive revenue in Q4 on a couple of key programs. So there's still uncertainty in the environment supply chain, contracting delays, things that we've talked about. We're working to control what we can, but overall we feel good about the demand environment in the program's we're just cautious on items that are out of our control. And just from a profitability perspective, we obviously expect margin expansion in Q4 and that's going to drive cash flow as well. Yes, okay. Just following up this kind of [applied]things right. So the higher margin program mix in the second half as we talked -- we do have a pickup in high margin IP licenses and some royalties on various programs. We are anticipating fewer execution delays and some inefficiencies. We saw supply chain and would say improve incrementally in the second quarter. And so as the condition stabilized and as hiring continues to pick up, I think we got fewer headwinds there. Impact, I think continues here. We've got continued savings relating to our pricing initiatives that we undertook early in the year. We've got some procurement savings. And this quarter, we had some facility footprint consolidation. We've got further consolidation in Q3 that will lead to savings. And then finally just obviously, better absorption and better overhead and leverage, largely as a result of the higher revenue. So although it's a big quarter, I think we've done the work and we know what's going to drive the increase. Hi, good afternoon. Just wanted to start out with some of the delayed payments that you were seeing from your customers. Are you seeing that behavior maybe persist? Or are you sort of building that into your guidance just given some of the challenges around cash flow management that everybody's sort of facing? Sure, Jonathan. We saw it a little bit in Q1. We talked about it on the Q1 earnings call, we saw a little bit more of it in Q2. Now remember our fiscal Q2 is our customersâ year end. So we did see them managing receivables to us, at the end of the quarter and as we mentioned, is about 30 million that we saw, held that was due for us in the quarter. We've received all of that already in Q3. So it was just a couple of weeks or less than a week delay as they straddle their fiscal and calendar years. Going forward, I think we've got a really good group of customers that normally pay on time. And so we're managing that with them. We also put in the factoring facility that I mentioned, and we use it exactly for this reason, Jonathan, which was a tool that we have, that's a very low cost of financing to us, in order to mitigate the impacts on our cash flow statement in our financials, because of our customer behavior. So we feel good that we're in a position to manage it from an organic standpoint, but we also have a tool in the factoring facility, should we need to use it, should we see this behavior continue. Got it. Got it. That's helpful. And then in terms of some of the pricing actions that you've taken how should we be thinking about, like the timing, and sort of the magnitude of how that flows through like, I know, there's a variety of different actions across both the pricing of services as well as products, but any color would be helpful, thank you. So pricing has obviously been a one of the major elements of the impact program. And so we stood up a pricing center of excellence, to try and drive strategic pricing and best practices in both pricing and cost estimation, depending upon the part of the business. In the commercial portfolio I think the team's done a really good job. And we're actually offsetting a significant amount of the inflationary pressures that we're seeing on the semiconductor side of things. So focus on value based pricing. We're looking at the discount and the quotes validity. And I think, as I mentioned, on the last call, we did do and across the board, price increase on our commercial products at the start of the year, that is really the major driver of offsetting the inflation pressures that we see there. On the non-commercial portfolio it's slightly different right here. It's largely some of the cost disclosure type of the the business. Here we're really mainly focused on wherever we possibly can, passing through both material and the labor inflation costs that we see as well as trying to do a better job in monitoring the scope creep with customers and monetizing those, as well. Now depending upon the type of contract and what's already in backlog the ability to be able to pass through those costs obviously there could be a time difference there. But I think overall, the team's doing a pretty good job. I think the inflationary headwinds with the work that we've done, aren't as detrimental to what we thought they could be coming into the year. Mike do you like to add anything? Thanks. Good evening, Mark. And, Mike, thank you for the time. So it seems like there's a lot going on Mark, just both externally with the board and internally. Maybe can you just talk to us about how you're balancing all the internal factors and what you're most focused on now in terms of the business? Is it just ensuring the sales come through its supply chain? If you could talk to us a little bit about that? You mentioned R&D as well. Sure. So it's a good question. So I think the demand environment continues to be strong. So we're still very, very focused on the top line. So bookings, as we said, were up 14%, year-over-year. We've had a 1.18 of the bill in the quarter and 1.16, over the last 12 months growing backlog 17% which gives us pretty good confidence and coverage along with the bookings that we expect in Q3 and Q4. So clearly, what the team is very focused on right now is the execution in the second half. It was unfortunate that we saw those FMS delays which has made the year more back end loaded. But we did talk about the coverage that we've got which is far higher than what we had coming into the second half last fiscal year. So we'll continue to focus on mitigating the supply chain and the semiconductor lead times which continues to be a challenge, albeit incrementally improved. Hiring, I think is better for the third quarter in a row. We are actually hiring more people than leaving and so. But we still got open wrecks along with the rest of the industry. And it's important for us to continue to fill those positions as we're looking at the growth in the business going forward. So I would say that the team is very focused on just execution, focus on growing the business and focusing on continuing to deal with the cumulative effects of the pandemic, Sheila. Sure, no, that's helpful. And if I could follow up, I don't know if you mentioned this in the answer that question, the FMS sale that slipped out, you said was $20 million of sales and 14 million of earnings associated with it. Was that right? It is. So it's a mix of capabilities. So again, there's hardware associated with it. But based upon the capabilities that is also revenues and royalties. Hey, good evening, guys. Thanks for taking the questions here. Kind of staying on what Sheila was asking with kind of internal external lot going on. Just I guess more, labor's been tight. To begin with? How do you think about managing talent right now? Talent loss? And doesn't this potential announcement of strategic alternatives? I mean, can't that add the disruption and kind of take employees off the ball focusing on execution so how do you kind of think about managing that risk right now? Yes. So I mean, look, it's a possibility, obviously, with just what we are now. But I do think that we've got a fair amount of hiring momentum inside of the company. I think there's obviously a lot of growth ahead of us and I think we're a great company to work for. So I don't see nothing thoroughly at a major challenge with respect to sort of retention, only attraction side of things I think we're really focused on two areas. One is on the direct labor side of things. And I don't really believe that the announcements that we made this morning, sorry, this afternoon around here the potential process will have an impact there. Probably the more challenging areas on the engineering side. But again I think we've got a great employee value proposition. And I feel pretty confident just based upon the momentum that we're going to be able to do actually make the highest that we need. Got it. Got it. And it just to follow up entirely separate. You guys have obviously, you talked about the demand environment, we've seen a very strong book to Bill, the last several quarters. How are you thinking about the bookings environment over the back half of the year, especially now with a budget in place? Yes. So I think we're expecting, again, strong bookings sequentially H2 over H1, Mike, I think just with some of the reasons chips falling anymore the growth in the fourth quarter, just given some of the movements that we've seen but we're expecting strong growth year-over-year with a positive book to bill. So I think this is not a demand issue. Obviously, the demand environment is very strong. If anything, these are kind of short term timing issues, and really a result of the cumulative effects of the pandemic. Got it. Then to be clear, you think you can do that 600, almost 30 million and booking second half last year, you think you guys can do better than that, what you're saying. So this year, if you look at H1 was far stronger than the prior year. So the waiting of bookings was far more balanced. So for the year, we do expect bookings to be up substantially just given the waiting H1, H2, I think it's really more of a sequential story than it is year-over-year in H2. Doing great. Just so my first question here, if we just stay on the topic of the supply chain, if we do continue to see lead times come down I mean, I know it was sort of an incremental improvement in the second quarter, but it's still notable. Do you expect you're going to be reducing inventory stockpiling if lead times continue to fall? And do you expect as we go into potentially a recession here, that materials costs might come down from Mercury? Yes. So with regards to the balance sheet, Austin, as the supply chain normalizes, as we've discussed, we do expect to see an unlined inventory and an increase in inventory turns that also has been impacting our unbilled receivables, where we've been unable to deliver in some circumstances, because of long lead times or even a shortage of parts. And once that normalizes we expect both those accounts inventory and unbilled decrease, which is why we think there's stronger cash flow in Q4 but really adding into fiscal '24. As things begin to normalize, we expect that there should be a significant reduction in working capital again, once that supply chain normalizes. And then on the semiconductor side of things, clearly, I think part of the semiconductor marketplace is rolled over on the lower end, largely as a result of what is going on on the consumer electronics side of things. The high end, as I mentioned, is still although it's softened somewhat from a lead time, it's come down a little bit on average, it's still far longer than what it was pre-pandemic. And so we haven't seen much movement there at all in fact, if anything, the prices are going the other way still. The high end semiconductors and seeing price increases from Intel, from Xilinx, from analog devices. And so the high end is still pricing is still pretty challenging. On the lowest on the lower end side of things we have been able to negotiate better pricing in some parts of the market. But it's still pretty challenging out there Austin. Okay, and then just a follow up on that. I think you said in the remarks, you're sort of anticipating improvement in lead times in the second half of fiscal year '24. What are you seeing on the year end that gives you confidence in that? Is that what's been communicated to you from TSMC and Intel? Or how should we think about the timing there? Yes. So we're obviously not in contact with TSMC directly, it's we're dealing with the companies whose chips are actually fogged in the TSMC facility, as well as other facilities offshore from various other companies. And so the 36 to 72, we believe times that they mentioned is, what we are seeing right now, with respect to the POC that we've got on the high end is semiconductors. And so these are the logic devices, the FPGAs that go into many of our processing systems. And so we're getting the input from our suppliers as to what they're seeing. And now we'll see what happens. If things continue. Hopefully, they continue to come down. Hey, good evening, everyone. And, Mike, thanks for spending time with us and working with us over the years and all the best going forward. It's been a funky year and a half or two years. If I kind of zoom out and try to sort of recalibrate for it. The top line actually never really got that bad. There is kind of three distinct quarters where the revenue decline is a little more severe and then a few where it's really actually not that severe. And that's kind of it. Relative to that, the margin change is more significant and pretty volatile in the year. And then the cash flow changes is very significant. And working capital, in particular, I guess, how do I square all of that, when you kind of look back at this 18 to 24 months window why does the profitability and the cash flow so much more volatile than the top line? Sure. So I think it's a good question. So it has been a few years and each year has been slightly different in terms of the impact and so bookings, bottomed out, I think in the third quarter of fiscal year '21, organic growth actually bottomed out this quarter. We had 1%, organic growth in Q2 versus 13% decline. So we've got various metrics beginning to head in the right direction. If you look at the margin profile, it's really I think, itâs a result of kind of what's happened a little bit with respect to linearity. So over the course of the pandemic is lead times dramatically increased. And as we started to see just the perturbations in the supply chain in terms of supply decommits, it obviously created a push more of the business into H2 which obviously had an impact on margins in the first part and then you've got the general inefficiencies associated with just the impacts that we've been facing. So the margin, pressure is pretty much all related to the pandemic and the effects associated with that. There is nothing underlying the business. And if anything, I think as we look forward as a result of the shift from development into production, build the mix, as well as the ongoing benefits of impact, we see substantial opportunities for margin growth. And then the cash flow, I think as you know, is very much tied up with the balance sheet again as the supply chain conditions became far more challenging as lead times actually increased we ended up leveraging the balance sheet to make sure that wherever possible, we could meet our customer commitments on an inventory side and then again on the unbilled side of things that's where we saw the effects of part shortages which type working capital off in unbilled. So ultimately cash collects everything. And that's where we saw the greatest ball tilting. Mike, if you want to jump in there? No, I think that's, I think Mark hit it. I mean, just given some numbers, if you look back, and just starting with adjusted EBITDA measuring profitability, a look back fiscal '19, '20, and '21, were all around 22% became into fiscal '22, we dropped down to 20%. I think we've talked about publicly that we had about 70 basis points or so as a result of supply chain inflation. You look at fiscal '23 and were our guide is 20.3% at the midpoint and probably have a similar 70 basis point inflation impact. So those two would put you at 21%. And the reduction there from 22%, from '19 to '21, down to '21, and '22 and '23 is really a result of the development programs that we've talked about. And so as Mark said, when we look at EBITDA margins going forward, and we'll guide fiscal '24 when we get to our Q4 but we do see the opportunity for EBITDA margin expansion. So I don't think anything's fundamentally changed in the business from a profitability perspective. When you look at gross margins, there's a lot more movements as you know. We had COVID expenses in fiscal '21 running through our gross margins. We've had some movements between development programs and production on a quarterly basis. We've had the physical optics acquisition, which impacted gross margins and then again on a quarterly basis, things like this FMS sale, our program mix, makes, creates some volatility. But again, going to EBITDA, looking at over the long term, couple of key metrics and we think the profitability the business structurally is the same with opportunity for upside in fiscal '24 and beyond. Mr. Aslett it appears there are no further questions. Therefore, I'd like to turn the call back over to you for any closing remarks. Okay. Well, thank you very much for taking the time to join us this evening. Lots of news from Mercury. Now we look forward to speaking to you again next quarter. Thank you.
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EarningCall_1221
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I am Sandra, the chorus call operator. I would like to remind you that all participants will be listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. [Operator instructions] Thank you, Sandra. Good morning and good afternoon to all of you and thank you for joining us for our full year results. Today, I'm joined by Philippe Deecke, our CFO. We are pleased to share with you a strong set of results, which underline our performance and progress in 2022. We are looking forward to sharing the detail of our performance in our presentation before moving to the Q&A. Looking at our agenda, I will start with an overview of our performance in 2022 before handing over to Philippe to talk through our financial. Finally, I will take you through the performance of our division and also say a few words about the outlook 2023 and our midterm guidance. Let's start by taking a look at the group results. We delivered a strong financial performance in 2022. Sales grew by 15.1% at constant exchange rate and stand at CHF6.2 billion. We also generated a core EBITDA of CHF2 billion, delivering a margin of 32.1%. This underlines the skill and commitment of our people we have worked to produce vaccine drug substance to control the pandemic, while also continuing to grow our business. We have remained focused on the long term growth and success by accelerating our investment. Last year in 2022, our c CapEx reached 30% of sales. This investment is securing long term growth in the year to come and consolidating our leading position in the CDMO industry. As we move beyond pandemic sales, we anticipate delivering high single-digit sales growth at constant currency with a margin of 30% to 31% in '23, sorry. Looking at our performance without the covering peak sales, we can clearly see the strength of our underlying business. This allow us to confirm our 24 midterm guidance at low-teen sales growth and core EBITDA margin within the 33 to 35 corridors. Finally, following the divestment of our Specialty Ingredients business, we have committed to return to pre-divestment leverage. We are continuing our focus on organic investment and attractive bolt-on M&A. Today, our strong balance sheet and outlook enable us to return excess capital to shareholders via a share buyback program up to CHF2 billion. We are also proposing a share dividend increase of alpha franc to CHF350 per share. Our full year results for '22 reflect another successful year and a strong cumulative performance. Year-on-year, between 2020 and 2022, we have delivered double-digit sales growth and continues to EBITDA margin improvement. These indicators confirm our strong position in the CDMO field and sustained market fundamentals. Our performance is also supported by a broad portfolio of customers and high proportion of long-term commercial contracts. We continue to invest to support our long-term growth and success and this is reflected in our CapEx investment program. Let's now take a moment to review our customer base as well as our CapEx project. Over the course of 2022, we signed around 115 new CDMO customers and around 375 new clinical and commercial programs. As you can see on the slide, 90% of all sales are focused in the EMEA and Americas. Turning to sales by customer type. We had the 60-40 split between sales to meet small mid pharma customers and large pharma customers. Finally, our top 10 customers continue to represent around alpha. We definitively have a unique, broad and diverse customer base, benefiting from long-term relationships. This number clearly show Lonza leading position in the industry. Now let's move to our gross project portfolio. The map here shows an update of our CapEx project. New investments are marked in white and investment brought online are marked in green. One example of this is our two new bioconjugate [indiscernible] Looking to '23, we continue to invest at the same pace. This level of investment will enable us to capture high value opportunity in the area of sustained market demand. It will also allow us to build on our strong market position and deliver long-term success. Since 2019, we have invested in 21 new assets, each with the value of more than CHF50 million. Of this program, eight are still in construction, while 6 are in ramp-up and 7 are already operational. As we are telling you about our growth, we also want to show it to you. To capture the scale of our growth beyond the number, you would see two image of our bio parking Switzerland. The two large facilities are Ibex 1 and Ibex Solutions 2. The first of these is now largely contracted, while the second is on track to be delivered on budget and on schedule. As well as delivering strong business performance, we have also continued to deliver on our sustainability commitment. In 2022, our ESG targets were incorporated into our global employee and executive remuneration policies. This is designed to ensure our people maintain their focus on responsible business. We continue to make progress in reducing energy, water and green gas emission intensity. In 2022, we reduced greenhouse gas emission intensity by 13%, energy intensity by 6% and water intensity by 10% compared to 2021. Finally, we are proud to be recognized by Ethisphere as one of the world's most ethical company for the second year in a row. I would like to take a moment to place Lonza in this industry context. The wider CDMO industry is very attractive and continue to show double-digit growth driven by the biopharma market and an increase in demand for outsourcing. In this space, we have a unique position with a diversified customer base and long-term commercial contract. This form 70% of our business, giving us a strong visibility on the year to come. With our rises CapEx program, we are securing our long-term growth and at high margin. The expertise of our people is another source of competitive advantage, and we continue to invest in retaining and leading and developing the best talent. We are well set to drive growth and capture value as a leading CDMO in the health care industry. Before moving to the next section, I would like to share a short recap on 2022. We delivered a strong financial performance at the high end of our outlook. We are also continuing to invest heavily in our long-term growth. We have largely been able to manage inflation through price adjustments in our product business and inflation clauses in our CDMO contract. Clearly, our strong performance confirmed our robust business model and healthy market fundamentals. Thank you, Pierre-Alain. Good morning and good afternoon to you all. Before we start our financial review, let me remind you that all financials relate to our continuing operations. Growth rates are reported actual exchange rates with the exception of sales growth, which is reported at constant exchange rates. First, let's take a look at our H2 and full year financial highlights. As we have already seen, the group has delivered a strong full year performance in line with outlook. Sales growth at 15.1% is supported by strong momentum in the underlying business so inflation related to pricing and a peak in COVID-related sales. The COVID business was strong in both volume and margin. Core EBITDA grew 19.8% leading to a year-on-year margin improvement of 1.3 percentage points. This increase was supported by a combination of growth projects ramping up and productivity improvement in the base business. We will come back to this in a moment. As expected, we saw slower reported sales growth and margin in H2 compared to H1. This is mainly because H1 included the Allakos cancellation fee, the impact of which was reversed in H2. Also in H2, we saw a reduction in the positive effect on sales from the low-margin third-party sales to Arxada, our former specialty ingredients business. Turning to our margin evolution; let's take a look at the graph on the right and deconstruct the different drivers. At the top, you can see our positive margin progression was supported by our growth projects. This is something we saw already in H1 2022. For the full year, the margin dilution from this project was less than in 2021. This was due to the fast ramp-up of both COVID-related mRNA assets and new small molecule facilities. We continue to see margin uplift from productivity and operating leverage in our base business. But this year, it was largely offset by the residual impact of increasing inflation. We are actively managing inflation impacts through price increases in our product business and applying inflation clauses in our CDMO contracts. We are also working on procurement and supply chain initiatives to manage the rising cost of raw materials. Taken together, these initiatives have helped us to contain inflation impact at less than one percentage point. Moving down the graph. Our business mix was more favorable this year, mainly helped by royalty revenues and the lower growth in Cell & Gene. One-offs were largely neutral for the full year. Finally, this is the last time we see a meaningful year-on-year dilutive impact of third-party sales to Arxada. going forward, we expect these low margin sales to remain more or less stable. Now let's take a look at the performance of our divisions. In Biologics, we saw strong continued momentum in sales growth and margin. This was supported by a strong underlying business growth projects ramp up in Mammalian and bioconjugates as well as a profitable mRNA contribution. In small molecules, sales growth for the full year recovered as expected after customer shipments delayed in H1 were delivered in H2. We are also pleased by the margin improvement, which passed 30%, supported by the ramp-up of new assets, focusing on complex molecules and highly potent APIs. In the Cell & Gene division, we saw a mixed performance between our business units. Bioscience delivered a strong performance driven by price increases and sustained demand. The good performance was partially balanced by the divestment of smaller noncore businesses as we focus bioscience on drug discovery and biomanufacturing. In our Cell & Gene technologies business unit, we saw softer sales growth compared to a high base in 2021. This was due to some product failures and delays to customer programs. We are also seeing some softness in the cell and gene market coming from the slowdown in funding. However, despite these short-term challenges, the business remains attractive and positive margin was maintained. Finally, in CHI, good sales growth was driven by price increases and demand for pharma capsules. The softer margin was driven by residual inflation and production delays at one side caused by supply issues. As Pierre said, our CapEx reached 30% of sales in 2022. That's just under CHF1.9 billion. Of our total CapEx spend, 85% was invested in growth projects. All our investments continue to meet strict approval criteria. They are backed by an internal rate of return between 15% and 20% and a return on invested capital of 30% or more at peak. As in the past, we continually work to mitigate investment risk to a diversified portfolio of assets supported by anchor customer or a strong pipeline. You can see from the bar chart that we have invested in growth across our divisions with a clear focus on biologics. This is where we continue to see many opportunities with attractive risk return profiles. Looking at our free cash flow, you will see that we have delivered a negative free cash flow of CHF465 million. This was due to our high CapEx investments and an increase in inventory. Inventory levels have increased from about six months pre-pandemic to seven months today to ensure we can deliver the products to our customers despite the more unreliable supply chains. However, we are now confident to bring supplies down closer to prepandemic levels, and we plan to consume excess inventories over the next 12 to 18 months. Underlying cash generation remains robust with free cash flow before gross CapEx at CHF1.1 billion, implying an 18% cash conversion. Our return on invested capital, ROIC, remained strong at 11.4%. That's 0.7 percentage points up from the prior year. This was driven by core EBITDA growth of 19.8% and partially offset by a five percentage points increase in our effective tax rate, which now stands at 15.9%, around the lower end of our guided range. Turning to leverage. Versus prior year, we see a slight increase from minus 0.6 to minus 0.1. The balance sheet provides significant headroom for organic growth investments, bolt-on acquisitions and the return of excess capital. We will come back to this in a moment. Looking more widely at our leverage, it's worth noting that we remain committed to our strong investment-grade rating of BBB+ over time. At Lonza's AGM on the 5th of May this year, we are pleased to propose a dividend of CHF3.50 representing an increase of 17% or CHF0.5 versus the dividend for 2021. Our strong balance sheet and confidence in the cash generation outlook also supports our planned share buyback program mentioned earlier by Pierre. Let me give you some more details. Today's announced share buyback will allow us to return excess capital to shareholders and return to our target leverage faster. The share buyback is not changing our priorities in our capital allocation strategy. Our foremost priority remains our accelerated organic investment plans, followed by the acquisition of attractive bolt-ons. Our M&A focus is both in the field of technologies and manufacturing capacities. The planned buyback of up to CHF2 billion will commence in H1 2023. This comes at a time when we consider our stock to be undervalued given our strong business fundamentals and differentiated position in the industry. It will be executed over a 24-month period via second trading line on the sixth Swiss Exchange. For sure, this share buyback program does not impact our ability to invest in organic growth and selected bolt-on acquisitions, while maintaining our strong investment-grade rating. Thank you, Philippe. Now let me take you through the different division. In 2022, the Biologics division delivered 21.7% sales growth versus full year 2021. Customer demand remained high 2022, reflected by a strong pipeline of commercial agreement. Specifically, in a new agreement with GSK, we will commence activity to manufacture a marketed product in our 20K [ph] Mammalian facility. This marks the beginning of a wider strategic partnership with GSK. We made good progress on the growth project for the division. However, there has been softer demand for a new facility in Guangzhou, China due to local market challenges. Also, two growth projects in biologics are delayed by a couple of quarters, mainly due to supply chain constraints. Across the network, we work to extend our divisional offering with innovative capabilities. These include new bioconjugate facility, extended early development services, complex protein services and mRNA early phase offering. Turning to our small molecule business. We saw sales growth of 5.9% for the full year. This was driven mainly by new manufacturing capacity coming online for ADC payload. We are very pleased to see new capacity coming online successfully, further increasing our share of hyper tontine complex small molecule. This supports our plan to focus the division on higher-margin niche, which has led this business to improve margin by 10 percentage points over the last 5 years. Looking at the Cell & Gene. The division reported a core EBITDA margin of 16.7% and sales growth of 13.6% versus full year 2021. A strong performance in BioScience was driven by robust demand for testing and media. This was partially offset by the divestment of some small and non-core business. Our Cell & Gene technology business supported customers in gaining FDA approval for two new commercial therapies manufactured at our Houston side. The business unit also experienced some headwind with delay in clinical trial and customer product challenge. In personalized medicine, the business remains focused on driving its R&D agenda and scan it is manufacturing. Looking at specific projects, our Cocoon platform is now enabling the manufacturing of multiple clinical cell therapy. Finally, let's take a look at Capsule and Health Ingredients. In 2022, we saw sales growth of 5.9% compared to full year '21. This was mainly driven by price adjustments and continuing demand for pharma capsules. Our strong performance in pharma was partially balanced by softer demand for nutritional capsule in markets, including US and China. Our innovation agenda within the division was supported by the launch of our new end protect capsules designed to target the delivery of acid sensitive APIs. The margin of 33% is softer than full year '21. This has been driven by inflation and partially offset by pricing adjustments and productivity improvement. As we conclude auto on the division, I would like to take a moment to focus on 2023. Our 2023 sales growth is driven by a robust underlying business partially offset by a reduction in COVID related sales, which peak in 2022. Therefore, we are anticipating high single-digit growth. As you can see from the graph, excluding COVID, we have a consistent year-on-year double-digit growth. Turning to the '23 margin outlook. We anticipate a core EBITDA margin of 30% to 31%. Besides the COVID contraction just mentioned, which also impact margin we see headwinds from residual inflation and the slower ramp-up of two new biologics assets. This effect will only be partially offset by our continued productivity in our base business, operating leverage and price increase. On this page, you will see the summary of our outlook for 2023. Please note that the performance will be weighted towards the second half of the year due to the headwind from COVID results-related peak sales in '22 and the ramp-up of new assets in H2 '23. We will also maintain CapEx at around 30% of sales to support our long-term growth. We are pleased to confirm our midterm guidance of low-teen sales growth and core EBITDA margin within the 33% to 35% range. This is supported by the strong visibility on growth projects and utilization rate of our asset. We will also see productivity gain speed from our Lean program. At the second half of 2023 will be stronger than the average of the year. Looking at the business today, we believe we are uniquely positioned in the CDMO market for the following reason. Our site network and geographic footprint is either help to meet our customer needs at a global and local level. Our long-term success is fueled by our growth investment. Our business is set up with the right mix of technology and capability to address our customer complex demand. Finally, our value proposition is clearly enhanced by the unique technical expertise as well as regulatory. Taken together, this will allow us to maintain momentum in the coming years. Before moving to the Q&A session, two information regarding investor communication. Commencing this year, we plan to hold more frequent qualitative updates. This is a chance for us to connect, share company news and answer your questions. In Q4, we will also host the Capital Market Day and we'll provide more details closer to this time. This will be a chance for us to share our divisional strategies and provide an updated midterm guidance. Now that COVID restrictions are behind us, we are also planning to as a visit to our facility in Visp, so you can see our business in action. With that, I thank you for your time and attention. Now we will take a two-minute break to set up the video for the Q&A session. I will hand over to operators and look forward to seeing you in a couple of minutes. Hi. Thanks for taking my questions, or question. Just a question on the contribution of the various headwinds that you're seeing this year to the margin contraction the relative contribution of the ramp-up of those growth projects, the inflation headwind particularly, energy and also thinking about the 2024 margin target of 33% to 35%, that implies sort of maybe a 250 basis point margin expansion. So what changes between '23 and '24 to allow the margin to increase and the relative importance of the ramp-up of those growth projects and reversal of maybe the energy cost? Thanks very much. Yes sure. Happy to get us started. So thanks Richard for the question. So I think in terms of 2023, we're not going to quantify the drivers individually, but I think youâve seen that we're talking about residual inflation. We've seen that in '22 and we see this despite inflation increasing in '23, partially because of the energy prices that you mentioned. We will still be able to contain most of that and have only a residual of that. We have a little bit of headwind coming from our mRNA business, which we mentioned before as well. And then, yes, I think we have still very strong productivity, online productivity, but we're facing couple quarter delays on these two sides which is waiting on our margins for '23. So without going into the details of quantification, these are really the key drivers. Donât forget that we also have our mix, which is historically been a negative on margin year-over-year. And now looking at '23 and moving to '24, I think again it's too early to give you detail on 2024, but we have strong visibility today as Pierre-Alain was mentioning on our growth asset coming online on the capacity utilization of these assets. And so we feel very confident that this will be a major driver for '24. And I'd like to remind you beyond maybe what Pierre-Alain was saying, that this is a bulky business. So if you look back at our numbers, you'll see that several points of margin can swing between half year and half year. So we feel very confident about the 2024 and therefore, our confirmation of the midterm guidance. I hope -- Vineet here from Citi. I hope you guys can hear me clearly. One, just a clarification on this slowdown in the ramp-up of a couple of biologic projects. Has any impact already been absorbed in 2022 or it's all in 2023? The second question is on the growth project portfolio. I was just wondering if there is a sort of time line that you can provide for your 20-plus growth project portfolio. So maybe you could say where the 6 projects are in the ramp-up stage? When do you expect them to move to operational stage? And of the 7 projects that are already operational, what percentage would you say are more closer to the peak sales? No, thank you. So as we mentioned, we have 21 projects since -- start 21 projects since 2019, six of them in construction, six of them in ramp-up and six of that what we're considering in production. I mentioned two of them to be slightly delayed. The impact slightly 2022 and will impact early part of 2023, but we will catch up by the end of the year. So basically, it was some delay in getting some equipment and starting them following the COVID, yes, impact on supply chain. Otherwise, we don't provide too much detail on each project, but you can reconciliate that with some of the project I mentioned on the CapEx map around the world. Regarding peak sales, we stick to previous message or a complex asset need almost three years to go at big sales, but for some smaller assets, and we mentioned Bioconjugate suites or small molecule and the active API this could go faster. One on CapEx. So in 2023, CapEx is going to be high again as it was in 2022, but you said previously that you expect that to decrease to high teens by 2025. So how much visibility do you have on the potential growth opportunities over the next couple of years? Is there a risk that CapEx creep higher sort of back into the 20 or low 30s over that time period? And is the high teens CapEx sufficient in order to support growth, particularly as you've mentioned that you expect growth to accelerate or previously mentioned, to accelerate from 2024 almost. So any thoughts on how CapEx could progress, it would be great. Yes. So James, just perhaps to remind all of us all the figures for 2023 are generated. So basically, the CapEx you see on '23 are coming for many projects we started in '21 and '22. For example, we announced last year a major CapEx of CHF500 million for drug product. Obviously, we spend a small amount of money in '22, a larger part in '23 and you've been '24, and then we finished the investment in '25. So a big part of the CapEx for '23 is already corresponding to CapEx announced before. We continue to see very attractive opportunity to invest. And obviously, as long as the opportunity are corresponding to a financial criteria that Philippe mentioned before and that we have also anchored customer we will continue to invest. But as mentioned, currently, we see a decrease going back to high teens by end of '25, but obviously, we will adjust as we go ahead if we see more opportunity for investment. My question is regarding China and the pressures that you flagged. I'd just be very interested as to what those local market pressures are. Is it COVID slowing down a plant coming online? Is it COVID slowing down trial progress? Or is it competition from local CDMOs? Any color you can give us would be very helpful. Yes. Thanks. Happy to do so Matthew. So basically on -- in China, we have a small -- we have a facility with small-scale disposable asset. A new customer are basic, we are targeting two type of customer some western company which want to manufacture in China. And as mentioned before, in some Chinese company, which interested to have easier access to Western market. Obviously, following the 2-year lockdown, strict lockdown in China, it was quite difficult to convince Western company to go there. So we see less business than expected. And we see also some competition on the local market. But I would like to stress that our operation in China are relatively small. And can I -- just a quick follow-on. How long do you think the pressures will last? Have you got a pipeline and increased interest as COVID eases and some of the restrictions ease? Or do you think it may be more sustained? I would say I don't want to speculate at that time. We were very pleased to see the end of the lockdown. We have some pipeline, but I'm not going to speculate at this stage. I was hoping to get some more color on the mRNA impact. It's been very clear now that this was beneficial to the margin, and that will hurt in 2023. But should we assume that this will again be a headwind in 2024, given that there's still some residual sales left from mRNA or how much revenues will actually be left that could impact 2024 in a negative way? So Patrick, as you know, as we have only one customer in COVID sales, we don't report the detail. But what you should assume is the peak sales were excel in '22. And the residual sales are marginal. So clearly, we don't anticipate further impact for '24. Philippe, any points to add? No, I leave it at this. I think, again, we mentioned that the 15% will clearly help probably three to four points of growth coming from that business. And yes, the margins were good and helped a little bit. Two, if I may, please. The first one, going back to James' question on 2024. Your guidance essentially implies top line growth of 14% to 15% in 2024. You're saying COVID is not going to be a drag. So I think that is useful. I'm just wondering if you can give any more color on what takes that growth up from high single digits to 14% to 15%. So if you think about that incremental 400, 500 basis points of growth, what are the buckets that we should be thinking about? And then secondly, perhaps a bigger picture question for you, Pierre-Alain. And we all seem to be getting very confused every half year report on various moving parts of your business. What would it take for Lonza to think about reporting with a greater amount of transparency to stakeholders? Thank you, Keyur for your questions. Regarding the first one, okay, today, the goal is not to discuss in detail '24. Clearly, to stress again what we mentioned before, with the long-term contract or utilization rates of the facility as well as ramp up this facility we have a clear visibility on '24 and it's why we are confirming this guidance. Building on the comment of Philippe, if you look back in the last two years' results, you have seen significant variability between half year results because our business is bulky. So again, we anticipate to finish margin for 2023 higher than the average of the year. And therefore, we are fully confident on '24 guidance. We understand your points regarding the moving part of the business, is definitively, I think one of the challenge reporting or results. As mentioned by Philippe and me a couple of times, our business is bulky. So we don't sell one million items every year. We sell 4, 5 campaign parse per year. And obviously, they have different characteristics. So while the trend we are committing in terms of growth and improvement of margin is consistent, you see variability quarter after quarter, half year after half year. Philippe? No, I'll just add, Keyur, I think as you've heard from Pierre, we are going to be increasing the touch points between us and yourself over this year. And so this will allow us to probably give more explanation of granularity or qualitative explanations around some of the questions that you have. And I think this will help all of you to better understand our complex business and many moving parts. So my question is whether you can share the level of net price increases that you plan to implement this year? And tell us what is the portion that you cannot offset these anticipated price increases? So Falko, for price increase, we have a couple of dynamics. So on our product business, we just increased price on a regular basis depending on the pricing power we have. And again, in capsule, there is some part of the business when we can pass all the cost and some it's more difficult. On the CDMO part, again, we have two parts. We have the long-term contract. And here, generally, we are well protected by close. But as mentioned by Philippe, they are coming generally once a year. So we will pass the cost once a year, so some time with some delay. For the other part of the CDMO business for development services, Phase I or Phase II, it's more a short-term pricing where we can price according to the marketplace. And here, we can pass the cost immediately. So we don't provide a fixed figure. But as we mentioned, you can probably calculate that because we are able to pass most of the inflation to the customer, sometimes with the small delay. Maybe Pierre, I could add one thing for Falko. I think, you saw that for 2022, we were able to offset most of the inflation. And the biggest lever we have is, of course, pricing. We continue to have increasing impact of inflation next year, but we're also increasing our ability or our increase in prices. And so the residual effect remains roughly the same despite the increase in inflationary pressure. Yes, sure. Yes, Falko. So I think we are basically buying our energy for the year ahead, and we're doing this gradually over time. And so for 2023, we've been purchasing most of our energy needs for -- in 2022 for 2023. There are some markets where you cannot do that or you cannot hedge your energy prices. So of course, this will be still spot rate. But most of our energy for '23 has been locked in. This has been locked in at higher prices than you see today on the market. And as we are now prebuying our energy for 2024, we are leveraging the lower price that we see today for next year. My question is on the Cell & Gene product headwinds that you've highlighted and the customer product issues. Are these issues fixed? Could we expect some sort of rebound? And have they disrupted the midterm opportunity in this division? And secondly, just a point of clarification, if you could provide it on the H2 weighting for 2023. How much more H2 weighted would you expect it to be than perhaps usual for the group? Thank you, Charles. So again, on Cell & Gene two or three key driver. First of all, we mentioned a couple of times, the pipeline is mainly made of Phase I, Phase II compound. So basically, they have a tendency not to be successful. And when we mentioned product issue is basically product not going through the clinical trials. And we have seen a slowdown in in funding for Phase I compound, and this is really explaining some of the headwind we have seen this year and we anticipate to see early in 2023. But we see also positive development. If we have a look on the product on the market, we see a robust demand, and this is developing. So again, we mentioned a couple of times -- our normal CDMO business is 70% phase -- commercial and 30% clinical here, it's exactly the opposite. So we don't see long-term disruption, but clearly, we have seen some slowdown in the uptake of new projects. Philippe, you take the second part, H2 versus H1? Sure. Happy to. Hi, Charles. So I think for our next year, as Pierre-Alain was mentioning, we probably feel the headwind of the two assets we are ramping up more in H1 and H2. And so you should be expecting for H2 to have more margins that are more in line with what you would expect from Lonza and therefore, also then the incremental to 2023 to not be so high. And from a revenue basis, would there be just a bit less of an impact, presumably than that H1 to H2? Well, if the H2 margin is going to be more -- as a Lonza normal margin in H2 and H1, therefore, will be weaker. Presumably, the EBITDA impact will be extreme on the H1, H2 phasing basis than revenue. Is that right? Congratulations on the quarter. The divisions that you provided in terms of growth, what would be the implication for 2023, similar growth that we saw in 2022? And specifically, the Biotechnology division, should that growth continue to be in the 20%-plus area? Paul, we don't provide detail per division. But basically, our growth is driven by many new assets coming online and improvement on the existing asset and biologics being the largest division, you will continue to definitively see -- to continue to see growth in biologics, corrected for the first part of the year of the headwind coming from the loss of COVID sales. But definitively, biologics remains strong. I think, Paul, if I can add, we did guide for the midterm growth of our divisions back at the Capital Markets Day in '21, I think if you get back to that, this gives you a good feel of where we see the growth over the period by division. The question is more on the manufacturing setup. So continuous flow is more and more a topic coming up and the companies involved there say that the yield is much better despite the fact that you need less bigger reactors. How is Lonza positioned there in the long term? What is your view? So Daniel, as a technology company, obviously, we monitor all the trend to fulfil the customer demand. We see a lot of continuous process mainly without going to be technical and minus one bioreactor. So people do that in the last bioreactor before the production on, but we are also developing in our lab, continuous manufacturing. So it's coming even if it's not representing the majority of the product today, we see also a lot of continuous process in the small molecule world, because its allow you to do reaction, it's much better condition. So it's coming, but it's not a large part of the business today. Hi. Thank you for taking our questions. I wanted to follow up on an earlier question about the weakness that you're seeing in the Cell and Gene Technologies division specifically? And just was hoping for some incremental detail around how much of your business there is related to gene therapy versus cell therapy? And where exactly you're seeing the most impact in terms of delays in customer product challenges as well as pullbacks due to the slowdown in biotech funding. I assume pullback is more in cell therapy just based on the commentary that we've heard from others in the space, but would be curious if my assumption is wrong there. And then relatedly, could you just walk us through the time line for when you started to see customer behavior change due to the funding dynamics? Is this something that has happened over the last couple of months here? Or have you seen a gradual weakening or softening over the last 6 months? And what are you anticipating in terms of softening moving forward? So thank you, Max. Regarding the pullback, there are independent of gene or cell therapy, I think it's probably more related to the success rate. We have seen clinical failure on both modality and success on both modality. Regarding the funding, it was probably more a gradual funding for the last 4 months to 6 months. So the latest part of last year, again, is probably a new company having difficulty to get additional fundings. To what is happening in the next month, again, always difficult to see. We see some improvement in fundings in -- towards the end of last year. We see also good ideas still getting funding. So -- but I'm not going to speculate, but probably expect a slow recovery in the quarter to come. Just coming back to the margin again. I just wanted to focus first on, on the second half margin where obviously Capsules and Health Ingredients declined sequentially quite a lot and also cell and gene therapy in particular. Now presumably, the latter is partly due to the one-off that you booked in the first half. But -- could you just talk us through exactly what happened in cell and health -- sorry, Capsule Health Ingredients in the second half to drive that margin? And I guess, how we should think about that going forward. Is that going to be one of the key factors we consider going into '24 in particular? Or do you think -- are the pressures now in that business that are likely to stay given that is a business where you do have pricing power without the lag? So you would have imagined less impact, I guess, than perhaps we see on sort of short-term basis. And then could you ask a point of clarification on your more qualitative updates with investment. Should we understand -- does that mean you're now going to be giving quarterly business updates, could have formal sort of business? Will it be more sporadic, less sort of structured and less planned? Just trying to understand whether -- how we should think about potentially the more regular communication. So I will take the latter part of your question, while Philippe will take the first one. So clearly, we have seen that it would be important to provide more information to the investor community. They are going to be qualitative -- and probably you should expect them as a kind of quarterly basis time, we will choose the right in an opportunity to give you an update of what is ongoing in the business. Philippe, perhaps you take the margin in CHI for 2022? Sure. So Peter, there was two questions, one on the CHI and Cell & Gene, let me take them in a row. So I think for CHI, I think, first of all, see that this is a business that is more subject to inflationary pressure, and this is more energy intensive than the rest of our business. It's also an area where you do not have pass-through clause for your raw materials. So I think everything ends up with Lonza and we need to pass on these costs through pricing. So we did successfully increase price twice last year. Again, as Pierre-Alain was mentioning in the areas where we have pricing power, some areas are very competitive, and so we cannot always pass through price as much as we would want. On top of some of the residual inflation, we also had operational kind of a drag towards the late part of the year, where we had supply issues where in some of our businesses, we couldn't get all the raw materials that we needed to produce for our customers. And so this created some absorption issues. So I think that's on CHI, I think going forward, we still see this as a high-margin business, and we are still feeling strongly about CHI. On Cell & Gene, maybe to note two things, we had this one-off in H1, which, of course, did not happen in H2. We had -- in H2, however, almost a similar amount size provision that we had to take for a customer that was in financial difficulties. And so on the one hand, is slightly too high first half and probably a slightly too low second half. And so this probably balances out to a margin that is not too far away from our guidance -- our midterm guidance for the division. My question is on the cash flow generation in 2023. For how long do you expect net working capital to sales ratio to stay at about 20%. And the underlying question is, do you expect the cash flow generation to perform better than the EBITDA growth in 2023? Thank you, Marcel. So I think in terms of cash flow, if you think through the cash flow for next year, one of the larger drag in 2022 was due to inventory, a little bit was due to receivables due to sales phasing, but most of the impact was around inventory. And so we do expect, as I said in my presentation, that we will decrease our inventories now that supply chains have recovered or are recovering. And so I think you should expect a better cash flow progression in '23. With that, I would like to thank you very much for attending the session today, and wish you an excellent day.
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EarningCall_1222
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Thank you for standing by, and welcome to the NI Q4 2022 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. I would now like to turn the conference to your host, Ms. Marissa Vidaurri, Vice President of Investor Relations. Please go ahead. Thank you. Good afternoon. Thank you for joining our Q4 2022 earnings call. I'm joined today by Eric Starkloff, President and Chief Executive Officer; Daniel Berenbaum, Chief Financial Officer; and Karen Rapp, Strategic Adviser to the CEO. We will start with an update on our performance in the quarter before opening it up for your questions. Our discussion today will include forward-looking statements, including, without limitation, those regarding the company's expectations of meeting or exceeding financial targets, its capital allocation, financing and investment plans, the payment of its quarterly dividend and its future business outlook and guidance, including demand for its products, ability to realize revenue from backlog, future results of acquired companies, execution of growth strategies and the outcome of the company's restructuring activities and strategic alternatives process. We wish to caution you that such statements are just predictions and that actual events or results may differ materially and could be negatively impacted by numerous factors. We refer you to the documents that the company files regularly with the Securities and Exchange Commission including the company's annual report on Form 10-K filed on February 22, 2022, and the subsequent quarterly reports on Form 10-Q. These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. We assume no duty to update any forward-looking statements to conform the statement to actual results or changes in our expectations. A reconciliation of our non-GAAP financial measures disclosed in this call to the most directly comparable GAAP financial measures or related disclosures are contained in our quarterly presentation deck on ni.com/nati. You can find the press release and quarterly presentation to supplement today's discussion on our website at ni.com/nati. Management will also be hosting meetings at the Susquehanna conference in New York on March 2 and the Morgan Stanley Conference in San Francisco on March 7. We look forward to seeing you there. So first, I want to take a moment to introduce Dan Berenbaum, our new CFO, who joined us on January 9. Dan has extensive experience leading financial operations of various technology businesses, and he's already had an immediate impact as we execute our growth strategy and focus to achieve our operating margin expansion targets for 2023 and beyond. Karen is going to close out 2022 on the call today. And I want to once again take the opportunity to recognize and thank Karen for her significant contributions to our success over the past six years. After Karen speaks, Dan will provide outlook for Q1 2023. And I'll start by kicking things off with an update on the business in the fourth quarter and for the full year of 2022. The key messages you'll hear today are, we closed out a record year in 2022 with a strong fourth quarter. We achieved record non-GAAP quarterly revenue of $449 million, up 7% year-over-year and in line with our guidance. And we delivered non-GAAP operating margin of 25% in fourth quarter which is an all-time record for a quarter. 2022 is a strong year as we continue to make strides in tricks forming NI into a higher growth, more profitable and more resilient company. Despite ongoing global macroeconomic uncertainty, we delivered on the 2022 targets that we shared at our September investor conference with record revenue of $1.7 billion, up 13% year-over-year and non-GAAP operating margin of 20%, up 130 basis points compared to 2021. As we head into 2023, we are planning towards the recessionary growth scenario in line with what we shared in September. And even in a wide range of downturn scenarios, we now expect to exceed our 300 basis point non-GAAP margin expansion target. Our results are due to the transformation of our business that started in 2017. We have successfully executed on a set of transformational initiatives over the past five years, including we transformed our go-to-market into a tier channel strategy based on customer potential and stood up a non-direct channel in 2021. These changes have driven growth in our top accounts and significant cost leverage in SG&A. We formed industry specific business units and have hired experts in those industries to lead them. We have shifted our road maps to focus on application-specific systems at software aligned to fast growing subsegments, including electric and autonomous vehicles, wireless communication, and new space technology. We've expanded our software portfolio, building on our leadership position in automated test through LabVIEW and adding additional development tools, application software and also expanding into growing adjacencies to systems management and product analytics. We've accelerated our strategic transformation with a number of important bolt-on acquisitions including multiple companies enabling us to deliver complete offerings in electric vehicle testing, now the fastest-growing part of our business. And we have been keenly focused on our cost structure to increase our leverage and our flexibility of spending. As a case in point, in 2022, we saw an unanticipated headwind to gross margin of 420 basis points, largely due to ongoing supply chain constraints and yet managed our operating expense to still hit our commitment of 100 basis point improvement to operating margin. We continue to focus on the efficiency of our operating expenses and expect a strong uptick in operating margin again this year. We have made shifts in our organization to consolidate our operational core and enable a leaner SG&A org. In Q1, we are also implementing a targeted restructuring of approximately 4% of our global headcount. Our high confidence in 2023 is directly correlated to the strategic shifts we've made, which we believe have created a stronger trajectory for growth. Now on to results by industry. The areas of intentional focus are delivering to our expectations. I believe this is a proof point that we're focused on the right areas to accelerate our long-term growth. Semiconductor and Electronics reported 2022 revenue of $433 million, up 10% year-over-year, with Q4 orders down 10% year-over-year, in line with our expectations for the quarter. While slower semi cycle has been anticipated, we believe the combination of our exposure to R&D tests and our ongoing progress in delivering software across the semiconductor workflow will soften the impact that the semiconductor downturn will have on our business. Last quarter, we won several large analytics software contracts in semiconductor, including our largest software contract ever, which will add predictable revenue over the next three to five year period of those contracts. Transportation reported 2022 revenue of $302 million, up 40% year-over-year, with Q4 orders up 35% year-over-year. Our strategic shift to focus in EV and ADAS where our customers are making significant investments has changed the trajectory of this business, and we expect that will continue to deliver market-leading growth rates in 2023. As we expected, EV and ADAS now represent more than 50% of our transportation business. The recent acquisitions of Kratzer NH Research and Heinzinger, accounted for approximately 24% of transportation revenue in the fourth quarter. Through these acquisitions, we believe we now have the most competitive portfolio of end-to-end battery test capabilities in the market today, and we expect these investments to drive long-term growth for NI. Our recent success was winning a large battery lab deployment, resulting in $22 million in revenue that will be recognized over the course of 2023. Aerospace, defense and government delivered strong results with 2022 revenue of $412 million, up 9% year-over-year, with Q4 orders down 12% year-over-year. As a reminder, and as we noted in our Q3 call, in Q4 2021, we closed a large program win in ADG, so the decline in year-over-year orders was expected. We expect to see order strength in this business in 2023, driven by robust defense spending. We also continue to see strong opportunities in commercial space technologies like launch vehicles and satellites. In our portfolio business, which serves the majority of our broad-based customers, achieved revenue for the year of $511 million, up 5% year-over-year, with Q4 orders down 10% year-over-year. This is the area that has historically been most susceptible to a softening macro environment, and we have been taking steps to make this business more resilient. Our focus on utilizing global distribution to better position our offerings and optimizing our digital channel to this broad customer base to gain traction, further providing leverage and scale in this portion of our business. We expect revenue from distribution and digital channels to grow to approximately 22% of our total revenue in 2023, up from 9% of our total revenue in 2020. We also expect our transition to software subscription will improve the resiliency and the growth opportunity for this business. As we mentioned previously, starting in January of 2022, we transitioned our single seat licenses to subscription, which resulted in a 2% headwind to revenue for the full year. We were pleased to exceed our internal targets on this transition in 2022. And going forward, the vast majority of our software portfolio is now recurring revenue. In summary, we believe the company is in a strong position. We plan to head and took action in anticipation of softening in the semiconductor cycle and a weaker overall macro economy. We are planning towards the recessionary growth scenario in line with what we shared in September. And even in a wide range of downturn scenarios, we now expect to exceed our 300 basis point non-GAAP margin expansion target. Q4 was a record quarter with GAAP revenue of $448 million, up 7% year-over-year. 2022 was a record year for revenue at $1.7 billion and 13% growth year-over-year. Our Q4 orders were down 3% year-over-year as we expected. We started to see a decline in the semi market and the macro economy at the end of September, and we plan for that to continue in Q4. As Eric mentioned, we had a strong Q4 last year with a large ADG order that we knew would not repeat in 2022. By region, fourth quarter orders were down 7% year-over-year in the Americas, up 7% year-over-year in EMEA and down 9% year-over-year in Asia Pacific. We ended the quarter with delinquent backlog of approximately $230 million, which is approximately 7 weeks of revenue. We're confident in the resiliency of our backlog and in our ability to realize this revenue as supply chain constraints continue to ease because our solutions are off in a capital expense and provide unique capabilities for our customers, we don't typically incur any double ordering risk, and we haven't seen anything that would indicate a change in that historic pattern. We also continue to see minimal cancellations due to lead times at less than 1%. Non-GAAP gross margin for both Q4 and full year 2022 was 70%. 2022 non-GAAP gross margin was down 420 basis points year-over-year, driven primarily by broker fees, paid for components that were in short supply. We continue to see supply constraints easing, while there are still some key golden components, especially in legacy semi technology, we expect the supply chain constraints to ease in the first half of 2023 and the reduction in broker purchases to positively impact our 2023 operating margin. In Q4, we generated $60 million of GAAP operating income and $112 million of non-GAAP operating income, a non-GAAP record for a fourth quarter. We delivered non-GAAP operating margin of 25% in Q4. For the full year, GAAP operating margin was 12%. Non-GAAP operating margin was 20%, a record for NI had an increase of 130 basis points year-over-year, demonstrating the continued focus we have had on driving variability and efficiency in our cost structure. We reported Q4 GAAP net income of $40 million and diluted earnings per share of $0.30. We reported record Q4 non-GAAP net income of $83 million and record diluted non-GAAP earnings per share of $0.63, an increase of 5% year-over-year. For the full year 2022, GAAP net income was $140 million. We delivered record non-GAAP net income of $255 million, up 14% year-over-year. In summary, Q4 results were in line with our expectations, and 2022 was another strong year of growth on both the top line and bottom line for NI. I'm proud of the results we're delivering. Finally, as many of you know, this will be my last earnings call, although I'll be here through May to help ensure a smooth transition. I'm excited to have Dan here. His background and skill set is a great addition to NI, and his experience will help us continue to grow in all areas. I've enjoyed getting many of you over the past six years, and I appreciate your time, interest and commitment to understanding our business. I'm confident in the trajectory of NI and excited about the company's future prospects. Thank you, Karen, and thank you, Eric, for the warm welcome to NI. I'm very happy to be here and to be participating in this call as we look ahead to 2023. As you can imagine, I spent my first few weeks in NI immersing myself in the business. It won't surprise those of you who have followed NI for a long time that I've been deeply impressed with the high level of talent across the organization, a testament to NI's strong culture of engineering and commitment to customers. It's also very clear that the transformation of NI continues to gain momentum. As I continue to learn more about our customers, products and operations I'll focus on continuing those operational efficiency improvements to achieve our short- and long-term margin expansion targets as well as on improving our working capital management and cash flow generation, and building investor confidence in our ability to execute on a quarterly basis as well as over the long term. As Eric mentioned, we remain committed to our target of delivering at least 300 basis points of non-GAAP operating margin improvement in 2023. We have a number of initiatives in flight, which underpin our confidence including supply chain planning improvements, tight control of discretionary spending and the restructuring, which Eric mentioned earlier. Specific to gross margin, as we enter 2023, we expect a tailwind from lower purchase price variance as we see our supply chain constraints ease. We also expect to see the benefit of pricing actions, which have been taken over the past several quarters. For Q1, we expect to deliver a more than 100 basis point sequential improvement in non-GAAP gross margin compared to Q4. With respect to operating expenses, we anticipate that Q1 OpEx will rise slightly from Q4 levels as we made targeted investments to ensure our future growth, while maintaining discipline around discretionary spending. The restructuring actions that Eric mentioned previously will result in a reduction of approximately 4% of our headcount, primarily in SG&A. We anticipate that most of the benefits from this reduction will start in Q2. After declining significantly as a percentage of revenue over the past few years, we expect OpEx to increase gradually in absolute terms as we go through 2023. But to remain flattish or decline as a percent of revenue in relation to Q1. Now let me comment on capital management. Our balance sheet remains strong with $140 million of cash at the end of the fourth quarter. Cash flow from operations was $52 million in the fourth quarter. In Q4, we continued to invest in inventory to enable us to meet customer delivery commitments in the face of ongoing supply chain challenges. As supply constraints ease, we expect inventory to return to more normal levels, along with a renewed focus on working capital management, we expect to be able to convert non-GAAP net income to cash at levels more aligned with our historic performance and at a meaningful improvement over 2022. Our capital allocation strategy remains balanced and disciplined. We will continue to invest in organic capabilities to ensure we stay ahead of the technology needs of our customers and prioritize inorganic investments that strategically align to the business in order to drive profitable growth. In the fourth quarter, we returned $37 million to shareholders through our dividend. And the NI Board of Directors has approved a quarterly dividend of $0.28 per share, payable on March 6, 2023, to stockholders of record as of the close of business on February 13, 2023. We've elected to continue our dividend at current levels, given the already very strong return of cash to shareholders. We did not repurchase shares in Q4. I would note that our Q4 22 weighted average share count was the lowest since Q4 '20. With some normal fluctuations, NI share count has remained roughly flat over the past five years as we have successfully used our repurchase program to offset dilution. With that, let's shift to guidance for Q1. For the first quarter, revenue is expected to be in the range of $415 million to $445 million. At the midpoint, this represents 12% revenue growth year-over-year. Our guidance assumes currency impact similar to Q4. We expect GAAP diluted earnings per share in the range of $0.14 to $0.28 for Q1 with non-GAAP diluted earnings per share expected to be in the range of $0.48 to $0.62, an increase of 35% year-over-year at the midpoint. Our Q1 non-GAAP earnings forecast excludes $20 million related to the restructuring we have discussed today, $18.5 million for stock-based compensation and $15 million for amortization of acquired intangible assets, acquisition-related expenses and other items. We anticipate a full year 2023 GAAP and non-GAAP tax rate of between 17% and 18%, assuming no changes to tax laws. In Q1, we will also incur an additional approximate $1 million tax expense related to changes in the R&D tax credit. In summary, we continue to see benefits from NI's multiyear transformation journey. We are laser-focused on making efficient investments in our growth while improving our expense control and working capital management. As Eric mentioned, we are planning for continued recessionary environment in the first half of 2023. Even against the slower macro backdrop, we are confident in our ability to deliver on our commitment to increase our non-GAAP operating margin by at least 300 basis points in 2023. We are confident in the actions we have taken to better position the company to perform, including in a weaker macro environment. We expect revenue growth even in a headwind environment and remain committed to meeting or exceeding our target of 300 basis point margin expansion. I believe our strong performance in 2022 is proof that we have the right strategy in place. We've done a lot of hard work over the past five years to fundamentally transform the company and change the trajectory of our performance, and we're not done yet. The key elements of the strategy have gained traction and demonstrate the success in driving a higher level of growth. Now we're focused on executing the strategy and achieving the return on these investments with a focus on top line growth, and strong leverage and earnings growth on the bottom line. I want to set a big thank you to all of our employees who have driven our strategy and committed to a significant expense management actions throughout this past year. I know it's not been easy. Employees in manufacturing and operations in particular have worked incredibly hard to navigate continued and unprecedented challenges in our supply chain. And I sincerely appreciate everyone's hard work and determination of perseverance. Before we take your questions, I do want to comment on the strategic review process. As you all know, NI issued a press release on January 13 announcing that our Board of Directors has initiated a review and evaluation of strategic options for NI. A comprehensive review will include consideration of a full range of available strategic business and financial alternatives. We know some of you have questions regarding the strategic review, but I'd like to note that we are not planning on answering questions regarding this topic on the call today. We appreciate your cooperation in advance. Hi, this is Angela Jin for Samik. On your 2023 guide, I know a few months ago, you sort of were guiding towards mid-teens growth in 2023. How is that path to that level of growth narrowed just given sort of the macro backdrop that we're seeing? The semi down cycle seems more severe than initially expected. And sort of what are your initial thoughts on 2023 revenue growth? So Angela, I'll take that. Yes, I commented that we're seeing an environment that's consistent with what we anticipated in the September conference, and we laid out a set of scenarios and recessionary scenario in particular. That's still our point of view. We didn't guide on revenue for the full year. We obviously guided for Q1 at 12% revenue growth. And we're really focused on driving the growth of the company as we continue to achieve this, growth expectations. And then the areas we can control. And you heard certainly in the call a commitment to the bottom line performance sort of well within our control and managing that for a wide range of outcomes. I can add a little bit of color and just say again, we guide one quarter at a time. So we're not going to make your comments specifically on the full year. As Eric said, there obviously is that macro headwinds, and we are planning for that macro headwind. But against that backdrop, I think there's some sort of well-known tailwinds as well. We have the acquisitions that are helping us we have some backlog in place that will help us specifically in Q1. If you look at our patterns exiting 2022 Q4 revenue was a little bit below what you would consider our normal seasonality. We're guiding Q1 a little bit better than what we would consider our normal seasonality. We have some tailwinds there from training what we would consider to be our delinquent backlog, meeting backlog that customers would have liked to see and ship in Q4 that for one reason or another, we weren't able to ship in Q4. So we have some of those tailwinds going into Q1. I will also comment that we have historically talked about backlog as a measure of orders that customers wanted in prior quarters, but we haven't really talked about our scheduled backlog. Our scheduled backlog is - would add another roughly $220 million to that $230 million worth of delinquent backlog that Karen talked about. Now part of that is really tied to the transformation of the company. It's tied to the different strategy of the company. NI if you look back over the years, really to be much more of a turns business with very little long-term backlog. Now with the shift to product solutions and the EV acquisitions, we're starting to see more of that backlog, scheduled backlog built up. So we have some tailwinds. Again, we're not guiding for the full year. We're really only guiding for Q1. We have some of those specific delinquent backlog tailwinds in Q1 that are going to help us, which give us confidence in that a better than seasonal guide for Q1. But just to give you a sense of how we think about the puts and takes for the full year, if that's helpful. Yes, that's really helpful. And then on the operating margin expansion target of 300 basis points are exceeding that sort of between your gross margin improvement, your restructuring and other sort of cost control. Where - what is driving that $300 million like is that mostly the gross margin improvement? Is it mostly the headcount reduction? Could you maybe walk through sort of the input into that target? Yes again, we're not really going to talk about guidance for the full year. I sort of pointed you for Q1 that we expect a little bit more than 100 basis points of gross margin improvement guide, the OpEx for Q1, given some commentary around that increasing in dollar terms from Q4. So that should sort of give you a feel for the profile might shake out for Q1. Again, just to give you the thoughts on the full year. And we do have some tailwinds from some of the price increases and some of the purchase price variances rolling off. So, we definitely have some tailwinds there, offset by continued headwinds in supply chain, it won't vanish entirely and the mix of our business, as the mix of our business changes. So again, just to give you some thoughts on how we think about gross margin internally. And as I said, the OpEx will gradually increase in dollar terms over the course of the year, but we're not going to guide specifically beyond Q1. Thank you, for a moment please. Our next question comes from the line of Rob Mason of R W. Baird. Your line is open. Yes, good afternoon. And hi Dan, the price that you're expecting is built into the first quarter guidance, and what you were able to capture price realization, price increase in the fourth quarter. What was that first quarter and fourth quarter? This is Karen hey. Pricing in Q4, we saw probably 8% lift in revenue, and we've built into Q1, some of our expectations in line with what Dan guided. Yes. Rob, I'll just comment for you to follow-up. We've been really pleased, as we've shared with you before, our ability to kind of capture price. We've been, I think, more and more sophisticated about how we've gone about those changes the ability to capture it has been strong in our expectations as we come into 2023 are predicated on changes we've already made on pricing. And Eric, as the price capture price realization, has that been even across your various SBUs or has it favored one area or the other? I'm just curious how that's plays down? Yes. No, it's a good question. And it's not necessarily that it varies so much by BU, but I will characterize we are surgical about it, right? So we're - there's a couple of factors that contribute. One is, as we deliver more and more systems capability, it's - we're delivering value that's greater than the sum of the parts. And so that's definitely been favorable. The second factor is we've just gotten is more sophisticated ourselves, and how we've done this is our efficacy of targeting price changes, selling the value through our channel, credit to our teams. We've got more and more effective at that. And then I'd say the last element I've been quite pleased with is that we've been able to maintain that also through the channel as we introduce distribution channel, our ability to get good pricing to the channel has been strong. And so those factors together have led to the results that we saw, which were very, very good in 2022 and an expectation of continued efficacy in that area in '23. I see. Just as a follow-up, can you walk through the sequential decline in your adjusted operating expenses, I mean, your operating expenses came in but down sequentially and frankly, better than I was expecting. And I'm just - I'm curious where the source of that was given that revenue was actually higher sequentially. Yes, so we continue doing - as you know, we've been early on in the year in 2022. We took some actions to get ahead of what we saw coming from a macro environment and knowing that the semi cycle doesn't always stay up. So we got ahead of that early in 2022, continued that in - all the way through Q4 because, as you know, at the end of Q3, we started seeing that come on even stronger. So we stayed incredibly disciplined in Q4, the entire team just stepped up. And as you know, we've also been increasing the percent of our costs that are variable as we go through the year and as we continue to move forward, we continue to drive that flexibility and variability, and we pulled that lever in Q4 as we saw the macro -- the PMI is below 50% now and the semi cycle really take a hit in Q4. So really - just the whole point of aligning expenses with revenue has become something that we live on a regular basis and taking that forward and we demonstrated that, I thought pretty clearly in Q4. Yes sorry you bring up a good point, and I just wanted to point out, build all the things Karen said. That's one thing we're really proud of our ability to hit that, the 25% non-GAAP operating income and Q4 is a record, as you know. And then as we come into -- you've heard the guy from Dan in Q1, that's approximately 23% operating income. So that's about 500 basis points above Q1 of '22. So again, we're really seeing the leverage of the changes that we've made and the transformation that we've done and the work we've done on cost structure and variability, we're seeing that really starting to come through. You saw in Q4, we're expecting it in Q1. So we think that sets us up in a real strong position. Go ahead, to get a little more follow-up. Just around the restructuring that you announced $20 million charge, what would you expect in terms of savings to fall from that? So we're not being specific about what the savings are. We just said that we'll see a positive impact from that starting really in Q2. And a little of that is, we're going to be selective about areas for investment as well. So I wouldn't necessarily try to draw a straight line from just the restructuring. Thank you. One moment please. Our next question comes from the line of Meta Marshall of Morgan Stanley. Your line is open. Great, thanks. Maybe first question, just on noting that some of the headcount reduction was due to SG&A or what's going to be -- SG&A was going to be most impacted. Does that change kind of how you think about more going through the channel? Or is it just kind of trimming around the edges? Just trying to get a sense of if there's any change to the sales cycle or to the sales structure? And then maybe as a second question, it did look like transportation was obviously very strong this quarter after a strong year, is that primarily coming from acquired businesses or existing businesses, just a little bit more context, that would be helpful. Thanks. Yes, I can take that. Yes, no problem. So on the restructuring, first of all, just as Dan said, like we're super mindful as we went through this process. On balancing our ability to achieve efficiency and scale, but also making some of the right investments for growth. I'll just say at the highest level, it's very consistent with some of the structural changes that we announced at the end of last year, which were about strengthening to be used, consolidating our core operations, and then this leaner sort of leaner sales and marketing team. And as you noted, they are primarily in SG&A. To your specific question, yes, it's got multiple factors. I mean there's just some areas for us to be a bit more efficient. There's areas that are really about the transformation. As I've said before, as we've gone to this tiered model, we achieve efficiency at both ends of the model. So at the top end of our account structure, we're getting really tremendous growth at average order size and account size in those large accounts. And so we're able to scale that revenue certainly faster than our expenses. And so we're realizing efficiency and scale there. At the Tier 3 level, the move to distribution of digital has been effective. It's exceeded our expectations as we've gone through the year. I gave some quantification of how much we go through the channel. So yes, as that grows, that also gives us an opportunity for some more efficiency there in the way that we're serving our accounts. So I think when you take those together, along with just some natural continuous improvement in the way that we sort of run the business, that's how I'd characterize those, but highly consistent with the strategy that we have. To your second question about transportation. First of all, we're really excited about that business. I mean 40% growth for the year. It's been a really, really good performance. And it really is good performance across the board. So you take, first of all, on electrification, which has been the primary area where we've done the acquisitions, those companies added critical capability that was highly complementary to existing software and measurement capability that NI already had organically. And what we've seen is that those businesses were growing and they've continued to grow part of our business that serves electric vehicles that was organic, has been pulled off to a very high growth rate as well. And then we're seeing reasonably good growth in the other parts of the business, certainly in active safety, which is a focus area, but we're actually seeing an uptick in the rest of the vehicle as well where we're testing all of the electronics of a vehicle. And part of that is just we've really grown our account relationships and the value that we can deliver to these automotive accounts, the shift to EV and autonomy has created a lot more opportunity in the OEMs in addition to the Tier 1s, which were our primary customers prior to our focus in that area. So I think things are -- to use the automotive analogy, things are hitting on all cylinders in that area. I guess that's a bad analogies. These vehicles don't have cylinders as much anymore, but you get to get the point. So all three of those factors are contributing to a high degree of growth and an optimism in our outlook and the pipeline that we have in those accounts. Thank you. One moment please. Our next question comes from the line of Mark Delaney of Goldman Sachs. Your line is open. Yes, thank you very much for taking the question. And Dan, congratulations on the new role. Starting with orders, even though orders were down 3% year-on-year, I think book-to-bill may have still been near or even a little bit above one based on my math. So could you perhaps level set us on where total orders came in? And then sticking with the order topic, could you also comment on the linearity of orders in the fourth quarter and perhaps how orders have trended into January? So we're not talking specifically about our level of orders or level of bookings. We can talk about maybe patterns a little bit. Yes, I can talk about patterns. I mean I'll just say, Mark, the minus three was, first of all, it's consistent with what we expected and coming into the quarter get commentary on the different business units, but I would just characterize that as sort of in line with sort of where we expected some headwinds as the things that we talked about in September, for example, and even in the October call. But so consistent with what we expected and sort of a similar level is built into our guidance for Q1. So both in the overall order rate and the order rate by business units. So that's what our expectation is built on coming into Q1. And Mark, let me comment a little bit further, want you to go back to the commentary, how of backlog earlier to maybe help you understand how again, how the business has transformed a little bit and how we're thinking about this moving forward. Obviously, as we go into Q1, we have that tailwind from draining a little bit of that delinquent backlog that Karen talked about, the orders that customers would have liked to have shipped previously that we had been able to ship. The business is also very focused as we have transformed as we've gone towards those system solutions, both organically and through the acquisitions in building longer-term backlog. So you're -- we're not going to talk specifically about book-to-bill and part of that is that I would start to get you focused a little bit more on thinking about our backlog and how that backlog will start to look as we drain the delinquent backlog tailwind for revenue early in the year. And then as we continue to drain that throughout the year and then as we build backlog for longer-term scheduled backlog as those pieces of our business grow. That's very helpful. And one more, if I could, please, for you, Dan. Maybe you could elaborate on what led you to take the CFO role and talk about how analogous the margin expansion opportunity at NI is with some of the other experiences you've encountered in your career? Thank you. Thanks, Mark. So listen, I mean, I'm obviously extremely excited about NI and the route goes back to when I was an engineer, and I was a lab user, NI is just a foundational technology company that is critically important to all parts of the technology industry, the technology supply chain. That's an incredibly exciting opportunity to be able to join a company like that with a long history of engineering and customer support like that. And of course, I've seen the transition that the transformation that NI has been on over the past five years. And the opportunity that still exists for that improvement in operating margin, the opportunity that exists for improvement in working capital. These are very exciting opportunities commensurate with that transformation into more of a systems and solutions business. So that's why I'm here. Thank you. One moment please, our next question comes from the line of David Kelley of Jefferies. Your line is open. Hey good afternoon. Thanks for taking my questions. Maybe following up on the margin discussion, it sounds like we're seeing some supply chain visibility improvement. Can you give us some color on the broker pricing impact on Q4, and if that improved into year end? And maybe if you can give us a sense on how you're baking in - broker pricing into 1Q guidance that will be helpful? Yes, so again, we're not going to be specific about the numbers in there. We do still have some of that inventory on our balance sheet, obviously, that we paid higher prices for. We expect most of that inventory to flush through as we move through 2023 and as supply chain conditions ease, we expect not to, be having to pay those broker pricing, but we're not going to be specific about how much we still have, and at what point it will flush through. Again, we said it will be a tailwind in Q1 and as we go through 2023. I'll add just a qualitative view of that Dave. We definitely have seen - we talked about improving supply chain. And certainly, this broker market issue has improved quite a bit. So it really peaked, I think, in Q3. And so, we started to see less necessity of using those broker markets to procure the very hard, to procure components. Again, as Karen said in her remarks there's, still some golden screws. And we're still working with that, and it's not like it's an unconstrained environment, but it's gotten quite a bit better and - the necessity of us doing additional broker purchases has gone down quite a bit. And that's what's led to - this thing going from a headwind to a tailwind to the expectation we set of a 100 basis point improvement in gross margin is based on that improvement that we're seeing and kind of - that we've seen over the last quarter. Yes just that, this is Karen. There's, some slides that we've posted on NATI, on our website that you can look at to get some color on some of that bridge for year-over-year as well. Got it, and thank you, really appreciate it. And maybe one quick follow-up on the automotive traction you referenced, your EV acquisitions clearly been a meaningful contributor to that. So can you talk about the margin trajectory of those acquisitions and maybe how those are trending versus your core transport business? Yes, I can take that. So we actually also - actually on the same slide that Karen pointed you to it's in the investor deck, you can see that the coming in those EV acquisitions had a headwind on gross margin. So some of the system components come in at a lower gross margin and that's an area of focus. We think there's significant improvement that can happen over time, given our own capabilities and scale as a company that our pricing leverage that we had in the company and will ultimately, improve those gross margins, and they will trend up. And then - and that's also built into our expectations, of course. And then ultimately, the strategy here is, as I mentioned in one of the previous answers to previous question is pulling the rest of our platform. And that's a big part of the strategy is selling these complete solutions that include these battery cyclers and things that we've got through these acquisitions, but also include very high margin software, include very high margin measurement components. So that the blended margin of the whole thing, ultimately meets the expectations that we have as a company. So, I just wanted to kind of follow-up on some of the comments regarding order trends. You spoke a little bit on semiconductor slowing and then talked about your longer-term view on transportation. But maybe you could just provide a little bit more detailed kind of outlook for your order trajectory over the coming quarters, across all your verticals just kind of based on what you're hearing from your customers and distribution partners? Yes, I'll just give overall kind of color on that, Damian. And a lot of it is - we shared the specific quarter numbers in Q4, and I think that's a pretty good guide other than I mentioned the ADG one was a little bit of an outlier, because we had this big compare with a big order in the previous year-over-year quarter in Q1, 2021. So in general, it's similar to what we expected. So semiconductor, it is our expectation that we'll see a near-term headwind in orders. We're seeing that and saw in Q4, for sure and that, that will persist for some time. We're still booked by the way very bullish on the long-term opportunity within semiconductor and the opportunities we're pursuing and the parts in the market that we're pursuing. We think are all very favorable, but we fully expect some near-term pressure on those orders that kind of consistent with what we've seen. Also in that kind of category, we said portfolio business unit is historically correlated more to the macro. Orders were down about 10% in Q4. And so again, that's an area where we're expecting to look at indexes like PMI. We would expect some kind of correlation and acts like a PMI with our portfolio business unit. And of course, as I mentioned in the script, we're talking about things, and we're certainly actioning things that will help that be more resilient over time. And then on the other side, transportation, we expect continued strong growth and that's on a steep growth trajectory. It continues to be on a steep growth trajectory that has correlated much more with the new model entrants and electric vehicles, the investment that OEMs and others in their supply chain are making in electrification and autonomy. We think those investments continue to be robust yes - may have seen GM's print, and they're still bullish on the market and their electric vehicle programs and so forth. And so, I expect that to continue to be high growth. Our expectations are high. And then ADG is continued to be a robust business for us. It's performed well and pretty steadily in different macro environment scenarios in 2020, it was sort of high single-digits even in a pretty tough macro in 2020. And so, we think it's a fairly favorable environment, and we expect that to continue to have a similar growth trajectory as it's had. And so that's our perspective on the overall color by business unit. Appreciate all that color, Eric. And then on - regarding distribution, you had spoken and previously about kind of your partner, your newer partners building out NI inventory as a tailwind this year? Just curious if that's more or less playing out as you are - had expected or perhaps given some of the broader destocking trends across markets or maybe any of these partners paring back or deferring their inventory buildup of NI products. I guess any number that you could share around that tailwind would be helpful? Thanks. Yes. Yes, so it's - they've built a small amount of stock in 2022, about $20 million, I believe. And then there is still their desire to build initial stock, but it's still absolutely the desire of those partners. The reason we haven't is because of supply, we've been constrained in our ability to do so. So it is still our expectation as we go through this year. That supply will ease up as we go through the year, and we will be able to provide additional stock into those partners, and that's another one of the tailwinds when we think of the year overall that Dan referred to. Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to Eric Starkloff for any closing remarks. Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.
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EarningCall_1223
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Good day, and welcome to the Preferred Bank Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the fourth quarter ended December 31, 2022. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Edward Czajka; Chief Credit Officer, Nick Pi; and Deputy Chief Operating Officer, Johnny Hsu. During the course of 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, uncertainties and other factors relating to Preferred Bank's operations and business environment, all of which are difficult to predict and many of which are beyond the control of Preferred Bank. For a detailed description of these risks and uncertainties, please refer to the SEC required documents the bank files with the Federal Deposit Insurance Corporation, or FDIC. If any of these uncertainties materialize or any of these assumptions prove incorrect, Preferred Bank's results could differ materially from its expectations as set forth in these statements. Preferred Bank assumes no obligation to update such forward-looking statements. I am very pleased to report that we have another record quarter of earnings. Fourth quarter 2022 net income was $39.6 million or $2.71 a share, which compares very favorably with prior quarter and prior year. Because of this increased earning power, our Board has announced a 28% increase in dividend in December and to be --start to be payable in January. Growth in interest income has outpaced the growth in deposit costs. Consequently, our net interest margin expanded to 4.75% for the quarter. However, towards the latter part of the quarter, we have seen that the deposit cost increase has accelerated. We believe the catching up and this process will continue into first quarter of 2023 at least. Many of our customers are continuing to manage their money by moving their deposits from lower cost to higher costs. And then we see the market continues to offer higher deposits nearly every day -- deposit cost every day. Going forward, to grow deposits at a reasonable cost will be a challenge and will be the thing that we must do. Sequentially, this quarter has net loan increase of 1.3% and a deposit increase of 1.9%. Deposit -- I mean, loan demand has tapered down or moderated since third quarter of 2022, and we believe it will be carry-over well into the first quarter at least. Our customers generally find it just more prudent in their operations. And then in terms of -- especially in terms of new transactions or new initiative committed. Because of our high earning capabilities, liquidity and capital ratio both improved from the previous quarter. And we believe our current liquidity level and capital level can easily handle our gross -- foreseeable gross need in the year 2023. Benefited by the net interest income increase, our efficiency ratio coming at 26%. Even when we consider included a $1.8 million of OREO items. Going forward, in 2023, expenses is expected to increase. General wage inflation is the main thing. The increase includes FDIC premium -- new premium assessment, two new --at least two new planned bank branches, some planned addition to SAF and also a fully operatable SBA department that will be fully operative in 2023. Our attention since early 2022, but I'm sure that you can see on my previous earnings release report, since 2022, we've been very focused on credit matters. I'm also pleased to report that both NPAs and NPL has improved from the third quarter. At December 31, they are at a lower level than September 30. In fact, in early January, we have resolved another $5.3 million of fully collected -- another $5.3 million of nonperforming loans. Effectively, as of today, our December 31, nonperforming loans is only $200,000. In a very good early indicator of credit quality is our 30 to 89 days past due loans. I'm also pleased to report at December 31, the amount totaled only approximately $4 million. Based upon a report published by Bank of America, our third quarter return on tangible common equity is 23.6% which ranked us the second among all California public traded banks over $2 billion. We believe our fourth quarter performance will lend us apart from the same situation at least. Because of our business spa model and because we are a business bank serving business and private clients, our motto does not that allow us to necessarily become a very low cost -- deposit cost operator. But however, if you add noninterest expense to the deposit costs, which will give us the total cost of operation. For years, we have been the lowest among our peer group. We believe or I believe, okay, the high earning power and the low effective total cost will be the best defense facing a recessionary economy. We are optimistic about 2023, but we'll be very careful. Wanted to start on noninterest expense and clarify some of your guidance around the growth this year. I assume it excludes the OREO-related costs in '22, roughly, I think, $2.9 million. Maybe you can speak to the run rate going forward and how you think that run rate might progress throughout the year? Yes. Matthew. Yes. So if we pull out the OREO costs in Q4, we were just under $18 million on a run rate. Going forward, at least for Q1, which is always a little bit of an aberration for us because of certain costs in Q1, we're looking at probably the low end at about $18.6 million in high end, just under $20 million in terms of noninterest expense. Going forward from there, it will probably be somewhat similar, although you'll have a slow ramp rate in terms of the growth in noninterest expense. Yes. Got it. Okay. And then shifting to the margin. Do you have the spot rate on interest-bearing deposits at the end of the year? Okay. And do you happen to have the -- since you have the average for the month of December, you have the average margin in December? Okay. Thank you. And then just on the overall outlook on interest-bearing deposit costs. We heard your comments earlier, Mr. Yu about things accelerating toward the end of the quarter. How are -- what are your thoughts on -- where your beta might settle out through the cycle, assuming we get another 50 basis points from the Fed here and were done relative to last cycle, I think you were in the mid-50s. Yes. Well, my thoughts is that -- from my experience is that we will continue to see the market competitors paying more interest. And we, as a small fish in the big pond, we just have to follow the trend and do our part in the same thing and hopefully that try to manage it more closely. Now actually, you'd be surprised some of the largest institutions back in November before the December rate, they're already offering one year, I mean, like a certificate deposit at 5%, okay, and I can list -- a whole list for you. We have gathered that. So going forward, is these big institutions, what the market rate they set, what market they prepare. We just try to catch up. And we have no idea what they would do so on. But based on my experiences, I think the first quarter, the deposit costs are further accelerating increases as compared to fourth quarter. And then our margin -- in my opinion, it's not at or near top, okay, in the cycle. And obviously, margin itself has to do with the leverage too, depending on how much it grows in loans, how much gross deposits you have, in general, the spread, I think, is among the top that it's starting in fourth quarter. Which not to say in this -- in the first quarter, we're not be able to earn a very handsome margin, you know. I wanted to start on just deposits, specifically noninterest-bearing -- if I look, I think your mix is around 21%,22% noninterest-bearing deposits as a percentage of total. I'm just trying to get a sense of, I guess, what you're seeing so far in 1Q in terms of noninterest-bearing deposit flows. And then what your sense is on where we could see noninterest-bearing deposits bottom out? The answer is we don't know. That's one of the reasons why we say we have no control of our margin going forward because we see customers continue to manage their money. They either pay off their loans or they just reduce their loans, save interest cost or in many cases, where customers using the excess cash to payoff their real estate loan because they consider 8% or 7.5% unbearable, okay? So this trend will continue. And this is also that more people will recognize that their money can earn over 4%. Now, they want to move to TCDs and other things, okay? So this kind of movement and I try to look at other press even as big as JPMorgan, they've no idea, okay? What this migration process would be. So this is one sector situation. Another one situation, I can never tell how the big banks set their price situation and become the main competitor for deposits because they've huge market share. So we just have to follow and lot to do with their funding condition or the overall tightness about the fund. So this is really the very important wirecard going into 2023. Yes. Understood. I appreciate the color there. Maybe if I could move over to just outlook on provision and reserve moving forward? I guess, how are you thinking about allowance levels moving through 2023? Well, our general philosophy is we have been building up our reserve at the year-end. We will take every quarter, take a look and generally stay conservative. Take a look and to see whether that number is going to be increased or needed or stayed approximately the same. Of course, we have to subject to CECL methodology and so some of the situation is to go through a calculation process. So in generally speaking, if we based on the credit metrics as of now, I have to say we're over reserved, but we don't know what the coming economy will be. So we stay at the level. I understand some of our direct competitors has reserved less than maybe basis points, okay, that they have the same type of business as we do, but we believe that we need to be stay at this level for now. Yes. Okay. Maybe sticking on credit. I'm just looking at loan yields, call it, near 7% -- just south of 7% in the fourth quarter. Obviously, really good for the margin. But I guess, any color on how debt service coverage profiles have changed at your borrowers, just given the increase in loan yields and any loans that you've had to restructure as a result of rising rates or any that you foresee having to restructure? Just any kind of incremental color there would be helpful. Andrew, this is Nick speaking. And for our TDR, we only have two small loans on our TDR lease, combined with only $1.5 million is belonging to one of the relationship and they're paying. Everything seems okay. And definitely for Fed's rapid rate increases and our borrower, I believe they do have some pressures on that service coverage ratio side. However, most of our loans, we have a very strong -- financially strong sponsorship behind it. And that you can see from our past year report, and we don't have that many past due under 30 to 90 days. And also nonperforming loan, we only have one mortgage loan as Mr. Yu mentioned previously, it's only a $280,000 around. That's it. So basically, our credit quality is still quite stable comparing to our previous quarters, and we expect that to be the situation and definitely there are still many, many economy uncertainties ahead of us in 2023, such as honorable energy or food supplies, inflation costs, weakening the purchase power and the rapid rate increase and fast QT side. All those kind of things are really give us uncertainties for this market and the management continues to maintain a kind of a moderate risk posture for factoring the reserve requirements at this time. Again, it's just pretty much that I've said at this time, if based on metric makers today, we are over reserved. Okay. That's my personal opinion. But however, in general, we have been trying to consider the recessionary economy, what the effect would be. Two questions. First, on the commercial construction segment, relatively small but had a couple of quarters of decline before increasing this quarter on an end-of-period basis. Just wondering if you could talk about kind of the committed pipeline that might fund over the course of the next year? And if there's -- does that number-- does the period end number continue to trend down? Was the fourth quarter a bit of an aberration there or anything else to think about? Nick will give you more color on that, but some of the fluctuations here then is because in the past, we have pandemic slowed down many of the projects, okay? Many of us has restarted and obviously, the summertime has been the greatest time to increase the construction, okay. So Nick. Yes, our construction portfolio, we try to manage this portfolio under 10%. During the past quarter, I believe this is around 8%, and this quarter dropped to -- a little bit dropped to below 8%. And just to give a little bit more color on our construction loans because we don't do many construction loans, which is not a desirable products. Most of our construction loans actually is from the existing loans, and we try to slow down a little bit, especially for those condo projects and those kind of things because there's a lot of uncertainties in the economy. So we try to slow down. However, all of our construction loans at the origination, we try to base on our increased projections to have interest reserve. So we are doing construction very conservatively compared to our peer groups. Okay, thanks. And then a question for Ed. There's obviously a lot of conjecture out there in terms of what happens to rates, how long they stay at elevated levels when the Fed does stop tightening. Just wondering, given the amount of progress you've made in terms of asset yields year-to-date or in 2022, any updated thoughts on how you might kind of manage the balance sheet to lock in some of those benefits looking forward to a timeframe where the Fed does start to cut right? Well, I don't -- I'm not going to speak for the production side, but I know we have had a lot of discussions around, as you know, Gary, about 80% of the book is floating rate. So there have been a lot of discussions around. And making headway into doing some more fixed rate lending at this time, given the overall level of interest rates, this would kind of be the opportune time to start doing more fixed rate lending. However, that still presents a challenge, obviously, as we've talked about already, the activity has slowed down â economic activity has slowed down. But I can let -- Mr. Yu, do you want to speak to more on that? Well, I think in overall fund management situation, we have a -- most of the floating rate loans, in fact, substantially all our floating rate loan has a floor. The floor sort of protects us from the fluctuation okay, the cognitive cost by the rate situation. And obviously, that during this high interest return, it will be sometimes a bit advantages to do selectively a few fixed rate loans. But the floor really puts us in the situation that -- I mean, that we can have time to adjust a bit along with the rate -- interest cost rate decreases. So going forward, we just have paved every step of the way, just like way is going up, we've built up the sensitive balance sheet. Just as a follow-up to that, to the degree that you've got new loans working through the pipeline, which, as you pointed out, I mean, that's slowed down dramatically. Are your customers more interested in variable rate loans because the customer has a sense that rates are going to fall quickly. Is that kind of the general view of your customer base that I think that, that will pivot quickly to the downside? Customers are probably more interested in this day as a floating rate loans because presumably talking about real estate, I'm not talking about C&I, okay? Because they forecast, they listen to forecast by all the economists who is indicating that rate will come down at latter part of this year or early next year, okay? And to them, it's the short-term situation. I wanted to touch on some of the expansionary plans that you touched on early in the call. Maybe specifically starting with the SBA department, just curious the plans for that, whether your plans are to retain production or sell it, maybe the time line for the build-out and maybe where you're going to be focused from a regional perspective? Okay. SBA department was started latter part of 2022 with the skeleton crew, okay? And then we are going through to be getting our PLP position. We've never been a preferred lender before, okay? So we expect the PLP position will be granted early part of this year, okay? So as far as the plan of the way you return, retain something like that, Wellington, you want to answer that? Thank you, Mr. Yu. David, our plan is to -- as we fund the SBA loan, we will just sell it to the secondary target. It's a wait-and-see, especially with current economy and current situation. The SBA with a recessionary economy, SBA tends to slow down. A lot of people, actually, the market has slowed down. But we're just looking at to go about methodically and just very careful since it's a new product that we have, although we have experienced team and the team leader. Okay. And then maybe just touching on the branch expansion side. Just curious, is -- are the branches a part of the Texas expansion in those LPOs? And maybe if you could just give us an update on where we are in Texas, how growth and demand and pipelines are trending there? Texas is going to be converted into a branch within about from LPO to a branch in about two months. Right now, we're all busy in working on these things, okay? Pipeline does not change that much from last year to this year, a long outstanding. In fact, we currently are in a situation, the entire bank is looking at things very carefully, okay. Another branch, we have signed a lease. I think we've really signed. We're committed, okay? We think it will be in the Southern California in a very good location. We're working very closely on that, but we have budgeted it already. That's what I mean. So going forward, in the remainder of the year, as new opportunities come up, we just grab it. And if there's a new personnel that to be hired, we're not going to be worried about its budget, we're just going to hire them. That's music to Ed's ears. And so the other thing is I wanted to touch on is you guys have been very good stewards of capital and you have a very strong capital position ahead of a potential credit cycle. But if we step back and think about a potentially slower pace of loan growth in your incredibly high levels of profitability, you're going to be accreting capital at a really rapid pace. We talked about a couple of growth initiatives. Just curious about your capital priorities here. We've seen some dividend growth. And again, carrying significant levels of excess capital into a credit cycle is not a bad thing. But just was curious whether there's any appetite to increase capital return or other capital priorities? Thank you for asking the question, recognizing all that, okay? We -- because we are a state chartered bank reporting -- I mean, without a holding company, any capital raising is requiring a capital buyback, capital transaction was required. Shareholder approval, which is required by the state regulator. So every time we want to buy back from stock, if we want to go through the whole process, that's 9 months process. So this year, what we're going to do is we just got the Board approval to submit for shareholder approval during our proxy season. For pre-approving a total amount of stock buyback. And then we will go to the state wherever ready to act on that. And generally speaking is that the majority of opinion of the Board, is that at the beginning of the year, we need to be a little bit more careful in watching the economy and have the capital ready if the economy for some strange reason turns out, okay? So once it is clear, then we expect to return things to our shareholders. Yes, I had a question about the cash on balance sheet. It still remains at elevated levels. And I'm wondering does the uncertainty about customer liquidity behavior outweigh the opportunity to reinvest that in securities. Well, that's a very good question. As you know, Tim, we have kept inordinately large amount of cash on the balance sheet actually since the financial crisis. So we've always had a fairly large cash position. One thing we actually did do during the fourth quarter is we did invest some of that excess cash in the treasury market at where what I consider to be extremely attractive yields. And I think we may do some here in the near future in order to lock in some of those -- some of that additional yield rather than have cash float along with the Fed's interest rate decisions. Okay. Okay. That's helpful. And then curious about what you're seeing from competitors. Clearly, your customers have started to express some cautiousness in terms of the lending behavior. I'm wondering, are your competitors, are you seeing them pull back from the market or otherwise tightened their credit boxes? Well, first of all, strangely enough, they're all like us they're looking for opportunities, but they were very prudent, okay? But there are competitors doing things at this point of time, which requires to research onto it, okay? There's one of the largest bank in California is offering -- still offering customers a seven years fixed rate, okay, CRE loans at low 6%, very low 6% and without pre-payment penalty. So they are willing to grab business by forgiving the interest income. So we're looking at that. We lost a number of accounts to them, but we're still looking at that and to see how we can compete with this kind of situation. I guess there's always going to be low, I should say, people that you cannot compete with. We lost another loan to credit union, 5.25% in five years, which -- fixed rate. We just can't compete. We don't -- happen things every day. Well, actually, the question-and-answer is all pointing out the things we want to further clarified. So thank you very much for your time. And as I said, we are optimistic but we would be careful. Thank you.
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EarningCall_1224
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Greetings, ladies and gentlemen. Welcome to the Home BancShares Incorporated Fourth Quarter 2022 Earnings Call. The purpose of this call is to discuss the information and data provided in the quarterly earnings release issued this morning. The company presenters will begin with prepared remarks, then entertain questions. [Operator Instructions] The company has asked me to remind everyone to refer to the cautionary note regarding forward-looking statements. You will find this note on Page 3 of their Form 10-K filed with the SEC in February 2022. At this time, all participants are in a listen-only mode and this conference is being recorded. [Operator Instructions] Thank you. Good afternoon and welcome to our fourth quarter conference call. Today's discussion will include prepared remarks from our Chairman, John Allison; Chris Poulton, President of CCFG and Stephen Tipton, Chief Operating Officer. The rest of our team is present and available for questions. Tracy French, President and CEO of Centennial Bank; Brian Davis, our Chief Financial Officer; Kevin Hester, Chief Lending Officer and John Marshall, President of Shore Premier Finance. 2022 was quite a year Home Bancshares finished the year though with a strong fourth quarter and to provide you with the details is our first speaker Chairman, John Allison. Thank you, Donna. Welcome to our 2022 year-end and fourth quarter earnings release and conference call. Properly managing last year was both arduous, stressful and somewhat exhausting at bear. Loan and deposit rates had not been this high since the late 70s and the early 80s. That's when Volcker took rates to the low 20s and; finally, killed the snake, better known as inflation. This is the second fastest that we've ever raised rates in the history of our country. Our belief is that we have higher rates for longer. We've not even hit the 50-year average at 5.44 fed funds and the pivot crowd will be disappointed because Powell is aware of the early pivot that Volcker did in the 70s. Inflation was not over then and it's not over now. We must hold the course, maybe not raise rates as much as in the past, but continue to raise, pause, observe as it takes almost a year for the impact of what we did today to show up in the comments. We're seeing some signs of inflation slowing but without continued rate increases. This could be no more than a hearsay The naysayers are saying, there will be run-on banks. Bad loans will start raising their hand. The recession is here. The biggest stock market crash is imminent. There is a financial hurricane leading in this direction, banks are out of money and higher interest rates are destroying the value by reducing the value of the securities due to ALCI. I have to agree that some of these risks are certainly out there, but most can be properly managed. A lot of the deposits at much higher rates are finding their way to those who did not show patience and continued on the same path, ploughing deposits into low rate loans and security. It will be a long road for those companies. They will not catch up for three to five years if that quick or until the low rate loans and securities roll off the books. I have said this before and I want to say it again, there is no substitute for experience. The key essentially have interest income down to our own interest expense to result in an increase in net interest income, even as conservative as Home is and the position we were in, this is a very trying task during the quarter, because those who spent their money were forced to buy money regardless of the cost as evidenced by their CD ads everywhere. There has not been a CD ad run at Home. We let deposits leave the bank only when they hit the stupid point. Otherwise we attempt to retain the deposits. In good times, these branded banks had a race to the bottom on loan rates and now they're having a race to the top on deposit rates. As tough as it is to maintain excess cash, we're still hanging out around 80% loan to deposit, additional cash flows from securities, principal payments and smaller payouts are resulting in about $300 million per month in cash flow. February is expected to be about $550 million because we have a $250 million treasury put that in where we could get another bite at the apple. We get that in early February. We have - with 80% loan to deposits, virtually no broker deposits, limited borrowing with billions of capacity plus cash flow only sets us in a great position. In spite of the damage done and more attempted by the West Texas Group, it appears the intent was to destroy shareholder value. The strength of the entire franchise is stepped up and delivered three record quarters in a row since we closed that transaction. We're keeping a tally of the unprofessional damage doing to our franchise and we'll talk more about that in coming months. I found this pretty interesting. Bill Bonner described as an underappreciated economic genius, explained that financial innovation always appear brig at first, but they sooner take you to access and become a forest and eventually the forest leads to a tragedy. All banks are not created equal as all cars, it's all land, people, management teams, football teams, we pride ourselves by trying to separate ourselves from the rest of the pack with top tier performance being named best bank in America by Forbes three of the last five years is certainly a great achievement by our team. I don't know if any other bank in the country that has achieved that goal. We just witnessed the Georgia Bulldogs, separate themselves from the pack in a very impressive fashion, no doubt about who is the national champion in the US. I don't know that Home is the national bank champion, but we're certainly in the playoffs and congratulations goes to our team. We are [indiscernible] of the trading given to us by our supporters as there are only a handful of banks trading over two times tangible book, while 66% of all publicly-trading banks are trading at 125 [ph] or less and that number came from last week and were taking them all down this week. The conservative management team at Home believes in maintaining a fortress balance sheet with excess capital and sufficient reserves. We do that in the event of a major downturn in the economy, all while continuing to report record profits and top care performers. Weâll continue to carry these conservative balances, but regardless of the situation, Home will be open in the morning next week and next month. There is no substitute for strength. You cannot get it when you need it. Therefore, we carried it all times better safe than sorry. Don't worry about Home. We're taking care of you buying. Let's go to the numbers. I'm pretty impressed with these numbers myself. Record fourth quarter income of $115.7 million or $0.57 a share, I'm sure that's a beat. Record '22 earnings as adjusted for the one-time second quarter adjustment of the merger expense of $107 million, $375.9 million or $1.93 EPS, fourth quarter ROA 1.98%, a little discipline I wanted to, but that's about as close to the [indiscernible]. ROTCE, return on tangible common equity in the fourth quarter amazing 22.96%. Tangible book grew from $9.82 to $10.17, even though we continue to buy back stock. AOCI [indiscernible] reported AOCI improved by $2 million. That's not much, but it's certainly moving in the right direction. ROE 13.26%; revenue, record revenue, $272.3 for the fourth quarter; fourth quarter margin, 4.21%, up from 4.05%, thatâs up 16 basis points. I think at the end of the first quarter, we said we'll continue to expand the margin in the second quarter, but not as much. It was a pretty good battle and somebody better be managing their bank every day to grow that margin. Non-performing assets from 0.27% and non-performing loans were 0.42% same or about the same or lower than last quarter. We did fourth quarter loan growth was $580 million and I think Stephen will report on how that rate that was over - I think overall portfolio was up 60 basis points in the fourth quarter. We added $5 million to reserve; puts us at 475.99 times classified assets, I guess that's what it may be reserved is 475.99% to performing loans, I'm sorry, non-performing loans. At the 2.01%, number is $289.7 million; efficiency ratio of 42.44%, we repurchased 840,000 shares for $20 million during the quarter. We didn't make any change in dividend. We'll be discussing that at the meeting on Friday. We received $15 million from our lawsuit against First Service in a lawsuit statement. And next quarter, I want to introduce a very exciting and profitable portion of our company that has never been properly recognized or promoted. So stay tuned for that. I think you'll enjoy that. It's taken a lot of my attention recently. And strong capital levels, and I think Stephen will go over those in his presentation. These are some of the best numbers that we've ever produced and probably the best that anyone has ever produced. We didn't win the National Bank championship, but I can guarantee you we were going to the playoffs. And during all this time we get down green with these numbers, I find that really totally unbelievable. But anyway, it is what it is. Donna, I think that pretty much wraps up what I've got to say. And if you want to take it from here? Okay Thank you for that. I know that all of our listeners always appreciate your insight and congratulations on another great year. Our next update will come from New York from Chris Poulton with COFG. And Johnny, I appreciate the shout out to UGA, Go Dogs, Q4 capped off what turned out to be a solid year for CCFG. For the quarter, loan balances grew by just under $200 million at $197 million on just over $500 million in new originations. This growth was despite a robust $320 million in payoffs and paydowns for the quarter. Q4 is generally an active quarter as customers look to complete transactions ahead of the year-end. You may recall that our portfolio declined by about $340 million in the third quarter. Much of the growth in the 04 was simply planned to the portfolio as we took advantage of the chance to redeploy our capital. Frequent steners may have heard me say from time to time that getting repaid is not, in fact, the worst outcome for a loan. These repayments provide us an opportunity to redeploy capital on new usually improved terms. For the full year, CCFG grew $356 million or about $0.18 on just over $1.5 billion in total originations. Looking ahead volatility in markets generally creates opportunities for our lending strategies as traditional bank financing becomes either unattractive or unavailable. We enter 2023 with our usual sense of caution. Today, our leverage is generally a bit lower and structure a bit tighter, but we remain confident that we will continue to see a number of opportunities to modestly deploy capital in the coming quarters. Thanks, Donna. As Johnny mentioned, it has been quite a year. It's fun to get to report on such a strong and high-performing company, and we look forward to another great year in 2023. I'll start first with the net interest margin, which Improved again in Q4 to 4.21%, up 16 basis points from Q3 and up 79 basis points from a year ago. The improvement comes as the earning asset mix improved on a slightly smaller balance sheet. We will continue with our approach of maintaining healthy cash balances at the Fed and look for opportunities to deploy that liquidity where and when it makes sense. We continue to navigate through customer expectations for interest rates on the deposit side amidst such a competitive environment that has already been mentioned, and we'll do that on a case-by-case basis. It we do see additional rate increases and able to hold the deposit rates at a reasonable level, the current ALCO model projections show about a 3.5% increase to NII in the next up 100 basis point scenario Switching to deposits Total deposits ended the third quarter just shy of $18 billion. The decline in balances slowed from prior quarters, and we actually saw Increases in North Arkansas and the Central Florida and Southern Florida markets. Noninterest-bearing deposits accounted for 29% of the total at $5.2 billion, while CDs only comprised less than 6% of the total deposit base We're focused on our core customer base in the markets we serve and looking to bring in new relationships as we deploy capital into the loan portfolio. Staying with liquidity for a moment. As Johnny mentioned, our loan-to-deposit ratio ended the quarter at 80%, and our primary liquidity ratio remains strong at over 19% Switching to loans. Origination volume was strong at $1.9 billion for the quarter, with over $1.3 billion coming from the community bank markets we serve. Yields on new production came in at 7.17% and increased each month throughout the quarter. We continue to focus on pulling these rate increases through the current pipeline and as loans mature. Payoffs moderated in Q4 with a total of $710 million, down from $1.2 billion in Q3 and helped contribute to the average and end period loan balance increases Switching to capital and a few key ratios. As Johnny already mentioned, we had total risk-based capital of 16.54%, a leverage ratio of 10.86% and a tangible common equity or TCE ratio at a strong 9.66% as of December 31. All of these are well in excess of our internal targets. Thank you, Stephen. Good report. Well, Johnny or Tracy, before we go to Q&A, do either of you have any additional comments? I was thinking what Johnny used all those adjectives when he started his prepared remarks. I came up with the word entertaining. It's certainly been an entertaining year, but well, the best ever. It's never been dull with you, Johnny, in the 21 years I've been around. So entertaining is probably the better word. But complement to all of our markets and regions and the areas over the past year. Certainly, we've seen the increase in interest rates has been something to work with, but all of our markets have done an outstanding job managing their balance sheet, which overall makes our balance sheet looks good. When you look at our numbers, for the bank and return on assets are in the 2% range of return on average tangible common equities in the 20s. You've got the efficiency ratio that's in the low 40s. We actually hit below that this past month, which is nice, and you got net interest margin around 4.25% That's pretty strong, tell about the type of folks we have working out there in our community. One thing you talked about inflation I think our company does really well and we talk to our market leaders on a regular basis, just talking to the customers. So we know there's still a lot of things of concern out there, some hold for people that cut back on doing certain things, some loans that we talked about doing nine months ago that customers called and said they were putting on a little while, which is just good business. And I think that's the -- the nice thing about our balance sheet that we have in the bank is knowing our customer. Our customers are making good business decisions. It's showing up in the numbers. But all the performance numbers are good. Mr. Allison, and I hate to say this in front of you, but I think we've got room that we can improve on all of them. Well I've always been easy. I've never kept raising the [indiscernible] Anyway, it's a great quarter. Thanks, everyone, for your support out there. I can't say enough about I don't know anybody have looked for somebody I don't just find somebody that we might win the national championship, Donna. I am yet to see somebody beating us in this market for the quarter. I'm not sure they'll love that. We'll get us some [indiscernible] Anyway, I think it's a great quarter. I look forward to the questions, and I'll give it back to you. Well, good report. I want to ask about the loan growth, strong trends in the fourth quarter. We got the report from Chris, pretty active in his group, but the Community Bank also had a strong quarter of growth. Any color there? And as you think about 2023, what are the expectations for growth there? Matt, this is Kevin. You heard Stephen talk about lower payoff numbers. So that factored in some. But certainly, he mentioned the production across the footprint, you can hear how much of that came out of the footprint. It was a strong quarter for really a lot of our regions. That's kind of a function of us continuing to do what we do. We're pretty conservative across the board. We stick with that. And sometimes it works in our favor these times where you've got competitors that are some out of money and some just choosing to sit on the sidelines in certain asset class, we keep doing what we're doing conservatively we're getting to go to the dance soon now. So we'll just continue to do what we do. And as Johnny said, sometimes it works in our favor, sometimes it doesn't. And - and this quarter, it's certainly been. And it looks we've got folks doing a lot of stuff right now looking at a lot of things. So we like where we're at. A lot of banks have money. I mean they're long up and puts us -- gives us gives us a shot. I think in some of these deals. I mean you think about somebody loaned up 100-plus percent, and the they're bared out it's going to take a while online that will they get back into the competition. Okay. I appreciate that. And then on the credit front, it looks like you pulled a positive loan loss provision expense for the first time in a while. Anything specific that drove that? And then I guess kind of stepping back, any specific asset classes you're watching closely? Or any loan categories you're more focused on in 2023? Matt, this is Kevin again. So we're certainly from an asset class standpoint. We're going to watch a few. You got retail that certainly has stresses. And as you see how this economic cycle continues. If we do truly go into kind of a consumer recession and that's something we're going to watch off this, obviously, is on everybody's mind. And we don't have a ton of office, but we'll look at what we got and continue to watch it like we do anything else. -- hotel seems to be doing well and certainly its we're in. And so we will watch the asset classes based on what we're hearing out there in our markets and in the national as a whole. Just from our perspective, in the fourth quarter, we had a group of about 6 ALF properties in Florida that total about $100 million that struggled to reach stabilization. The equity came from an institutional investor. These loans have always been current, continue to be current and supported by this investment group. But given the long stabilization runway that they've been on and the more challenges ahead, we decided in the fourth quarter to move those loans to substandard. We'd watch them for a while, not anything particularly different today than yesterday. But just given the late time watching, we decided to move them so you'll see that as the quarter numbers come out. But again, we'll watch the market and watch our asset classes that we're heavier in and look at particular loans as their annual reports come in, and we'll act accordingly. Yes. We've talked about these credits over the years. And the current plan has agreed, but the they still bother me well. I think we're on the road when we had the pandemic hit and they said, Home is going to get killed on hotels. We did a fireside chat so everybody, we motor them properly. We underwrote these properly too. So I don't anticipate a lot of push to do so, but it is something we've talked about in the Kevin thought it was time to downgrade them. So we did downgrade them. Outside of that, we had about 100 million of them, only really - the only ones that probably is about $60 million of them, so $60 million. So if there was a lot to be small, I would say. I mean you might lose $10 million maybe, maybe not. So anyway, we just like we always like a 2% reserve you asked about the loan amount, good days, bad days, recession, high rates, low rates, inflation, whatever comes, it goes, 2% reserve has worked and that's been a rule for us for many years. We like 2% reserves. We don't want to use our reserve like a Peak pulled stuff out, put money in, pull it out, put it in. We have a 2% reserve. We like that. We feel comfortable with that. We went through '08, '09 and '10, the worst financial crisis I've ever seen in my business career. - with a 2% reserve and it paid off for us. So we'll continue to maintain strong reserves in the event that something were to pop out there anywhere. So that's- we actually fell out below 2% So we put the money in there. We got to get from service first gave us a little gift during the quarter. So we just kind of thought we'd put that money in reserve. Okay. Well, I appreciate the disclosure on some of those downgrades. And just to clarify, Kevin, what types of credits were those? I was a little unclear on what those were It's primarily member care. One thing we've learned is the member care people - I'll be glad to get a pill we can take for member share, but people struggle with member care. And even as it is the patients don't live very long. A lot of turnover in really expensive. The staffing has been really a challenge after COVID, so there were a lot of headwinds. I'm sure that asset class was steatite out at some point in time because the baby boomers are rolling, 65 and older. A lot of baby boomers rolling into that. And I think that's what was anticipated in this field was that's what would happen. But it has been a struggle on the cash flow side. And particularly, people wouldn't go through a love once when the pandemic hit, they wouldn't got their loved ones, and took them out. They brought it home and a lot of that happened selling them back up. One of those community care centers or safety living centers was hit by hurricanes. So we should we got to ensure hopefully, we'd sell that on to the insurance capital. That would be one of the ones that were in question. Yes, that's correct. That would be the coupon on total production for Q4. Only a portion of that would have funded by year-end or during the quarter, but that was we wrote. Yes. I think I mentioned, it increase kind of throughout the quarter, just as market conditions have changed, and I think we wrote about 7.40 or so in December. So it's got a nice trend towards it and just kind of lining up with what you're seeing from the Fed. Got it. Okay. And what kind of reaction are you getting from clients at those rates? It seems like there's plenty of demand, but just kind of curious on sentiment. This is Kevin. It's I think people have recognized that that's where the market is and their dealer has to work at those rates or they can't do their deal. And we've had a couple - we builders came in and some of the -- some of these projects didn't work at those rates, and he just pulled them off the table to get had inflation, building costs were up, interest rate were up [indiscernible] didn't work. So to his credit pull projects off the table. We'll see them again. I think it was the one of the land -- we won't go forward with the project. Good news. Actually, our customers are thinking through this process well, looking at it, analyze it, decide if they need to do it now or do it later, some need to do it now. So need to do it by the strong loan growth for the quarter. Cap rates are still good. So they're billing to sell, this is just an increase in their interim cost more than it is a cost of the project. So most will factor that in and take a little less proppant and get it built and get it sold and move on. Our homebuilders we did they just visited with our homebuilders out of Florida, big homebuilders, you had softness in and around Houston. But there in Florida and Alabama are continuing to run really strong. I think it's - Tracey got that information. What do you say? Yes, yes it is. October was good. November was a little dip, December was strong, but they've adjusted some of their whereas they market it over time, but margins are still -- a little bit less than what they were, but they're still really good. Yes. We talked about asset quality, we're all going in some people. Everybody has been watching Shore Premier. I've been talking about Shore Premier. If you don't mind, I'm going to give John Marshall to talk about Shore Premier, his performance and his past dues. If you could quickly tell us not stealing your share we're talking about asset quarter, I thought we'll let John reset and I forgot it. John, do you want to talk about what you're seeing out there? Yes. Mr. Allison. Thank you. I appreciate the question. I'm seeing some forecast in the market of elevated delinquency and defaults. But I also believe Mr. Allison, what we're going to do, we're going to observe that in the smaller book and trailer retail segment, you all will recall that our marine book is underwritten to a prime credit quality standard. Our average application, Mr. Allison is 820,000. And our average loan size is $670,000. Our borrowers have verified liquidity of 66 months. Imagine that So completely indifferent to their income, the W2 They've got 5 years of average liquidity to cover their obligations. That's all of their obligation, not just their boat loan. If you consider delinquency at the harder of default, at 21 basis points, our delinquency is consistent in the fourth quarter with where we've seen it all year. And again, we feel like that's a very low number. So Mr. Allison, I don't know if that answers the question, but kind of what we're seeing Thank you for that. I don't mean to steal your thunder, Jon, but I want to get that Matt asked about asset quality, and you probably would ask about it anyway. So you've got the floor, Jon. Yes. No, I appreciate that. That's helpful. You guys - you alluded to the margin drifting up, but maybe not as much as the quarter this past quarter. It seems like you've got some pretty good repricing coming, pretty good momentum in loan yields. How do you feel about the margin trajectory? And how are you guys funding some of the deposit pricing requests and pressures? Is it just taking the loan-to-deposit ratio up? Or is there something else going on? Well, we're taking loan deposit up a little bit, but I think the trough on the deposit. I think we hit that interesting. We manage this company, as you know, every day. And October was a screaming home run. it was just we knock is grand home run for October November, rates took off, as you saw, and it was a -- it was hand-to-hand combat in November. We actually went backwards in November from October. And then here comes December, and we're booking some loans and we're getting them on the books and they're starting to run [indiscernible] with the increase in revenue, the increase in interest expense until the 15th or 18th of the month, we're actually running backwards and it turned the whole thing turned at that point in time, we got enough new loans on the books to outrun the interest expense and it ended up being a great December. So it is hand-to-hand combat, and we're taking them one at a time, but we've dealt with most of it, and I'll let Stephen comment on what he... Yes. You said it, John. I think it all hinges on what we do have to do on the deposit side. I mean we did -- as Johnny mentioned, we were a little more aggressive in October, November on the heels of the 75 basis point rate increases had to pass some of that along to deal with the customer demand. But feel like what we did in December and then depending on what we see here in a week or 2, the first of February from the Fed, we maybe be a little more conservative there. It's not that we don't - we see it every day. We see it. We see it plus or minus we'll compare December 8 with November [indiscernible] how will we do it at And with October and how well we're doing there to a compare, we win and we lose it. It was it was a battle - really it's a battle. I think that most of the rate increases are done at this point in time. So I'm optimistic that we'll have a shot we have a shot at increasing margin in the first quarter. If we can continue to where we're writing and if I'm right, most deposit expenses are behind us. First of all, great quarter. I think it kind of played out as you guys said, it will get some of that liquidity to work I'm kind of curious, Johny, digging into the comment you made in your prepared remarks, I think it was around $300 million a month of cash flows and repayments and other things. I'm wondering how much of that specifically is coming off your bond book in terms of cash flows. Just kind of trying to think about how much loan growth you could fund if without any incremental new deposit growth? There's about $30 million, $35 million coming off the bundle, and we really haven't redeployed that because rates have kind of backed up here a little bit, as you've noticed. So we've just settled that money, and we far it's better off growing bid funds on that extra cash that's what Brian has been doing with that. Yes. So as rates as we think, Rich, we go back up, we walk in somewhere, we picked our spots to rigs kind of backed up on the car. You've seen the tenure what's happened there. So is it over now? It's not overall, certainly, they're going to continue to raise. It may not raise at the level that they've been raising, but they're going to continue to rise. Yes. So the $35 million, that's per month in terms of cash flows, and I was more thinking maybe not deployed back into securities, but could you deploy that into funding the loan growth? Absolutely. Where we want to put it, yes. Absolutely, we can. about when you think about it, it's coming off of 150, you can put it in at 46 or 40, If you put it in, that's a pretty good spread. So we're still sitting we got - - we still we still got cash and we're generating cash and - we got a CD treasury coming out in February, it's $250 million that we'll put to work. So we're pretty happy where we are. We don't need to borrow anything right now. We've got plenty of plenty of room. We don't have a broker deposits. We really don't - we're not barred at all. We need to get barred up if we can. Got it. Makes sense. And then you referenced in the headline of the report despite continued West Texas headwinds, but hard to see any headwinds in the results. I guess can you expound on that a little bit? Or what's coming out of there? Or is growth just not what you would want out of those markets yet, and it's just been other areas that just kind of kept us from seeing this. They went after -- that bunch went after -- a bunch of our customers took a bunch of our deposits and did what they could do the damage the company, I guess, is what it certainly appears like and had we not had that, we would have had a much better quarter, and we're keeping up to how much that is. So I think it's important to know and we'll keep a run tally of how much they got from us or stole from us or took unprofessionally from us and so we're as you know, we don't when someone tries to ensure the company has happened with service first, we stayed after for years until we got our money. And I'm not saying we're going to do that here either, but I don't like people trying to hurt our shareholders. So Okay. Got it. And then last thing for me is really just like you mentioned, you guys have continued to repurchase shares and are one of the few bank stocks trading above 2x tangible any longer. So at 2 30 in tangible, does M&A become more interesting than repurchasing your own shares at some point? Or is that math just not attractive to you at this point in time? No, it does become attractive. I mean I'm a first tip of our the support that people have given us to trade at that level and be one of the fee to trade there. But it is -- we're interested in M&A. I don't think the problem is that a private bank don't recognize that their price goes down like the rest of the banks do. Rest of the bunch used to be at 170, 175 times tangible book, and now they're at 125 or less, 66% of them are. And regardless of what they do, their is going up the same way. I mean it's going to be exactly the same. So whether private bank recognized is not, they go up and down like we do as a public company. So my thoughts are that will be acquired flyer - next we have 2 weeks away, and we're going to visit with some people out there, there's some opportunities there. So now M&A is how do you do an M&A deal today, though Stephen? I mean you guys are pretty damn good. Your group is good or is out there doing deals or one of the best at doing deals. How do you do want to how do what do you go to market loan book at today with these rates where they are It would be extremely I mean you got to take a mark the loan book -- and AMC has already booked the securities basically. Can we do a deal, Brian? No that makes sense. And obviously, the market's appetite has still been relatively tepid towards deals. But I think you guys showed with a happy deal if you do the right deal at the right price and the right structure, it still can be received well. So I appreciate all that color. Congrats on positioning the company well yet again. We appreciate it. We work hard at doing what's in the best interest of our shareholders. And as it turned out, we ended up happy ended up being diluted to us because MCI, but I think we retain that pretty quick. And the rest of the franchise jumped up to help us. So I'm very proud of the year. I think we had a great year in spite of all this, it is very stressful while managing your business with all this going on with the distraction in West Texas, along with all these interest rate changes. So but we got through it and had a great year I wanted to talk about deposits for a second. And just - I think everyone is trying to figure out how much more they might be operating now from a DDA perspective decline and how much more liquidity could drain out from the low-cost core deposits. And just wanted to see if you had any crystal ball thoughts on that for your bank, and you've obviously not had to really push too hard on deposit betas versus many peers but wanted to see if that was something that you might be looking to amp up if loan growth is going to be there for you from an opportunity perspective. Brett, this is Stephen I guess as you said, that's a crystal ball thought if we knew we wouldn't be sitting here. Like as Johnny mentioned, I mean, if we found a trough, yes. I mean, I think certainly in Q3 - excuse me, Q4, the decline slowed from the prior 2. If I go back and look, we think pre pandemic ran 22%, 23% noninterest-bearing to total Yes, I don't think that's necessarily where we go back to. But yes, I think some of that is going to still be to be determined, I guess, as some of the money that's been in the system over the last year or two moves around. We talk around the table here. It's taken a little while, I guess, to kind of spin back up the conversations that loan committee and other places around raising deposits again and having that be a part of the discussion when you got a new opportunity at loan committee and those kinds of things. So I think before we push hard on beta and rates and CD specials and those kinds of things like you see, I think we stick with the relationship banking approach as a business. I was just going to say, Brett, the only thing remember when the pandemic hit, deposits really boomed, right? And we stay disciplined and we didn't lock in a lot of loan opportunities back then at 3% for seven and 10 years. We always knew that the deposits would go away to some degree, I thought it would take a little bit longer than it did this past six months. But as we watch a lot of our customers would give us a call. Give us a call if we wanted to match a high rate, we certainly get that opportunity So it's not that we've lost a customer, but instead of normal deposit rate in the bank, they could take it out and do an investment and do more money. And then we also have some customers that used to borrow a little money that choose their own money. So that time will turn back with that deposit money will come back in. Johnny has mentioned about the West Texas. I think we've got a really good calling opportunity coming down the pipe on regaining some of that we generally lose whenever you do an acquisition. So as Johnny mentioned, we talk we meet every day and discuss it every day, watch where it's at. So I don't have a crystal ball either, just real pleased with the way our team has managed that challenge over the last four, five months, which has been interesting. Okay. That's really helpful. And then one, just to go back to the loan pipeline and the loan growth. And John, last quarter, you said some folks were flying in to see you that weren't able to get credit from their bigger banks. And we wanted to see how much of the growth or the pipeline was tied to stuff like that, maybe market share opportunities and if that might continue to be something that helps your loan growth going forward? Or if maybe you're going to pull back as well relative to the environment. This is Kevin. There was certainly some of that, and that particular deal hasn't actually materialized yet. But I mean, there are other things that were similar to that opportunities like we said, that other folks are on the sidelines for one reason or another, and we continue to do what we do. We've got money loan because of the way we manage through this last couple of years, and we will continue to do that, I mean, I think that's the reason we held off like we did is to be able to take advantage of the situation. Johnny said three years ago, rates were going up. And that's the way we manage it. And now we're in a position to be able to take this money and put it in good earning assets at a good rate We moved on that credit, pick it up that customer didn't do that big transaction. He will do. He will do lots of transactions. We built a relationship He said to all merry Christmas and happy New Year, and they're class people and he said, I'm impressed with your team and how quick you moved. It was a complicated credit and it went to Chris Poulton. He actually left here and went to see Chris in New York and Chris spent two or three days with him and ironed out the problems, and then we, Donna and I met him in Boston and Chris in Boston. And he said on will do business a matter of fact, KBW conference is coming up in Florida, and we're going to go down a day early or stay over a day line to go have dinner with him and meet some more of those people So that's going to turn out to be even though we didn't close that transaction, we didn't build it in will turn out to be a good long-term relationship. Your point is well taken. We picked up some of that business during this time that we'll build some relationships with as Tracy did in '08, '09, '10 and '11 with a lot of Florida borrowers there are still long-term customers with us. So we charge a little more, but they know that, but they know the money is good, and they get it done. They don't have to worry about where the loan gets funded or not or get funded properly. So we're half quarter - or 3/4 of higher and lots of instances, but that doesn't seem to bother the project - good question though I appreciate the question. Just Johnny, I wanted to circle back or I'm not sure who -- just on expenses. I know you talked a little bit about it last quarter and some things that were going on, but just kind of the run rate on expenses and just how you're thinking about that going forward here, just any changes or how we should think about that prospectively? Well, we had - we had a forensics team, and we spent millions of dollars with this forensic team on what happened to us in Texas. So you're seeing a lot of that in last some of that you saw last quarter, you saw a bunch of it in this quarter. So it is that will probably continue on the legal side for a while going forward. But most of the forensic is, I'd say, is pretty much done. What about you, Tracy? Yes, yes, they never get done. Okay. So anyway, that's where a lot of those expenses came from. The increased expense, you can see where - I don't know, $2 million or $3 million this quarter, I think, Brian? $5 million? Okay, $5 million, excuse me. So that will come down at some point in time, we'll be collecting a lot of money. Brian, this is Tracy, I think with the cost of everything that we're seeing out there in just the real world, you're going to have to have to expect there will be some cost is involved. Now we also I've said earlier in the call that I think we've got room for improvement in some of that too. So we'll constantly go to that. I think Brian work in his numbers and budget for next year, and it's going to be a little bit of an increase, but not anything significant. Well, Macro had to do a Go Fund Me deal for us several years ago. And I may have to get Michael to do another one now because we had - I don't drink Baileys I drink [indiscernible] and I want them to buy me a bottle of Carolines the other day that in order to play $22 or $23 and it was $36.50. And I said, "Are you sure you have the price right. And she said, yes. She said, it's correct. She said, drink it and enjoy, but drink it slow. Got you. And I guess just maybe one other one, just on the loan growth this quarter. Can you guys just - can you talk a little bit about now with the expansion in the Texas, maybe just how things played out. Can you give some kind of wrap up of the year as far as how Texas contributed, the growth that you started to see there? Is there some momentum? Or just how you expect that to continue relative to kind of the other parts of the footprint? Or just any commentary on how trends are there given kind of some of the issues that have occurred there? Well, we were treated a little rough in indiscernible], as you remember, and a lot of our some of our accounts left. We were forced to do some low-rate loans in those markets than we did. And I think I told everybody would use the strength of the Home's balance sheet to counteract whatever anybody was trying to do to us. So we- I kind of take this stuff personally. You probably didn't know that, but I kind of take it personally, and I don't give up So anyway, I think we've leveled out from that. I think Stephen Scouten or someone asking about at home will be find their grinders. And that's true. We don't stop. We don't give up. We work hard. We've got the power of Home's balance sheet. We need to use it. And the people that last went some bike there somewhere, and they can't find much. I don't know if they're out of money. I just heard that they're out of money and they can't fund anything and they're pull up, they loaned up. So I don't know if any of that's correct or not, but if it is, it probably is. And so it gives us some opportunity to go back and pick up some of - we're going back to some of those customers that were taken from us. We're going back to try to brand them back home. Some we're getting some were not. So just it was unforeseen. Very unprofessional and unfortunate. It was not done properly. Not that I can't go somewhere else to work, do where we want to work. It's just how you go about it Right. Are you starting to see the momentum in Texas kind of gradually pick up here? I guess that's kind of what I was getting at. Just as you kind of look to '23 and just kind of your outlook on kind of the loan growth in general for the company Well, the final quarter did really good. And Robert runs -- or [indiscernible] runs Central Florida, and he never slowed down. He never missed the- he never missed a step. He just kept rolling. So while we were trying to deal with West Texas Lubbock and what was the other place where it is, Also, what is plans we were - while we're dealing that stuff. I mean the Dallas-Fort Worth area never slowed down. They just kept moving and they kept growing. They did excellent. Adding a lot of those customers that were in love were Dallas customers that they've been signed is 1 loan officer went out to love he took them with him. And so they just brought them back home. So its they all those big customers, they saved all those big customers are never all of them. Got you. Okay, Perfect. And maybe just one last one for Stephen. Just going back to the margin permit, Stephen I guess is your thought-it sounds as though the margin is at least puts and takes as you look forward based on if you see a couple of more rate hikes here that it's probably flat to up a little bit in the near term and then maybe you see some decline thereafter? Or is that just in general, because looking over the next couple of quarters, how you're - what you're expecting there given some of the liquidity levels and putting that back to work? Yes I think mentioned just on the deposit side. I think our beta ran mid-50s or so in 04, where it was high 20s than 03. And so if we kind of get back to a little more normal levels on what we have to do on the deposit side, our forecast show we could have a little slight increase to it. But I think we'd be pleased with holding the line where we're at now. I mean I try to get arms length away from Johnny I don't think I'd be pleased where we're running right now. Most of my questions have been asked and answered, but just one last one. So you talked about the reserve coming down to about 2% now. I think if you look back a year, 1.5 years ago, your reserve was almost 2.5%. But it sounds like you're comfortable with the 2% level. Do you think that, that 2% level will be maintained here? It seems like if you're going to be able to grow loans and you guys have great asset quality, you could see reserve drift below that 25%. I think consensus has it drifted below 2%. But you're signaling it's a 2% kind of from here on out? Yes I think that's reasonable I think that's reasonable When we everybody in the country made due to the pandemic major big reserve moves, we made our big reserve move and who knew what was going to happen in the pandemic. So it's pretty shocking times. And we're going to maintain that reserves up in there. And I don't know - I actually thought we might take $20 million or $40 million put in reserve You got you see all the big banks thinking saying we've got a recession. We've got a recession, we've got a recession. There's going to be a stock market crash. All the naysayers are out there saying all the negative things and kind of makes you a little nervous and you wonder if you're doing the right thing. 2% enough or do we need to put more in there. We'll kind of follow it through the next quarter or two and see what we need to do. Well, I just had one question that was kind of more conceptual in nature. I think we're hearing a lot about pullback in commercial real estate and construction kind of especially, it seems like a lot of banks are really pulling back in some of those areas, just given caution, but you guys are in a really good fundamental position from a capital and a liquidity reserve standpoint, everything that's been kind of brought up today. I mean, do you see that as an opportunity for you guys to kind of gain some market share here? It sounds like, at least in Chris' group, when times are tough like this, this is an opportunity to grow. But just in the broader context of your business? I mean is this the time to actually maybe actually gain some market share and get a little bit more aggressive on the loan side? Or is it just some you would continue to be cautious and kind of stick to your underwriting guidelines that have voted so well for [indiscernible] I think whenever you have these situations, it is an opportunity. I mean all the things that we've done through the bank is during challenged times, it's turned out to be a great opportunity for us. And it's-to use- as Johnny, I think said, I heard about one of our customers. I mean they've elected to not do things. We probably would still have participated some with them they're going to put a lot of skin in the game. And speaking to all of our markets and regions, as Chris said earlier on his part to redeploy some of this capital that we're doing So we're looking at them. We get to see is just as many as we always have. Kevin, don't you Yes. I would answer to specifically answer your question, I don't think we have to give one other to get the other in this environment. I think we can continue to be conservative, and in some cases, even more conservative than we have been and still gain some of these market share clients that Johnny was talking about just a minute ago I think that's going to happen because of where we're at. Yes. It's been 1 guess we had money and they thought we were easy. They were not easy, as you know, but it has we saw what Tracy did in '08, 09 and 10 and Kevin, in our box-built relationship, and we're going to pull some through this big we'll put some big customers through this run There are no further questions at this time. I will pass it back over to the management team for any closing remarks I just want to say thank you to everyone, all the supporters of Home. It was trying times out there. I have to complement our management team and people in the field, the hard work that they put together and put together this great quarter I don't know if you could-I don't know I didn't say if I turn out these kind of numbers, probably somebody will turn out as good numbers or better, but I didn't see anybody turn out these kind of numbers yet. We're proud of our numbers We're proud of what we did in spite of all the problems and the difficulties we had getting there, we got it done, and we're set in a great position for 23. And our lenders are ready to roll Actually, our Dallas lenders wrapped up their year and early on working on 23 So overall, it's a great, great quarter, great year. I'm happy. I think we can get-I think we can run the run rate holds where it is, and we can get $100-plus million a quarter to run a 2% RDA incoming running at $440 million or so. Next year, I think that would be a great be good for all of us. So anyway, thank you and we'll talk to you in 90 days. This concludes the Home Bancshares, Inc. fourth quarter 2022 earnings call. Thank you for your participation. You may now disconnect your lines.
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EarningCall_1225
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Good day, ladies and gentlemen, and welcome to the Levi Strauss & Company Fourth Quarter and Fiscal Year-End Earnings Call for the Period Ending November 27, 2022. All parties will be in a listen-only mode until the question-and-answer session at which time instructions will follow. This conference call is being recorded and may not be reproduced in whole or in part without written permission from the company. This conference call is being broadcast over the Internet, and a replay of the webcast will be accessible for one quarter on the company's website, levistrauss.com. I would now like to turn the call over to Aida Orphan, Vice President of Investor Relations at Levi Strauss & Company. Thank you for joining us on the call today to discuss the results for our fourth fiscal quarter of 2022. Joining me on today's call are Chip Bergh, President and CEO of Levi Strauss; and Harmit Singh, our Chief Financial and Growth Officer. We have posted complete Q4 and full-year financial results in our earnings release on the IR section of our website, investors.levistrauss.com. The link to the webcast of today's conference call can also be found on our site. We'd also like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could materially differ from those contemplated by our forward-looking statements. Please review our filings with the SEC, in-particular, the Risk Factors section of the Annual Report on the Form 10-K that we filed today for the factors that could cause our results to differ. Also note that the forward-looking statements on this call are based on information available to us as of today and we assume no obligation to update any of these statements. During this call, we will discuss certain non-GAAP financial measures. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call, in its entirety, is being webcast on our IR website and a replay of this call will be available on the website shortly. Today's call is scheduled for one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed. Good afternoon, and thanks for joining us today. Q4 concluded a strong fiscal 2022 performance with the quarter delivering on the high-end of our expectations for both revenue and EPS. This was driven by strong growth internationally and in our direct-to-consumer business, which saw record quarter performances across U.S. DTC channels and positive comp sales across the Americas, Europe, and Asia. On a constant currency basis, Q4 net revenues were flat with the prior year's record Q4 revenue and we grew the business 6% above 2019âs pre-pandemic level. For the full-year, we delivered another year of strong growth. We grew reported revenues plus 7%, plus 12% in constant currency. We delivered strong market share growth globally. And despite facing a more challenging consumer environment in the second half, as well as currency headwinds, we grew adjusted EPS year-over-year by managing the factors within our control. We continue to diversify our business nearly 40% of our revenues came from outside of denim bottoms. We drove outsized growth on women's, tops, DTC, and international. We returned $350 million to shareholders, an 84% increase over prior year. And we chartered the course for sustainable, profitable long-term growth by introducing our new strategic plan and long-term financial targets. Let me go into more detail. Note that for the balance of our remarks, Harmit and I will reference revenue growth in constant currency. Starting with our brands, focusing first on Levi's. In 2022, the Levi's brand grew 11% and grew global market share more than any other denim brand for the second year in a row, led by share gains in both men's and women's. Levi's is bigger than the next three brands combined, reflecting market share gains for five out of the last six years. According to [Euromonitor] [ph], in 2022, the denim category grew low-single-digits globally, outpacing total apparel for the full-year and is projected to grow at a similar rate in 2023 and at a mid-single-digit CAGR over the next several years. With exciting initiatives planned through the year, including rolling out a robust and innovative product pipeline and a powerful brand marketing campaign, we remain well-positioned to continue to grow market share and drive category growth in the year ahead. Levi's brand equity remains very strong as evidenced by the 6% AUR increase and healthy 60% gross margin, which was up another 20 basis points in 2022. Another barometer for the health of the brand is the success of our iconic 501, which grew nearly 30% for the year. Looser fits remain on trend and grew double-digits this year, representing more than half of our total bottoms assortment for the year. And in 2023, we're celebrating the 150th anniversary of the iconic 501 jean. This will be anchored in a powerful multimedia brand campaign that launches next week during the GRAMMYs and will show up around the globe across TV, cinema, print, and digital. We also have an exciting lineup of exclusive collaboration drops and continued product freshness and innovation hitting stores across the world throughout the year. Turning to our direct-to-consumer business, we made excellent progress in growing our global DTC business, which was up 18% for the year, driven by a 19% increase in our owned and operated stores and a high-single-digit increase in e-commerce. Combined DTC delivered solid mid-single-digit growth in Q4, plus 10% growth, excluding Russia and comprised 39% total company net revenues, a fourth quarter record. In both Q4 and throughout the year, we generated solid comp store sales growth, while expanding our footprint with our global rollout of 136 NextGen stores. In the U.S., our DTC business broke a Q4 record with mainline and outlet stores and e-commerce each delivering record revenue. We continue to see strong momentum in traffic across our fleet, as well as strength in AURs, which increased high-single-digits versus last year. We opened 11 mainline stores in the U.S. in Q4 alone bringing total U.S. mainline doors to 66. Early results are very encouraging with most of them exceeding revenue and profitability expectations since their opening. And we have a great pipeline of mainline doors coming in 2023, including Nashville, Honolulu, and Miami. During the year, we grew our base of loyalty consumers to nearly 23 million, representing an almost 50% increase over last year. And our app is now up in 18 countries across the U.S., Europe, and India. As we look to the year ahead, we're investing in capabilities and talent to drive sustainable profitable long-term growth in our digital business. Last week, we announced hiring our new Chief Digital Officer. Jason Gowans joins us in early February from Nordstrom, where he was most recently SVP of Digital Commerce. Jason will focus on bringing together our engineering data AI and digital product management to spearhead our digital efforts for both e-commerce and our digital go to market. We also made progress in wholesale. For the year, our total global wholesale business grew 9% and is more elevated and digitally oriented. In the quarter, against a 20% comp a year ago, global wholesale was down 4%, largely because we were unable to fulfill approximately $40 million in orders due to capacity challenges at our U.S. DCs. Still within wholesale, we saw bright spots, particularly our Levi's women's business at our Top 10 accounts, which grew mid-single-digits, compared to the prior year. As we move into 2023, we are encouraged by healthier inventories in the channel and the work we have done to improve our own inventory dynamics and actions to improve capacity at our U.S. DCs. Finally, we also achieved substantial progress on our diversification strategy. Nearly 40% of our 2022 revenue was beyond denim bottoms, including chinos, active leggings, tops, dresses, footwear, and accessories. These businesses grew 10% in 2022 and we expected sales penetration to continue to grow meaningfully over the coming years. Expanding our women's and tops businesses is a key priority in our strategic plan. And in 2022, we drove double-digit growth in each category. Total company women's revenue grew 13% surpassing $2 billion and our tops business grew 12%, exceeding $1.2 billion for the year. We're expanding our offerings in both women's and tops and believe these areas still represent meaningful upside. International diversification is also a key strength in these times of macro uncertainty and international now represents 53% of our total business. In 2022, our international business grew 13%, 15% excluding Russia, even as we navigated a more challenging consumer environment in Europe and lockdowns in China. This was driven by broad-based growth in Latin America, Asia, and Europe, excluding Russia. The Dockers and Beyond Yoga businesses are also becoming growth drivers with long runways that expand our addressable market opportunity. For the year, Dockers grew 27%, driven by broad-based double-digit growth across all geographies and nearly doubled EBIT. Revenue continues to shift to a healthier mix with nearly half of sales now coming from outside the U.S. and about a third in DTC. 2022 was the year of integration for Beyond Yoga, and we're pleased with its $100 million revenue contribution. In Q4, we opened Beyond Yoga's first two brick and mortar stores giving the brand an opportunity to showcase its full category offering. Approximately 50% of their sales are from customers new to the brand, and we believe brick and mortar will be a powerful catalyst for the brand. As we look forward to 2023, we have a lot to be excited about. We are the undisputed leader in the denim category and are driving its growth. Our brands are stronger than ever, resonating in the marketplace and driving strong AURs. We have exciting initiatives planned to continue to capture market share, and on top of our continued DTC momentum, we are driving even more excitement with the 150th anniversary of our most iconic product for 501. Finally, I'm excited about the future leadership of this company. Michelle Gass, joined us as President earlier this month and she has hit the ground running. Michelle brings deep omni-retail experience and strong brand building skills. As President Michelle is responsible for the Levi's brand and the global commercial organization, which includes all go-to-market wholesale franchise retail and e-commerce. She effectively has about 85% of the company's P&L and though it's only been three weeks, she's already making a difference. She and I have a well mapped out transition plan and I'm confident she will become our next CEO within the next 18 months. I'm also pleased to share that Harmitâs role is expanding the Chief Financial and Growth Officer. You all know that Harmit and I have had a great working relationship and I cannot understate the role that he has played as my partner these last 10 years in turning the company around, taking it public, instilling financial discipline, and driving accelerated profitable growth. In this expanded role, Harmit will assume additional responsibilities for strategy and retail real estate. I'm certain with the expansion of this role, he will continue to be a key partner for me and Michelle in steering the company to our long-term goals. Thanks, Chip. I'm both humbled and excited to be taking on the new role given the tremendous opportunity for our portfolio brand. I remain committed to this company and delivering on our long-term plan and working with you and Michelle to deliver for our stakeholders. Before I walk you through our Q4 results and the outlook for 2023, let me start with three key points. First, we delivered a solid quarter with net revenues in-line with prior year. Highlighted by continued strength in our direct-to-consumer business. This quarter's performance reflects the benefits of the diversification of our business as our success internationally in Asia and Latin America was sustained incredible momentum in Q4, demonstrating the power of the Levi's brand around the world and helping offset declines in U.S. wholesale and Europe largely driven by Russia. Second, the steps we have taken to emerge stronger from the pandemic have substantially improved the structural economies of our business, enabling us to deliver gross margin for the year 380 basis points ahead of 2019 and adjusted EBIT margin, excluding foreign exchange of 12%. We have positive momentum entering 2023. Our global direct-to-consumer business is delivering strong growth, accelerating through the holidays, and positioning us to drive further revenue acceleration in the channel. Europe exited December with positive constant currency growth, which was broad-based across major markets. And we also expect to benefit from several tailwinds, especially in the second half, including improved commodity costs, foreign exchange, and the continued benefit of cost initiatives we have implemented. I will now walk you through the progress we achieved in Q4, then what that positive momentum means for 2023. Net revenue was in-line with the prior year, driven by strong growth in our DTC business. Our international business was up 3%, offset by a mid-single-digit decline in the U.S., which was primarily due to supply chain challenges impacting U.S. wholesale. Our DTC channel net revenue grew by 6%, driven by positive comp sales growth across all segments, including in the U.S. and Europe. Traffic, AURs, and UPTs, all grew on a global basis. And despite consumers returning to our stores in large numbers, our e-commerce business grew 5%. Adjusted gross margin in reported dollars was 55.8%, up 150 basis points versus 2019, but contracting 230 basis points year-over-year, partially due to an approximate 100 basis points unfavorable currency exchange rate impact. Price increases and a favorable channel mix, partially offset the impact of higher product costs and lower full price sales. The decline in gross margin was greater than our guidance owing primarily to the impact of foreign currency and lower full price sales than we anticipated. Moving to SG&A, adjusted SG&A expenses in the quarter was 745 million, down 4% from last year as we remain laser focused on controlling costs, while continuing to invest selectively for the long-term. Adjusted EBIT margin was 9% contracting 300 basis points on a reported basis and 210 basis points on a constant currency basis. Adjusted diluted EPS was $0.34 at the high-end of our Q4 outlook, despite a $0.04 negative impact from foreign exchange. I'll now take you through key highlights by segment. In the Americas, net revenues declined 5%, a strong growth in DTC and double-digit growth in wholesale in Canada and Latin America was offset by a decline in U.S. wholesale. DTC growth of 8% was driven by positive store comps in the U.S., Canada, and Latin America and e-commerce, as well as the addition of new stores. Overall, Canada was up mid-single-digit and Latin America grew 15%, driven in-part by strong growth in our second largest market, Mexico. Europe outperformed our expectations down modestly at 4%, excluding Russia, on top of 17% growth in the prior year. Overall, Europe's Q4 revenues saw a sequential improvement relative to Q3, primarily driven by DTC and the strength in our core bottoms business. DTC was up 3%, excluding Russia and we experienced momentum in key markets like the U.K., Germany, and Spain entering Q1 2023. In Asia, net revenues were up 17%, reflecting sustained broad-based growth across most markets led by India, ANZ, and Indonesia. DTC revenue growth of 17% was driven by strong comp performance in company-operated stores and wholesale also grew 16%. Our successful pricing actions also delivered double-digit AUR growth in the quarter. Overall, operating margin also expanded over 600 basis points to 11.4%. Turning to balance sheet and cash flow. As we discussed throughout last year, we have strategically built inventory ahead of our U.S. ERP implementation in the first half. Reported inventories increased 58% on a dollar basis over prior year, in-line with a plan. If you exclude the ERP build and goods in-transit, the increase is approximately 35%. The bulk of the increase was in core products, which can be sold across multiple future season and represents more than two-thirds of total inventories. We are confident that Q4 inventory growth will be the high point and have [managed buys] [ph] down for the first half of 2023 by 25%. With the ERP preparation on the way, we expect to bring inventory back to normal levels by the end of Q2, which will provide a working capital tailwind in the second half. Cash and liquidity remained strong with the end of quarter net debt of approximately 500 million and overall liquidity of 1.5 billion. Our leverage ratio remained at 1.1x. Owing to investments in inventory, adjusted free cash flow was approximately negative 53 million in the fourth quarter. We remain committed to returning capital to shareholders and in the fourth quarter we returned approximately 82 million bringing our [2022] [ph] total return to 350 million. In Q1, the company declared a dividend of $0.12 per share in-line with last quarter and we currently have approximately 700 million remaining under our share repurchase program, which has no expiration date. Before turning to our outlook for the year, I will touch on our holiday performance. DTC momentum continued through the holiday period of November and December, up almost 10% versus prior year. Growth accelerated sequentially from November into December. This reflects the continuing strength of the Levi's brand generating strong results across the globe, led by continued strength in brick and mortar, including in the U.S. And despite operating in a largely promotional marketplace, during the November, December period, gross margin remained robust almost 200 basis points ahead of 2019. Now, let's turn to our fiscal 2023 outlook. As we look forward, we are confident in our strategies and continue to expect profitable growth in 2023. That said, we acknowledge there's still a lot of macro uncertainties and have assumed caution in our outlook. We do however expect additional tailwinds in the second half as we lap higher product costs and the stronger dollar. For fiscal 2023, we expect net revenues between 6.3 billion and 6.4 billion reflecting reported revenue growth of 1.5% to 3% year-over-year, inclusive of 200 basis points of headwind split evenly from foreign exchange and the suspension of our business operations in Russia. In reported dollars, we expect low-single-digit growth in the Americas and Europe, excluding Russia, and mid-single-digit growth in Asia. This includes a negative 100 basis points of FX impact in Europe and 500 basis points in Asia. For gross margin, we anticipate expansion of 20 basis point to 30 basis points driven by the favorable accelerated shift of our business towards DTC, Digital, Women's, and International. Our SG&A rate is expected to deleverage 40 basis point to 50 basis points, due to continued strategic investments to set us up for future growth yet remaining disciplined on expenses. Overall, we expect adjusted EBIT margin to be down 10 basis points to 30 basis points versus 2022. We expect interest expense to normalize to approximately 15 million a quarter, due to not benefiting from deferred comp interest as we did in 2022 and a full-year tax rate in the mid-to-high teens. Adjusted diluted EPS is expected to be in the range of $1.30 to $1.40. We continue to invest behind high ROI growth initiatives. Uses of capital in 2020 include full-year CapEx of around 218 million. We expect cash flow to be positive as inventories normalizes in H2. In terms of DTC brick and mortar, we anticipate opening more than 80 net new company operated stores globally. In the U.S., we plan to open around 15 full priced Levi's NextGen doors in 2023, taking our mainline door count to approximately 80 by the end of the year as we progress towards the goal of opening 100 full price doors in the U.S. I will now share some color on H1 versus H2, and then some H1 quarterly detail, given the ERP implementation taking place in the U.S. in the second quarter following successful implementation in Canada and Mexico. Our guidance assumes that our business will strengthen in H2 versus H1, given more difficult compares in H1, as well as continued headwinds from foreign exchange and higher product costs. Therefore, we expect reported revenues in H1 to be down low-to-mid single-digits compared to prior year. We expected headwinds to moderate in H2 and reported revenues to increase high-single-digits. Given the 150th anniversary kicking-off in late Q1, we expect advertising as a percentage of revenues to be higher in H1 than a year ago by 40 basis points with no change on a full-year basis. As we advance wholesale orders prior to the ERP implementation, we expect revenues to increase low-single-digits for Q1. Q1 gross margin is expected to be down at least 200 basis points. Conversely for Q2, we expect revenues to be down high-single-digits due to the shift in sales to Q1. Q2 gross margin is expected to be slightly up due to a more favorable mix with higher DTC penetration. Before I turn it over for Q&A, I want to leave you with three key points. Our market share expansion, the diversity of our business, and December exit rates bolster our confidence in our ability to continue to deliver profitable growth in 2023. The investments we have made in DTC are driving strong and sustainable performance. We will continue to strategically invest in growing our store base, ensuring we drive comp sales growth, and accelerate e-commerce. Finally, our commitment to our long-term growth goals and strategy is unwavering. Although 2023 will be impacted by the softer macro environment, the underlying momentum in our business and strength of our brands gives us confidence in our ability to deliver on a growth algorithm beyond 2023. No, well deserved. Question here, Harmit is on gross margins. There's a lot of debate out there. If you think about â if compare your gross margins relative to 2019, they're up 400 basis points. Harmit, I think during the pandemic, in 2021, you talked about three quarters of that is more structural and then maybe 100 basis points is just the lack of [promos] [ph]. We did see the promos kick-in, in this fourth quarter. How do we â is that still the framework that we should think about going forward? And then maybe just clicking down on 2023 guidance, this gross margin of 20 bps to 30 bps, can you, kind of maybe walk through like how much is ocean freight recapture, commodities offset by increased promotions? Sure. Good question, Laurent. So, to your point, when we started 2022, we had anticipated gross margin accretion three-fourth structure, fourth potentially giving way to higher promotions. I think as we ended the year, the variables were broadly similar, but I think slightly different. So, I think what probably happened, the accretion is largely structural. We had further promotion. I said, it was â second half got a little bit more promotional. So, the 100 probably â I'm just thinking aloud here, itâs probably 150. We also got foreign exchange headwinds in the second half, which was different to what we anticipated. Now, as you know, we do hedge, but we don't hedge every currency. And so, that was probably the third element that got introduced. But given the diverse nature of our business, I think we ended the year structurally from a gross margin perspective, a lot better and a lot stronger company. So, you think about 2023 and our gross margin guidance that I gave, I'd say, primarily driven by structural improvements, higher DTC is growing at a fast pace. I think our DTC business in 2023 is going to grow at low double-digit. International definitely helping, and where we are really focused on is growing women's, which is accretive to gross margin going beyond yoga, which is accretive to gross margin. So, those are things that are structurally helping. In terms of a couple of other changes that I think happened, yes, we do get some tailwind from ocean freight and air freight. As the year progresses, FX probably helps us in the second half versus the first half. The first half FX is going to be a bit of a headwind. And we're assuming probably 50 basis points for the year higher dilution relative to 2022. So, we are being a little conservative. Largely, our view is probably is the first half versus the second half. So, that's how one is thinking through it. The real growth is really going to come from structural improvements in a very diversified business. That's very helpful. And if I could quickly sneak one more in. Harmit, Chip, I think you've talked about mass channel, I think that was a source of pressure. Just curious to know how it performed in the fourth quarter U.S. mass? And how do we think about that going forward into 2023? Yes. So, our mass channel, which is really Signature and Denizen was down, I think 19% in Q4. As we are planning the next year, we are planning this down double-digit. So, if you think about global wholesale being down 4%, half of that was probably the mass channel, half of that was Red Tab. And if you think of the fact that we were not able to fulfill $35 million, $45 million that would say, global wholesale would like to be a positive. So, the brand is really doing well. The other only point I would make, Laurent is, as we get into January and exit December, we are seeing sell-through rates in U.S. wholesale actually turn positive, which is I think a good sign. Harmit, congratulations on the expanded role from me as well. And Chip, congratulations on bringing in Michelle Gass. I think she's going to be great. I guess a couple of questions that I have â sorry, a couple of questions I have. On the â as you look at the year in terms of the year forward, just the revenue cadence that you expect, I don't know if you could maybe give us a little more color on that and the confidence around that piece? And then, Chip, the category growth that you assume for denim, I don't know if we could talk about that? And then I do have a denim question for you afterwards as well. Okay. So, let me get the tough question, but I'm glad you asked it, Bob, which is the first half, second half. The way we're thinking about the year folks is, we're thinking about is the tail of two halves. Where the first half is weaker than the second half. A tale of two channels, direct-to-consumer strong; wholesale, kind of flattish, and a tale of two worlds; you know The Western world probably growing low-single-digit, and Eastern world, which is Asia and Latin America going low-double-digit. It's great to have a business that's so diversified. Thinking about revenue and to your point, because one would think, okay, this is a bit of a hockey stick, actually it's not. If you think about the cadence of the first half and the second half, the normal cadence is 47% of our total revenue is in the first half, and 53% in the second half. Last year, we saw real strong growth in the first half. We were up 19%, 20%. Second half was flat. So, last year is more 50-50. And so, as you think about 2023, it's a 47 in the first half, 53 in the second half. That's one way of looking at it. The other way of looking at it is, how does it relate to 2019? If 2019 is what we call a good base. If you think of the first half, our guidance assumes that we grow first half to 2019, about 8% reported dollars and the second half of about 10%. So, the real pickup is about 2 points or 3 points of growth and that's driven by couple of things. One, FX headwind doesn't remain. And second, just acceleration of the macro â improvement, slight improvement macroeconomic condition, but we're not necessarily â it's not a hockey stick and we're not banking a lot. We haven't built in any upside from China with a smaller business and any major consumer demand swing, if that happens, it's great. On the denim market trends that you asked about, Bob, I'll stay real high level here, but globally, Euromonitor data, this is Euromonitor data, globally, the denim category grew low-single-digit in 2022. That was actually ahead of total apparel, which was down low-single-digits. And you know, on that basis, actually on a â that's a calendar 2022 basis. And for calendar 2022, the Levi's brand was up 11%. So, we did grow share last year, again based on Euromonitor data we grew more share than any other player in the category. We grew share on men's. We grew share on women's. It's also worth noting that we have grown share five of the last six years. So, we consistently grow market share. And as the biggest brand in the category, you guys have heard me say this before, we feel a certain obligation to grow the category and part of how we do that is to grow share in the category. So, specific to the U.S. because we shared some U.S. data from NPD on the last call, the U.S. does remain pretty soft. It hasn't gotten any worse from the prior quarter. We're seeing it. It's largely a wholesale phenomenon. Harmit has taken you through the numbers on our own direct-to-consumer business and our U.S. DTC business was also very, very strong for the quarter. So, we're in control of the brand. We're growing. We're building share. The biggest challenge has been the wholesale dynamic here in the U.S. As we look forward into fiscal or into calendar 2023, the outlook from Euromonitor is for a continuation of, kind of low-single-digit category growth and we're confident, it's kind of in the range of where we've got our revenue outlook, kind of in-line with our full-year guidance. And as I said, if you go back even pre-IPO for a 5, 6 year period of time, the category was growing, kind of low-single-digits and we put up 6% compound growth rates during that period of time. So, we've consistently outgrown the category and that by the way was during a period of time when both Dockers was a drag and we didn't have Beyond Yoga. So, we're really confident that we're going to be able to put good numbers on the board even if the category continues stay a little bit soft in our biggest market, the U.S. There are pockets of growth in the category as well. As Harmit said, we're seeing good growth in Asia and in Latin America. So, the benefit of having a really diversified business whether that's geographically or from a product standpoint really matters. And that's part of how we've been able to get through it. So, hope that answers your question. That does. And Chip, if I could just jump in with two more quick oneâs for you? Are skinny jeans over, you're talking about the success of the loose fits and are rises going up or down, just curious from the trends perspective? Thatâs a good question. So, a little fun fact, our top two women's items were the 311 and the 721 and they're both skinny jeans. So, the news, as Mark Twain once said, the news of my death has been greatly exaggerated. I've been known to say skinny jeans will never die. Having said that, the looser jeans are still a thing. They're definitely the trend. Half of our revenues on bottoms this past quarter came from the looser, baggier fits, but our Top 2 women's bottoms items were the 311 and the 721. So, the skinny jean has not gone anywhere anytime soon. [Rises] [ph], for a long time, we were marching the rises up. We have the rib cage, you may remember, about 18 months ago that was the look back then, rises are now coming down. And we're not quite to hit [indiscernible] territory yet, but the mid-rise jean is, kind of the hottest item right now. And I think we're going to continue to see the shift from high-to-mid and maybe even mid-to-lower rises as we go forward. Thank you for that question. Great. Thanks. So, maybe two things. Chip, could you speak to pricing power for the brand into next year? And also the overall health that you see for the brand in Europe today? And then maybe Harmit, could you just outline the fundamental drivers as we think about over the course of the next year and more so the back half of the year, what level of visibility you have in the improvement in top line as we think about the back half? Yes. So, let me just talk to the pricing power of the brand. One of my favorite sayings is, you know a brand has good brand strength when you don't have to hold the prayer meeting to take pricing. We've taken pricing over the last 18 months to 24 months. Our AURs were up 6% for the year and that was driven fundamentally by pricing. You see it in our gross margins. Our gross margins are up nearly 400 basis points from 2019. The Leviâs brand itself, gross margins are over 60% and we grew gross margins by about 20 basis points and we were able to build share through all of that. So, the brand equity as we measure it, we measure very detailed every quarter in our Top 10 markets around the world. Our equity remains really, really strong. We're not seeing any slippage as a result of pricing. And in fact, in some markets, we own the equity for worth the money I pay for it. So, the brand continues to deliver a really strong value. In Europe, Europe revenues were down 4% in constant currency. If you exclude Russia, it was down 8% overall, but Russia was 4 points of that. The good news is, we did see sequential improvement from Q3, driven primarily by DTC and strengthen our core bottoms business. And even through the holidays, December was positive for Europe. So, we're â it's still challenging there. I don't want to mislead anybody, but we're very, very confident in the strength of the brand there. The consumer will ultimately come back and we're seeing good broad-based growth across markets like the UK and Germany. So, we have embedded a little bit of caution in our outlook relative to Europe, just reflecting the challenging consumer environment there, but it's not because we're seeing any slippage in the strength of the brand or the equity of the brand and pricing seems to be holding up there. And Matt, to your question on the fundamental drivers, we are going to very soon celebrate the 150 anniversary for what changed everything in denim, which is the 501. And so, and we're spending money against it. It's been growing at a [indiscernible]. So, I think that's going to be, fundamentally drive the category as well as our Levi's business. I think the other key drivers I talked about direct-to-consumer expected to grow double-digit. Women's and tops, we continue to accelerate growth. Tops are expected to be low-double-digit, women's growth high-single-digit. And then you think of the other brands that for a long-time, a, Beyond Yoga didnât exist and Dockers was a drag, I think expected to both grow a double-digit from that perspective. And as you know, through the year, supply chain, we've had supply chain challenges. Weâve not been able to fulfill demand. We think that becomes a bit of a tailwind in the second half. So that's overall the revenue growth and expectation geographically. Asia, Latin America, low double-digit, the U.S. and Europe, which as Chip said, is exiting positively in December growing low-single-digits. So, that's what we're thinking about it. We haven't built in any dramatic change in China. It's too early and it's a small piece of our business. And so, that's how one is thinking through it. In terms of the P&L, cotton headwind in H1, but a tailwind in H2 because we're just locking in purchases for H2 and cotton is back to about $0.80, so that should help. Hi. This is Jay. I donât know if you can hear me, but if you can, my question is on SG&A. And it looks like SG&A dollar is about, down about 30 million year-over-year in the trend in terms of the growth rates improving. Harmit, can you just talk about the source of the SG&A savings and how you think about the opportunity to continue to stay laser focused on costs as we get into the first half and then the second half of the year? Thank you. Sure, Jay. As you've seen both during the pandemic and when things turn tough in the second half, we went after controllable costs big time. And our focus on controllable cost starts with discretionary expenses. We slowed down hiring. We have slowed down hiring [423] [ph] through the year. Just being cautious. We are hiring where it matters. We talked about the Chief Digital Officer, Michelle coming on board. So, in areas where we think we can accelerate growth, we are still doing what is right, which is getting the right people, but generally across the board, hiring has slowed down. In terms of â and that's what led to Q4 SG&A being down year-over-year. The guidance reflects SG&A as a percentage going up, but that is largely driven by the volume deleverage. We're growing [1.5%] [ph] next year as against growth algorithm of 6% to 8%. And so, we're keeping a fair focus on discretionary costs and keeping it low from that perspective. I think where you are going to see a little bit of spend is really in the opening of stores. We're talking about 80 net doors, and growing e-commerce. And then first half, second half, I talked about spending a little bit more in advertising, but keeping the full-year as a percentage constant. Okay. Thank you. And then maybe if I can ask one quick one. On the EPS guidance for the year, is there any buyback contemplated in that guidance? Yes. There is â we're going to start slow, but there is buyback contemplated as it will spread through the year as against happening on day one. We've got probably a center to from an EPS perspective, not a lot. Thanks. Great job on the market share this quarter. A couple of quick follow-ups. Maybe you could dive in a little bit deeper on inventory. What gives you the confidence that you're going to get that down to a level where you're comfortable by the second half? And also, what is the ERP? Can we talk a little bit more about what the ERP implementation enables for you guys to do with your inventory? And then also any peaks on the [150th 501] [ph] product initiatives, you're going to do a lot of marketing around that, but are there some new product initiatives around the 501 that we can look forward to as well? Thanks. Hi, Omar. I think Iâll answer the first two questions, inventory. So, inventory up 58%, if you exclude the build-up for the ERP and the early receipts, it's up 35. It's the thing that we did very quickly early on is we cut the buys for the first half and they're down 25%. And so, I think that's in an essential part of what we think gets us to normalize inventory levels by the end of Q2. The other piece is our inventory is generally healthy, a large chunk, especially the stuff you build for the ERP has â is largely a stuff that we can sell through multiple season. The only other fact, I think that's important to note, the buildup of the inventory for ERP, which is largely oriented to U.S. wholesale customers, we have the orders for most of that. So, that just flows through, and so those are the things that make us believe that we can get inventory back to normal levels by the end of Q2. To your question about the ERP. And as you know, a lot of retailers are upgrading the ERP. The old ERP, the SAP ERP was really something that was built for wholesale companies or brands. As the model evolved into more a DTC model, the new ERP actually provides from an operational perspective, lot of visibility and how that is run. The one we are implementing is on the cloud. The big change in the ERP and what we're seeing in Canada, Mexico, because I tell people it's not a technological solution, it actually has to lead to some real change in the business. It's really access to data and data on a real time basis. So, our commercial people, our operations people get access to data and they can then leverage the data to actually drive business. I mean, I haven't modeled all that in our algorithm, but those are the benefits we are really seeing. Inventory management gets a lot better and handling direct-to-consumer gets a lot better. I'll take the 501 just real quickly. We have a year-long plan, kind of mapped out with product marketing. It's very, very holistic. We're going to bring product freshness and innovation. We're going to pay homage to a number of items right out of the archives. So, just to give you a flavor of some of those, we're going to do several limited edition drops. One of them includes, kind of what the original 1873 XX Waist Overalls, which was the very [first pair of] [ph] Levi's Blue Jeans ever sold. We're going to be doing, kind of reincarnations of those. That's going to be out there. We're launching the Men's 501 1954 jean, the Women's 501, the Original Women's 501, which launched in 1981 on both Vintage fits and 100% cotton. The [1954 501] [ph] is really trend right for right now. It's amazing. The 1981 women's jean was the first women's 501. We've also got some innovative 501âs that we're going to launch. We've got a plant-based 501 that is real sustainability, ecologically minded approach to the 501, which is comprised of 97% plant based and bio-based inputs. It's died in plant-based Indigo. You all have probably picked up the news that we've made an investment in Stony Creek Colors and that's with also with a 100% organic cotton made at Cone Mills, which is our oldest denim partner. So, just a lot of good stuff there. From a marketing standpoint, lots of center of culture stuff, music events. We've got a deep partnership with Rolling Loud. Celebrities influencers, advertising kicks-off at the GRAMMYs next weekend or following weekend, I'm really excited about the ads, you know more on that in a little bit, but we're putting all of our marketing muscle behind the 501 and celebrating the 150th. And everybody's got a great 501 story to tell. Thank you. Good afternoon. As you think about AUR for this upcoming fiscal year, how you're planning AUR go forward? And imbedded within the gross margin, how are you thinking about promotions versus within the channels, DTC and wholesale? Just one last thing, Chip you had talked in the past about wholesale accounts, whether it's a target or the others, what are you seeing in terms of order trends from the wholesale accounts? And how are you planning it? Thank you. Yes. So, in terms of â Dana, in terms of AURs, we're not planning any major price increase. So, the AUR, so if you think about revenue growth, think about revenue growth being equally balanced between AUR and unit volume, for the AUR driven by mix more than pricing. If your question about promotion and dilution, I talked about a 50 basis points full-year impact higher in the first half, much less in the second half. And most of that is largely wholesale versus direct-to-consumer. We did some smart promotions and in our own direct-to-consumer business and is really resonating in terms of driving traffic. That's what driving traffic in our comp sales that I talked about. Yes, what I would say on the wholesale trends is, right now, our assessment of wholesale inventories is that they're pretty clean and back to, kind of normal levels. And as we alluded to in the prepared remarks and also during the Q&A, we're seeing sell-through trends strengthen over the last couple of weeks in wholesale and that should bode well for replenishment orders. The other big thing that we got coming up here as Harmit has talked about in the U.S. is the ERP implementation, which is going to have a dynamic between the second quarter and the first quarter. As we shift customers ahead of the ERP conversion where we have to take the distribution centers down for a couple of weeks. And so that will have a dynamic between the first quarter and the second quarter. Hey, thanks everyone. Harmit, congrats as well. I guess, I'll just go back to the inventory. I guess, Harmit, I'm not trying to [nitpick] [ph], but you're saying now that with the inventory of [58%] [ph] everything is in line with your expectations. And by Q2, you're expecting inventory to revert back to, I guess normal. On the last call, you said you expected inventory to revert back to in-line with sales growth in Q2. You're guiding sales growth down in 2Q. I'm assuming that's not where you're expecting inventory to go. So, it just seems like something is a little bit different than three months ago on inventory. I'm trying to just figure out exactly if you could elaborate a little bit more on the pacing of inventory or if there's anything that's kind of changed a little bit, it'd be helpful to understand? I mean, we're just being cautious Ike, given the macro environment. And so, nothing dramatically changed. Everybody is worried about holiday. Holiday for us is actually quite decent. And as I mentioned earlier, most of the inventory that has been built is inventory that's core, passes through season-to-season. And that's why I think, you know in our reflection of getting to normal levels by the end of Q2 is how we're thinking about it. All right. I guess we will wrap it there. Thank you all for dialing in. It's been a pleasure talking to you and we look forward to speaking with you again at the end of our first quarter of fiscal 2023. Take care. Thanks.
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EarningCall_1226
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Greetings, ladies and gentlemen, and welcome to the Cullen/Frost Bankers Inc. Fourth Quarter Earnings Conference Call. At this time, all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. Please go ahead. This morning's conference call will be led by Phil Green, Chairman and CEO and Jerry Salinas, Group Executive Vice President and CFO. Before I turn the call over to Phil and Jerry, I need to take a moment to address the Safe Harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend such statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 as amended. Please see the last page of text in this morning's earnings release for additional information about the risk factors associated with these forward-looking statements. If needed, A copy of the release is available on our website or by calling the Investor Relations department at 210-220-5234. Today, I'll review the fourth quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will provide additional comments before we open it up for your questions. Well, in the fourth quarter, Cullen/Frost earned $189.5 million or $2.91 a share compared with earnings of $99.4 million or $1.54 a share reported in the same quarter of last year. That represented an increase of 90%. You don't get to say that very often. Our return on average assets and average common equity in the fourth quarter were 1.44% and 27.16%, respectively, that compares with 0.81% and 9.26% for the same period last year. These are very strong results and along with our strategy of sustainable organic growth, they position us well heading into 2023. Now taking a closer look at the quarter, loan growth was solid and above our long-term expectation of high single-digit annual growth, average loans, excluding PPP in the fourth quarter were just over $17 billion compared with average loans of $15.4 billion in the fourth quarter of 2021, an increase of 10.6%. For the full year 2022 average total loans, excluding PPP were up 11.3%. Our growth in loan balances for the fourth quarter versus the third quarter represented approximately 2/3rds C&I growth and 1/3rd consumer. CRE balances were basically flat. We booked $2.2 billion in new commercial commitments in the fourth quarter, and this is up by a non-annualized 9% from the third quarter and demonstrated our staff success from our calling and prospecting efforts earlier in the year. That said, I believe it's clear that the Fed's program of interest rate increases is having an impact on economic activity, especially in the commercial real estate sector as more borrowers evaluate the impact of the current environment on their projects. For example, I think it's interesting to look at our weighted 90-day pipeline at year-end. It's down 14% from the previous quarter. However, the prospect component of that pipeline is up 19%, while the customer segment of that pipeline is down 32%. So as we continue to see potential deals come in from prospects as our strong available liquidity and our consistent underwriting shine through, our current customer base reflects the overall softening of the commercial real estate market. Average deposits in the fourth quarter were $44.8 billion, an increase of more than 9% compared with the $41 billion in the fourth quarter of last year. And for the full year 2022, average total deposits were $44.6 billion, up 15.9% over 2021, and Jerry will talk more about recent deposit trends in his comments. We continue to see great growth in our consumer banking business. Average consumer loans were $2.3 billion in the fourth quarter, up by 22.6% over the fourth quarter last year. This is primarily from our consumer real estate products of HELOC, home equity and home improvement. The outlook for these loans continues to be good and credit strong. In fact, the consumer loan growth in 2022 was 283% of our previous best year. The sharp increase in mortgage rates created the perfect environment for our secured consumer real estate loans, such as home improvement, home equity and HELOC. Credit quality is outstanding in this portfolio, and our average credit score is 754. I'm also pleased that we recently began funding loans in our mortgage program. Our team has created a new mortgage loan process from the ground up to originate and service mortgage loans and keeping with the Frost philosophy, and we've created a great digital and mobile experience around it. Once we complete this pilot program, we'll roll out mortgage lending to customers on a or limited basis with the goal of opening it up to everyone later this year. Growth in new households continues. For the year, we added almost 26,000 new households, about 6.6% higher than the number of customers we had at the end of last year. While we believe this represents best-in-class organic growth, it was down slightly from last year's all-time high of almost 27,000 customers, and that's related to the lower net number of branches that we opened in 2021. Given the increase in opening since then, we expect to achieve all-time high number of new customers in 2023. In addition, our across wealth advisers has seen a record amount of new business. Regarding our branch expansion efforts, the original 25 Houston expansion branches have surpassed $1 billion of deposits, and they continue to exceed pro formas. Loans totaled $727 million at year-end, including the additional branches we've opened in what we call Houston Expansion 2.0. At year-end, we stood at 114% of our household goal 170% of our loan goal and 104% of our deposit goals, and we'll continue to add new locations in strong areas around the region. In Dallas, we are very encouraged by the early results of the new sites, which are doing even better than what Houston had achieved in the same time frame, 229% of the new household goal, 275% of loan goal and 372% of our deposit goal. We added new financial centers at a rapid pace in the fourth quarter and soon, we'll be up to 13 locations under the program. Overall, credit quality remains good. Problem loans, which we define as risk grade 10 and higher, totaled $322 million at the end of the fourth quarter compared with $387 million at the end of the previous quarter and $691 million a year ago. We reported a $3 million of credit loss expense in the fourth quarter. Net charge-offs for the fourth quarter were $3.8 million compared with $2.8 million in the fourth quarter of 2021. Annualized net charge-offs for the fourth quarter were 9 basis points of period-end loans. Non-accrual loans were $37.8 million at the end of the fourth quarter, an increase from the $29.9 million at the end of the third, which was the result of 2 small credits. With regard to the current economic environment, there are potential risks on the horizon that could result from higher interest rates, continuing high inflation and pockets of supply chain disruption. Overall, investor commercial real estate loan metrics remain stable and indicative of above-average project operating performance across all portfolio asset types. While acceptable debt service coverage ratios are still reported for office, multifamily, office warehouse and retail asset types, a year-over-year decline is observed at fourth quarter '22, primarily due to the impact of rising interest rates, higher operating expenses for multifamily and the inclusion of now completed construction projects that remain in lease-up. Regarding specifically the office portfolio, our optimism around this asset class stems from, one, the character and experience of the sponsors; two, the predominantly Class A nature of most portfolio office projects; three, tenant quality and lease duration; and four, strong existing office portfolio metrics, including low loan-to-value at an average number of 56% and weighted average debt service coverage ratio of 1.59x for the current stabilized office assets. Office buildings outstanding at year-end were $1.8 billion, and of this amount, half was owner-occupied and half represented investor projects. Our energy loan portfolio concentrations remains in the single digits at 5.4% of loans excluding PPP at the end of the fourth quarter. Our energy borrowers as a whole have advanced rates and leverage ratios that are the lowest, we've experienced in many years, as borrowers have continued a program of deleveraging and returning more to shareholders. The current oil and gas price environment continues to be favorable for them, and our borrowers generally have a bullish outlook for prices for the near and intermediate term. Frost will continue to offer energy lending with prudent structures including appropriate advance rates and hedging structures to minimize risk. We've done a great job with closing out the PPP forgiveness process. So I want to say I remain proud of our team to work so hard and the relationships that we've built and strengthened with customers when they need to help most. We say this often that we've got a lot going on for us. We're expanding into new areas with beautiful new financial centers. We're enhancing our consumer offerings with all new mortgage loans. We're strengthening our communities and growing our brand awareness with exciting new sponsorship opportunities that will pay dividends for many years. And best of all, we are continuing with our strategy of sustainable organic growth. It's kept our company strong positioned us well for whatever the future holds. Day in and day out, our employees do all this while adhering to our core values of integrity, carrying and excellence and by providing industry-leading customer service. At Frost, we truly work hard to be a force for good in people's everyday lives. Looking first at our net interest margin. Our net interest margin percentage for the fourth quarter was 3.31%, up 30 basis points from the 3.01% reported last quarter. Higher yields on both balances held at the Fed and loans had the largest positive impact on our net interest margin percentage. The increase was also positively impacted to a much lesser extent by a higher yield on investment securities and by higher volumes of both investment securities and loans. These positive impacts were partially offset by higher costs on deposits and both higher volumes and cost of repurchase agreements. Looking at our investment portfolio. The total investment portfolio averaged $20.1 billion during the fourth quarter, up $727 million from the third quarter average as we continue to deploy some of our excess liquidity during the quarter. We made investment purchases during the quarter of approximately $1.2 billion, which included $735 million in Agency MBS securities with a yield of 5.43% and $470 million in municipal securities with a taxable equivalent yield of about 5.38%. For 2023, our current expectation is that we would invest an additional $4 billion of our excess liquidity into investment purchases during the year or about $2.2 billion net of projected inflows during the year. The taxable equivalent yield on the total investment portfolio in the fourth quarter was 3.09% up 15 basis points from the third quarter. The taxable portfolio, which averaged $12 billion, up approximately $534 million from the prior quarter had a yield of 2.41% up 21 basis points from the prior quarter, impacted by the higher yields on recently purchased Agency MBS securities. Our tax-exempt municipal portfolio averages about $8.1 billion during the fourth quarter, up about $193 million from the third quarter and had a taxable equivalent yield of 4.17%, up 8 basis points from the prior quarter. At the end of the fourth quarter, approximately 76% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the fourth quarter was 5.8 years, up from 5.3 years at the end of the third quarter impacted by the extended duration of our Agency MBS securities in this higher rate environment. Looking at deposits. On a linked-quarter basis, average deposits were down $1 billion or 2.3% with about half of the decrease coming from demand deposits and half coming from interest-bearing deposits. Customer repos for the fourth quarter averaged $3.6 billion, up $1.6 billion from the $2 billion average in the third quarter. We have seen some deposit flows into our repo product during the quarter. Total combined deposits and customer repos in the fourth quarter averaged $48.3 billion, up $571 million from the prior quarter. The cost of interest-bearing deposits for the quarter was 1.16%, up 54 basis points from the third quarter. Regarding credit loss expense, during the fourth quarter, we booked a credit loss expense of $3 million, which represents the first quarter we booked a credit loss expense this year. The credit loss expense was driven by growth in unfunded commitments. Unfunded commitments grew $698 million during the quarter, ending at $12.5 billion at the end of the year. Looking at non-interest income on a linked quarter basis. Trust and investment management fees were up $1.1 billion or 3% as increases in estate fees of $1.6 million, investment fees of $860,000 and real estate fees of $529,000 were partly offset by a decrease in oil and gas fees, down $2 million due to lower commodity prices. Service charges on deposit accounts were down $639,000 or 2.8% primarily as a result of lower commercial service charges, down $1.5 million, largely resulting from a higher earnings credit rate on annualized balances. Partially offsetting this decrease was a $756,000 increase in combined consumer and commercial overdraft charges. Insurance commissions and fees were down $1.5 million or 11.2% from the third quarter as a result of lower life insurance commissions, which were down $706,000 and also impacted by our normal business cycle. Other income was up $7.1 million, primarily due to a $5.1 million distribution received from an SBIC investment. Regarding total non-interest expenses, total non-interest expense was up $23.4 million or 9.1% compared to the third quarter. The primary drivers were salaries and wages up $9.5 million or 7.5% and other expenses up $13.3 million or 29.2% compared to the third quarter. The increase in salary and wages was impacted by a $6.4 million increase in stock compensation as those stock awards are made in October of every year and some by their nature, are expensed immediately. Additionally, accrued incentives were up $1 million from the prior quarter. The increase in other non-interest expense of $13.3 million was impacted by higher fraud-related losses up $4.7 million, $4 million related to a licensing negotiation and marketing and advertising up $2.7 million, which is typically higher in the fourth quarter. Looking at our projection of full year 2023 total noninterest expenses, we expect total non-interest expense for the full year 2023 to increase at a percentage rate in the mid-teens over our 2022 reported level. Our continued expansion in Houston and Dallas and the introduction of our mortgage product accounts for about 2.5% of that projected growth. Also impacting the projected growth rate is significant investments that we will be making in information technology for both people and infrastructure. Investments in marketing in both advertising and people as we focus on expanding the communication of our value proposition and expense growth is also impacted by costs associated with continued support of our staff. The effective tax rate for the fourth quarter was 13% or about 13.8%, excluding discrete items. Our current expectation is that our full year effective tax rate for 2023 should be in the range of about 14.5% to 15.5%, but that can be affected by discrete items during the year. Regarding the estimates for full year 2023 earnings, our current projections include a 25 basis point Fed rate increase in February, followed by a 25 basis point decrease in July. Given those rate assumptions and the 2023 non-interest expense growth of mid-teens, we currently believe that the current mean of analyst estimates of $10.89 is reasonable. First wanted to follow up on remarks, Phil, around commercial real estate. So you noted 2 things. One, you mentioned the impact from rate hikes was having an impact on the pipeline cooling off. But at the same time, we talked about the strength of your book. But give us -- like how do you see this playing out if interest rates don't get cut. one, and maybe this may not play out at Frost, but do you see credit pain in the sector across your markets to manifest themselves over the next 12 months across multifamily office. And how do you think that translates to impacting cash flows for your customers? Maybe it has a pressure on rent rolls as we look out? Would love some color around that? And just your thought process around both the risk for the market and how it may come back and translate in terms of risk to Frost? Thank you. Okay. Thanks, Ebrahim. Well, we are seeing some tightening on debt service coverage ratios, as I mentioned. But we don't expect, let's say, multifamily, for example, to be underwater on those the word that I got from our credit people was, I'll quote, so we feel pretty good about it. If you look at -- I think I gave you what our loan-to-value on offices was about 56%. If you look at our loan to value on multifamily, it's 58%. About half of our deals will be completed in '23, the other half in '24. So I don't think there's a lot of pressure today as it relates to our portfolio. I also hear from our people that rents are keeping up for now. So that's helping things, but costs are also increasing. I think in this market, if you have issues, it's been kind of what everyone's been hearing. It's going to be the lower-class office buildings where you're losing tenants and you've got some risk around that. But I don't want to give the feeling that we've got problems. I just want to make sure I'm being honest, if things are tightening up. If you took a look at our portfolio, I was asking about, I guess, the office portfolio, I think we have $44 million of what might be problem credits on what is the portfolio. It's probably over $1 billion. So you don't really have much that are issues and they're kind of specific. So again, I don't want to give the impression things are too negative, but I do want to give the impression things are not as good as they were. I would also say that property tax is a big problem around here, and they've seen a big increase. So when you combine that with interest rates and then also operating costs on apartments, multifamily. It's going to create some pressure, but at this point, not so much. Again, offices are probably the biggest concern, I'd say, generally in the market because I don't think anybody has figured out what's going to happen with offices over the next couple of years, we're still trying to figure it out as a business. So I'm sorry I don't have any better clarity than that but that's what we're seeing Ebrahim. No. That's helpful, Phil. One, Jerry, you mentioned about the earnings outlook for the year. Give us a sense of what you expect in terms of net interest income growth for the year? And how you see that trending, do you expect NII continues to grow given just what you expect in terms of loan and deposit growth? Or do you see some trajectory where NII declines quarterly at some point in '23? Yes, sure. I think that I said last quarter, we got a little bit into 2023, and we were talking about the NIM percentage. I think that we're currently, I don't expect that the fourth quarter was our peak. I still think that, obviously, we had a nice increase between the third and fourth quarter, 30 basis points, I don't see that sort of a growth coming into the first quarter. But certainly, we do expect some improvement. And in my mind, I think given our assumptions that we'll see a rate increase in February and then a decrease in July. I would expect that our NIM is probably given our assumptions, probably peaks in the third quarter. As far as we're not going to give specific percentage growth on net interest income. But it's year-over-year, I think we grew between '21 and '22, say, 30%. I don't think we'll be there based on kind of what I'm seeing. But I think we're going to have strong growth this year compared to last. I wanted to start on the deposit side. So the outflows of non-interest-bearing were fairly sharp a bit more than we were looking for. And I know you mentioned repos, but could you give a little bit more color what you saw in the quarter, what you might still see at risk moving out of non-interest bearing. And where do you see that mix stabilizing? Yes, non-interest-bearing. I think what I said on the non-interest-bearing is that's really been kind of the area that I've been concerned about that we had some exposure there. And I continue to think that's really the area where we have the most exposure. With rates where they're at today, and we all know there's some pretty nice rates out there. I think that it really is compelling a lot of treasurers and CFOs to make sure that they're managing their liquidity well and looking for alternatives. I think that certainly, we can be competitive in a lot of situations, but there's probably going to be cases where we're going to see some deposit outflow, especially on some of the larger balances, especially, I think that's where most of the risk is. I don't think it's anywhere unique to anybody. I think that from a deposit rate standpoint, our rates, I think, are competitive with banks. I think the challenge becomes trying to compete with some alternative sources. But I do expect that the commercial side on the commercial DDA is probably the most at risk in my mind. Got it. Okay. And then, Jerry, in terms of the loan-to-deposit ratio, moved up slightly through 2022. I hear what you're saying I'm putting liquidity to work in the securities book. But should we expect a similar trend through 2023, just basically funding loan growth with deposit growth? I think that for 2023, I think probably the bigger unknown in my mind, is more what happens on the deposit side than what happens on the loan side. I think Phil given some good color of what we're seeing in loans. I think without knowing exactly what happens in the economy, there might be a little uncertainty there. But I think we feel pretty confident, I think it's that deposit side. So you could because we've always said the loan-to-deposit ratio from our standpoint is really a results in fact, right, because we're really out to grow both deposits from a relationship standpoint and loans. So I think that given that I don't project that we'll have the sort of increase in deposits that we've had the last couple of years, I expect that to be much more muted in 2023. You may get some improvement in that ratio just simply because the denominator decreases. Got it. Okay. And then, finally, on the expense side, so you reported mid-teens expense growth in 2022, basically in line with what you had guided for the year, now guiding mid-teens for 2023, more investments that you'll have to make. When you guys take a longer-term view, do you think for a period of time, beyond 2023, we stay in this mid-teens range? Or do you see this as sort of a 2-year scenario, and then we get back to something more normal after that? Thanks. Steve, it's a good question. I think the simple answer is 2023 is an unusual year for us. I expect to see our run rate on expense growth to go down in 2024. And Jerry mentioned the IT investments mentioned marketing. As I've talked to investors over the last couple of years, I've been pretty open that there are some things we are going to invest in. We're going to invest in physical distribution, and I hope by now we've proved to everyone that's a payoff for shareholders are going to continue to be. We're going to continue to do that. We sort of set that aside. Okay? But we're also going to invest in people, and you saw those numbers on salaries, I mean, they are pretty sobering, but we were competing in the marketplace. I think we're being successful there. I think we've reached a place where we're touching bottom. And I was looking at our turnover rates. Last year, it was in 2021, our turnover was 23%, this year. In 2022, it was 14%. It was down from 23% in '21. So that tells me that we are hitting the right balance on what we need to be paying people. We've done a lot on benefits, making sure that we have comparative and really top-quality benefits in areas of health care and retirement and those kind of things. So we're really focused on that. We said that we're going to invest in marketing that was one area that we really hadn't done, one of the key areas that we hadn't done, we needed to. And we've hired some great talent there. We did that last year. So we've got those costs, but we've also got some additional media that we're going to be investing in and we need to. And look, I think we've been winning on account growth and growing the business. And I think we've done it without kind of -- we'll sort of with the marketing hand tied behind our back. I think we get that out from behind our back. It's going to really help us. So I'm optimistic about that. And then, the fourth one that we said we're going to be investing in IT and cyber. And that's the big number that Jerry is talking about because as we looked at this and did our planning for this year, we really call this a generational investment in IT. And it's really, I'd say, around if you're interested, I'd break it down into three areas. One is customer experiences and growth which really revolved a lot around digital, mobile, for the consumer and commercial businesses. We are almost doubling our number of digital agile teams. We're going from 6 to 11, 2 of them in the commercial area. We're speeding up modernization on certain core systems. There are 3 of them. We need a new loan system. We need to invest in real-time payments, which is a developing competitive issue, and we need to take care of our check processing system, which is at end of life. We're a big correspondent bank providers. So check yes, checks are going away, but they're not gone, and we process a lot of them. So that's probably 35% in terms of that core modernization. And then we need to continue to expand our efforts on, I'll call it, information security and fraud mitigation, that's probably the other 15%. And that's a big percentage increase. We've increased IT, we've been 11% for '19 and '20 and '22, it was up 8% in '21. We really backed down expenses all over the bank that year, but in 2023, we're looking for a 24% increase in IT-related expenses. And that's a generational investment in necessary IT. And I say it's necessary because remember, our success at competing and I believe we're winning at the organic growth competition is from an empathetic customer service experience and from great technology, and we can't sleep on that technology piece. Now having said all that, I don't believe those are investments that we're going to have to make at the same level as we look into next year in 2024. So it's a big number. We hate spending money. We hate wasting and even worse and so we don't think we're doing that. We do need to do this to compete where we are, and I think we'll see that run rate go down as we hit 2024 and beyond. Just a quick one on the NII guide. I was curious what the impact is you see for the rate hike in February and then the rate cut in July, what the NIM sensitivity is for those moves that you're baking in? And it sounded like you're assuming a positive, but maybe more muted deposit growth trend for the year. I was just wondering if you could give an update on the total deposit beta assumption, you're not baking into that? Thanks. Right. I guess I'll just start with the deposit betas. I mean, I think we ended up a year kind of where we expected we would be. We had said that we'd be about 30% on interest-bearing at about 20%, 20% to 25% on total. And that's really kind of where we ended up. So I think for -- we were higher in the fourth quarter. I think I said in the third quarter that I thought we have to be a little bit more aggressive than we were. But we ended up cumulatively exactly where we expected. As far as betas for next year or for this year, excuse me. And I think basically what we're assuming is that we would have the same sort of increase that we had in the first quarter in February is kind of where we go back. I think we're assuming a little bit more aggressive betas, say, where we were at about 30% on interest-bearing, I think we're probably assuming right now that we'd be somewhere closer to the 33% to 35%, and then our assumptions are that we take all that back in July. And we'll just have to see, I think we said all along is, we want to see kind of where the market is, but those are our current assumptions today. And I think you had one other question on. The sensitivity to the right moves that you guys are looking at, the hike in February, and then the cut in July, how much of that we think will move the NIM? Yes. From a NIM standpoint, I don't think it's going to have a significant impact on the percentage itself. Like I said, we want to be careful. We don't really give all that sort of level detailed guidance. But what I have said is, I do think the percentage will peak in the third quarter just right before our projected decrease. And I think that we're feeling good about where we're at. A lot of it will be dependent on what happens on those deposits. As I've said, yes, do I feel like it's a little bit more muted in 2023 than it was in 2022? Yes, most certainly. I mean, I think we saw some of that just in the linked quarter movement, although a lot of it was moving into repo. And so we had certain customers coming out of the money market account and choosing to move into the repo account because of some sort of operational processes and money flow issues that they liked more in the repo. And also the fact that, that product is collateralized. So we did see some movement there. So I tend to have less concerns, although it's still going to be relatively soft, it's going to be softer than we saw this year on the interest-bearing side, but most of the risk is on the commercial DDA in my opinion. As far as what we think a 25 basis point hike gives us, it gives us about on a pretax basis, a little over $3 million a quarter. Okay. Great. And maybe just one last quick one. On the 159-debt service coverage ratio you gave on the office book, that's an updated figure for today's rates. Is that right? Hey Dave. I just want to make sure when I said around a little over 3%, that's on an after-tax basis. I couldn't remember if I said pretax after tax. I wanted to start with your comment about growing the bond portfolio. I think on a net basis of about $2.2 billion in 2023. If you look at the amount of cash that Frost still has at least on an average basis in the fourth quarter, it was 24% of average earning assets. It feels like you could do potentially more than the $2 billion adding to the bond book, especially as the rates are more attractive today. Is there some possible upside to the amount of bonds that you'll consider adding in '23? Yes, that's a possibility, obviously. Right now, what we're really concerned with is, it's just making sure we understand exactly what's going on with deposits. I guess what I'd say is that it's something that we're talking about. Should we get the opportunity, if we think something we get an opportunity on the yield side with some sort of market correction, we could jump in. So there is that possibility. But I think right now, we're really -- the numbers that we're giving is really kind of the way we're modeling. Like I said, I never say never sort of thing, but I'd go with our projections. Let's not forget that in 2022, we spent $8.6 billion, I think, grows. And in that year, we only had a little over $8.6 billion, we only had a little bit over $1 million in inflows. So net we spent $7.5 million. So we've moved the needle quite a bit. And so, we've made some purchases already in January of this year of $1 billion, I think, roughly. So could we, yes, I don't see that as a high probability at this point. But yes, that's always a possibility given what happens in the market. Okay. And then, my second question is on mortgage. Is that relatively new unit gets up and running for you guys, I think that's an originated keep model, not an originated sell model. So as that business continues to mature, do you think that, that will push the loan growth outlook beyond the high single digits just because you'll have that new lever of loan growth as you keep those mortgages. Good question, Brady. I don't know if it goes above high single digits, but it will be additive to it. I don't really have it in my mind enough to know how much that would move the needle. But it's going to be a significant part of the portfolio. The way I hope it turns out is, if you look 5 years out, it'd be the 10-ish percent of the portfolio back when we used to have them on the book before, I think we're around that area, 10%, 12% of the portfolio. So I just think directionally, we'd be in that same level. So if you kind of took what would that be and what kind of volumes would that be, you could sort of pencil out how much that might add to growth. I had a quick follow-up on the expense side. Are these expenses that you have pretty much set in stone for 2023? Or do you have some flexibility depending on which way the overall environment goes? And then, I also had a clarification on your comments on the run rate moving lower. Do you think that basically the growth rate moves lower off of the new expense base in 2023 as you go into 2024, or do you think as you get the new loan system and check processing system, et cetera, running and the old one rolls off, that the actual dollars can stabilize or come down as you go into '24? Thanks. Well, my comments really weren't intended to indicate that the dollars would come down because, obviously, we're growing company. We're going to continue to invest. My point is that I don't see us investing at the same level with some of these. I mean, for example, I didn't mention it, but take mortgage, we have bootstrapped that operation. We spent some serious money doing it. It's a fantastic product. It's going to be a tremendous product for us going forward, but we don't have to rebuild that next year. So we're going to have that same level of cost structure and it will be higher because of inflation and growth, that kind of thing. But we're not going to have to bootstrap it. So that's really what I'm pointing out. I think we're making a lot of these generational investments that we're really going to be trying to harvest and we'll be dealing more with an increasing expense base, but just not increasing at the same level that we have been that's my hope. That's what we're going to try to manage to. Got it. All right. Perfect. And then, a follow-up on the prior questions on the securities book. I guess even if you don't get a market correction opportunity to make larger purchases you are, given that we've come off the highs in yields, what would change your strategy to maybe accelerate some of the investments in that securities book? Yes. I think that if we felt like there was a correction that was significant that got our attention. I think that we would accelerate that. Got it. And any thoughts on what -- once the Fed begins to cut rates, what your cash position should look like as a percentage of earning assets? We've kind of been all over the board. I think the thing is today, you're right, we've got more liquidity than we have had. I think that we feel comfortable being able to bring that down to something much more normalized. But we don't have a number out there. A lot of it is going to be dependent on what we're seeing. I think if you've got, say, something as far as earning assets are concerned, something in the range of 10% or lower, I mean I think we could be somewhere in that range. So, you guys are always sitting on very strong capital ratios, low credit risk. I was just curious what your thought is on share buybacks. I know it's not a focus, but what are your thoughts on share buybacks here? Yes. It's really not something that's top of mind to be quite honest with you. I think that right now, we really don't even have one in place. We had $100 million one that expired. We expect that we'll bring that back into the toolbox here in the near future. But we had one for all of 2022, we didn't utilize it. We've got it primarily to ensure that if we did see some market correction on our stock that we'd be in a position to take advantage of that. But right now, I think from a multiple standpoint, I think we feel that capital is better served through organic growth. And I think there were some concerns, not that we were concerned, but I think the market had some concerns about tangible capital. And given that concern some of the questions we were getting, I can't see that we pulled the trigger any time soon. Okay. And then just on office space. Phil, I heard your comments, most of your exposures to the A-type properties. But I was just wondering if you could comment what you're seeing on the B and C properties like Houston and Dallas? There really aren't many that have come to my radar portfolio wise that I know of because that's going to depend on sponsorship, guarantees, equity, all those kinds of things, right? But I can just tell you that what you're seeing all over the country is that the B and C properties just hard to get people into and I can imagine there are some issues out there. I don't have anything that's more complex than that, just recognition that people aren't using as much office space, and it better be nice if you're going to try to get employees to go into it. I agree, you've got to be nice to get people back. That's a good comment. Most of my questions were scratched off and Peter just took one of them. But you made a comment earlier, Phil, about the prospect pipeline versus your own pipeline and the difference between the two? Can you just talk about that a little bit more and maybe that's more of a competitive environment question, but help us understand that a little bit more? Thanks. Yes. We are getting lots of calls for deals, right, because we've got liquidity, we've got consistent underwriting. People know what we do in the marketplace. As far as that goes, underwriting is tightening up. It's coming our way as far as guarantees and equity and all that kind of stuff. But my point was, and I should also say that we're not looking to do all those deals. We bank people, not things, right? We bank relationships. So but there might be some relationships that we've been wanting to have that we'll see the opportunity to do, okay? And we're always on the lookout for that. And now the phone rings more. So we see prospect activity, to me, it's more the advantage of us having the balance sheet that we do and reputation we do. But my point on our customers, to me, it's kind of like same-store sales. I know it's not that. But I mean you already have the customers and the deals you have in the pipeline for them are the deals they're looking to do, they're new deals are looking to do, right? They're not necessarily deals that are out there that already have been papered already that are in the marketplace that you might see with the prospect. So my point is, as I looked at it, to me, it was like, okay, our customers, we've got their business. If we're not seeing new deals from them, it's because they're not doing new deals or they're slower on them. But we are still seeing good prospect deals that are out there in the marketplace just because of the advantages that we have. Maybe I'm awful on that, but that's what it meant to me. Okay. Good. That's helpful. And then just one other thing on the step-up in IT and security expenses. Are you seeing that as a -- that's a permanent step-up or it's just kind of modernization and core spending related just for '23. Are we talking about a growth rate and expenses slowing in '24 or your expenses kind of flattening out and coming down in '24? Thanks. Yes, Jon, it's growth rate. It's a growth rate coming down. I mean once we make this into our base expense load. I mean it's staying in there. And there'll be some growth on it because inflation and all those kind of things, but we won't be having to do the same thing. Again, our growth rate for 4 out of the last 5 years, where 3 out of the last 4 years before this year has been 11%. And IT is a cost that is -- it used to be health care with the out-of-control cost. I think it's clearly IT these days. But we'll need to get it back down to those more historical levels. Thank you. We're showing no additional questions in queue at this time. I would like to turn the floor back over to Mr. Green for closing comments. All right. Well, we want to thank everyone for participating today. And thank you for your questions and for your interest. We'll be adjourned. Ladies and gentlemen, thank you for your participation and interest in Cullen/Frost Bankers. This concludes today's teleconference. You may disconnect your lines and log off the webcast at this time and enjoy the rest of your day.
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Good day, and thank you for standing by. Welcome to the Fourth Quarter 2022 Halliburton Company 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 your speaker today, David Coleman, Senior Director of Investor Relations. Please go ahead. Hello, and thank you for joining the Halliburton Fourth Quarter 2022 Conference Call. We will make the recording of today's webcast available on Halliburton's Web site after this call. Joining me today are Jeff Miller, Chairman, President and CEO; and Eric Carre, Executive Vice President and CFO. Some of today's comments may include forward-looking statements, reflecting Halliburton's views about future events. These matters involve risks and uncertainties that could cause our actual results to materially differ from our forward-looking statements. These risks are discussed in Halliburton's Form 10-K for the year ended December 31, 2021, Form 10-Q for the quarter ended September 30, 2022, recent current reports on Form 8-K and other Securities and Exchange Commission filings. We undertake no obligation to revise or publicly update any forward-looking statement for any reason. Our comments today also include non-GAAP financial measures. Additional details and reconciliation to the most directly comparable GAAP financial measures are included in our fourth quarter earnings release and in the quarterly results and presentation section of our Web site. Thank you, David, and good morning, everyone. Halliburton finished the year strong with solid financial and operational performance in both divisions and both hemispheres. Halliburton's execution in 2022 demonstrates the earnings power of our strategy, and I expect this earnings power to strengthen in 2023 and beyond. Let's jump right into the 2022 highlights. We delivered full year total company revenue of $20.3 billion and operating income of $2.7 billion. Adjusted operating income grew 70% compared to 2021 with improved margin performance in both divisions. Our full year international revenue grew 20% over 2021, and our revenue and operating income increased each quarter in 2022. I am pleased with the international growth and margin progression Halliburton demonstrated this year despite a second quarter exit from our Russian business. Our full year North America revenue increased 51% over 2021 with improved margins driven by activity and pricing gains. Both our drilling and evaluation and completion and production divisions grew revenue and margins this year. The Drilling and Evaluation division generated full year operating margins of 15%, an increase of 320 basis points over 2021. The steady expansion of D&E margins demonstrates the global competitiveness of our D&E business. Our Completion and Production division posted 18% full year operating margins, a year-over-year increase of 290 basis points, driven by activity and pricing improvements. We generated strong free cash flow of $1.4 billion, retired $1.2 billion of debt, maintained capital spending within 5% to 6% of revenues and ended the year with $2.3 billion of cash on hand. Finally, our service quality performance excelled in 2022. Nonproductive time improved by 7% over 2021, which drove the highest ever uptime across our business. Execution is at the heart of who we are and our results are a testament to our employees' continued commitment to superior service quality. I'm pleased with the fourth quarter results. Revenue grew 4% and operating income grew 15% sequentially. Margins increased in both C&P and D&E divisions and in both hemispheres. Cash flow from operations in the quarter was $1.2 billion and free cash flow was $856 million. Building on the strong foundation of execution, today, I am pleased to announce the following shareholder return actions: first, our Board approved an increase in our quarterly dividend to $0.16 per share in the first quarter of 2023, representing a 33% increase from last year; second, we have resumed share buybacks under our existing Board authorization of approximately $5 billion and in the fourth quarter of 2022, bought back shares totaling $250 million; finally, our Board approved a capital return framework that we expect going forward to return at least 50% of our annual free cash flow to shareholders through dividends and buybacks. These actions demonstrate Halliburton's confidence in our business, customers, employees and industry outlook. Before we continue, I want to take a moment and thank the Halliburton employees around the world who made these results possible. Our success this quarter and throughout 2022 was a direct result of your hard work and dedication. I thank you for your relentless focus on safety, operational execution, customer collaboration and service quality performance. Now let's turn to the macro outlook where everything I see today points towards continued oil and gas tightness. On the supply side, in the US, an increased spend of almost 50% and activity growth of nearly 30% yielded a production increase of about 5%. Given the increased spend required to grow and replace production, I expect activity to remain strong and service intensity to increase through 2023. I see the same supply side challenges in the international markets. One indicator being that despite OPEC's 2022 production quotas, several members did not meet their goals. On the demand side, we saw the resilience of oil and gas demand throughout 2022, even as central banks raised interest rates to combat inflation. I expect oil and gas demand to remain strong. As we start 2023, I also expect China's reopening to further increase demand. It's clear to me that oil and gas is in short supply and only multiple years of increased investment in both stemming declines and reserve additions will solve short supply. I believe these investments will drive demand for oilfield services for the next several years. The unique feature of this up cycle, as I see it, is the investor driven return discipline by both operators and service companies, which I expect drives a longer duration cycle and translates into years of increasing demand for Halliburton services. Now let's turn to Halliburton, starting with our performance in the international markets. We successfully executed our strategy to deliver profitable international growth through competitive technology offerings, improved pricing and selective contract wins. International revenue grew 20% year-on-year with strong growth and margin expansion from both divisions. This gives me confidence in the earnings power of our international strategy. In 2023, we expect international activity to grow at least mid-teens with most new activity coming from the Middle East and Latin America. As this up cycle continues, I believe that we will see substantial growth in all international markets, both onshore and offshore, led by development activity and increased spend at the wellbore. This is excellent news for Halliburton. About half our revenue comes from international markets. We have leading positions in key well construction product lines and a strong geographic footprint. I'm excited about the growth and profit opportunities that will come with the adoption of our new drilling technology platforms. Our iCruise drilling technology, iStar logging while drilling platform and LOGIX automation capabilities. Each of these technologies are in different stages of implementation, and we are already seeing benefits. Our iCruise directional drilling system represents about half of our rotary steerable fleet while drilling about 70% of our global footage. It is a key contributor to increasing international profitability. Our iStar logging while drilling platform now delivers high definition measurements closer to the bit and deeper into the formation. While early in its rollout with only 600,000 feet logged, the iStar platform directly complements the iCruise directional drilling system. Finally, LOGIX automates drilling with iCruise and iStar. With more than 7 million feet drilled in 20 plus countries the LOGIX platform reduces operational risk and delivers wells reliably. Turning to North America. We had a terrific year. Our performance demonstrated our strategy to maximize value in North America through capital efficiency, improved pricing, differentiated technology and alignment with high quality customers. In 2022, our North America revenue grew 51% year-over-year, while revenue in the fourth quarter was flat sequentially due to weather related downtime late in the year. Looking ahead, we expect strong activity and anticipate customer spending to grow by at least 15% in 2023. The market for equipment is tight. Lead times for new and replacement equipment remain long and service companies remain disciplined. Our completions calendar is fully booked and pricing continues to improve across all product service lines. Against this constructive market backdrop, Halliburton will outperform with our unique strategy to maximize value. We see strong demand for our Zeus e-fleets with several repeat customers contracting additional fleets. Zeus is a proven design with a strong operational track record. Our new automated fracturing platform, Optiv, fully automates equipment operation, reduces maintenance and extends component life. We are in the early innings of this rollout, having proven it over 15,000 stages, and I expect it to drive higher capital efficiency. Finally, our SmartFleet intelligent fracturing system is gaining significant traction with customers. SmartFleet data helps customers answer key questions such as the existence of flow barriers, well interference, parent-child performance and depletion, all to improve completion performance. These are a few examples of how technology maximizes value in North America. Each example delivers better margins either by reducing capital cost or increasing capital velocity and in many cases, both. Halliburton is unique and is the only integrated services company to have a strong presence in both North America and international markets, a strong execution culture and differentiated technology. We will continue to sharpen our value proposition to collaborate and engineer solutions to maximize asset value for our customers. I am confident in Halliburton's strong long term outlook. This is the best setup and market outlook for oilfield services and Halliburton that I have seen in a very long time. Our exceptional financial performance this year is a clear result of the execution of our strategic priorities to maximize value in North America, deliver profitable international growth and drive capital efficiency. I expect Halliburton to continue to deliver financial outperformance. Thank you, Jeff, and good morning. Let me begin with a summary of our fourth quarter results. Total company revenue for the quarter was $5.6 billion, a 4% increase over the third quarter while operating income was $976 million, an increase of 15% over third quarter operating income. Operating margin for the company was 17.5% in the fourth quarter, a 460 basis point increase over operating margins in the fourth quarter of 2021. These results were primarily driven by increased global activity, pricing and year end product and software sales. Our fourth quarter reported net income per diluted share was $0.72, an increase of $0.12 or 20% from the third quarter. Our 2022 full year adjusted net income per diluted share nearly doubled from 2021. Beginning with our Completion and Production division. Revenue in the fourth quarter was $3.2 billion, a 1% increase when compared to the third quarter, while operating income was $659 million, an increase of 13% when compared to the third quarter. Despite weather related downtime late in the year, C&P delivered an operating income margin of 20.7%, the highest operating income margin since 2012. This was due to improved pricing, service efficiency and activity mix in North America land as well as increased activity in international markets. In our Drilling and Evaluation division, revenue in the fourth quarter was $2.4 billion, an increase of 8% when compared to the third quarter, while operating income was $387 million, an increase of 19% when compared to the third quarter. These results were driven by higher year end software sales and an uptick in international activity. Operating margin increased 210 basis points above Q4 2021, which demonstrates the global competitiveness of our D&E business. Moving on to geographic results. Our international revenue increased 9% sequentially due to solid year end sales, pricing gains and activity increases. In North America, revenue in the fourth quarter was $2.6 billion, a 1% decrease when compared to the third quarter. This decrease was primarily driven by weather related downtime in North America land. Latin America revenue in the fourth quarter was $945 million, a 12% increase sequentially due to higher activity in Mexico and across the region. Europe/Africa revenue in the fourth quarter was $657 million, a 3% increase sequentially driven by higher completion tool sales, drilling activity and well intervention services across the region. These increases were partially offset by lower activity in Norway. Middle East/Asia revenue in the fourth quarter was $1.4 billion, a 10% increase sequentially, primarily resulting from higher software sales and drilling and evaluation services across the region. Now I'd like to cover some additional financial items. In the fourth quarter, our corporate and other expenses was $70 million. For the first quarter, we expect our corporate expenses to be slightly lower. Net interest expense for the quarter was $74 million, a slight decrease due to higher yields on cash balances and debt retirement in September. For the first quarter, we expect this expense to remain approximately flat. Other net expense for the quarter was $60 million, primarily related to unfavorable foreign exchange movements. For the first quarter, we expect this expense to be slightly lower. Our normalized effective tax rate for the fourth quarter came in at approximately 21%. Based on our anticipated geographic earnings mix, we expect our first quarter effective tax rate to increase roughly 150 basis points. Capital expenditures for the fourth quarter were $350 million with our 2022 full year CapEx totaling approximately $1 billion. Turning to cash flow. For the full year, we generated $2.2 billion of cash from operations and delivered approximately $1.4 billion of free cash flow. As a result, we ended the year with approximately $2.3 billion in cash. Next, I'd like to provide a few more details about our capital return framework. First, an important pillar of our capital framework is to maintain CapEx between 5% and 6% of revenue. I believe the spending level is appropriate and supports our earnings growth and free cash flow generation over the next several years. Second, we expect to return a minimum of 50% of free cash flow to our shareholders in the form of dividends and share buybacks. Our Board of Directors increased our quarterly dividend by 33% to $0.16 per share, effective with a dividend payment in March 2023. Finally, in the fourth quarter, we repurchased $250 million of shares and we have remaining authorization of approximately $5 billion. We were clear about our goals to reduce debt and increased cash returns to shareholders, and I am pleased that we've announced these actions today. I believe Halliburton's capital return framework provides visibility for investors and affords us the flexibility to pursue acquisitions and strengthen the balance sheet. Now let me provide you with some comments on how we see the first quarter. As is typical, our results will be subject to weather related seasonality and the roll-off of year end product sales, which will mostly impact our international business. As a result, in our Completion and Production division, we anticipate sequential revenue to be essentially flat with the fourth quarter while margins will drop between 75 and 125 basis points. In our Drilling and Evaluation division, we expect revenue to decrease in the low to mid single digits sequentially while margins are expected to be down 25 to 75 basis points. Thanks, Eric. Let me summarize our discussion today. Oil and gas is tight and only multiple years of increased investment will solve short supply, which translates into years of increasing demand for Halliburton Services. The announced dividend increase, share buybacks and Halliburton's new capital return framework provides shareholders with clarity and consistency on how we expect to return cash to shareholders. This exceptional financial performance is a clear result of our execution of Halliburton's strategic priorities. I expect Halliburton to continue to deliver financial outperformance, strong free cash flow and shareholder returns. So Halliburton's international business is now half of overall revenue. Middle East has been a big part of that growth over the years, it was up 10% this quarter. Just wondering if you could just give us a little bit more insight into kind of your views on that market over the next kind of couple of years. So based on activity is how it's trending and the ramp up is going on, I guess, in the near term, is it reasonable to think the growth should sort of stay at these levels the next several quarters? And also, if you could highlight some of the countries where you see most of the growth coming from over the next several years, including kind of where you think you're best positioned in terms of footprints or product lines in the Middle East? Look, I'm really excited about international growth. I think I said in my call, north of 15%, which clearly, I expect it will be north of that and should continue actually to expand, I think, over the next few years just because we will -- it takes longer to get traction internationally, get things contracted. And so really excited about what we see. With our international business being about half of our business today, that indicate or demonstrates that we have strong footprint sort of everywhere where we think it's important and our technology, as I described, rolling out. So clearly, it's got strong application in the Middle East and Latin America, which we kind of saw this year but it's the same technology that's applicable in all corners of the world. And so I think we're early in the rollout a lot of this technology and that's only going to help strengthen our international business. As we see activity grow, I expect our share of that to grow and improve margins as we focus on profitable international growth. And if I could shift over on the US side, there's been a lot of recent talk about activity levels slowing down in the US. The rig count has drifted down a bit in recent weeks, been some weather, as you highlighted, and there's also some concerns out there in the natural gas market. I also know how any E&Ps have announced any spending budgets this year. So I was wondering if you can just help us out with a little bit of visibility on the market. Kind of what are your customers saying about kind of how activity is going to play out into the spring? And then based on that, kind of how do you see sort of the dynamics of that pressure pumping market in terms of capacity and the tightness for 2023? Look, North America is going to, in my view, will surprise to the upside. Our outlook is north of 15% growth. Clearly, we outpaced that last year and that's what I said last year. I don't have any clients that are not -- that are -- that plan to get smaller, they all plan to grow. And I think that North America has a dynamic of the more -- the more you grow, the more the market has to work in order to maintain even the growth given decline curves. And so I expect we see increased service intensity throughout '23 and likely beyond, the market is extremely tight for frac equipment and the supply chain still backed up. And so I don't see -- I see discipline in the marketplace and more importantly, I see sort of required discipline based on equipment being unavailable. So the more activity we see then ultimately, the more price we will see. And so I am very positive on '23 North America. So I think the the concerns are misplaced and rig count likely moves up actually as DUCs get blown down. Jeff, clearly, one of the themes this earnings season has been the inflection in Middle East spending in offshore. I was wondering, Jeff, if you could talk about Halliburton's portfolio and competitive position in both the Middle East and as well as offshore? And how do you think you're positioned in this cycle versus last? Look, we're better positioned than we've ever been as Halliburton, both from a technology perspective that I described examples of that. But clearly, that's not all of the technology we've got in the market today and from a footprint standpoint. So a lot of that build out was done prior cycles, it's still there and ready to go. So I feel very good about our geographic footprint, our technology advancement that we've made and our team. I mean we've just got an exceptionally strong team today internationally. So I feel very confident certainly from that perspective. And when we look at where our business is, offshore is good for us. I think that about 40% of our international business is offshore today. And so that's a good market for us. And I think another nuance as we look out into next year, certainly and likely beyond, is the sort of emphasis on development activity as opposed to exploration that maybe we've seen in prior cycles. And I think that's very consistent with where operators are from a capital discipline standpoint and just producing more barrels sooner, which leads us to development. And that is a place where we have leading positions in a number of the service lines that allow that to happen, so meaning drilling fluids, completion tools. And so I think this is going to be a great even better market for Halliburton. And maybe a follow-up for Eric. Eric, I wanted to get your thoughts on cash conversion in 2023. And just wanted to think about just working capital needs to support the growth this year? And just any broad thoughts on collections, particularly for international -- some of your international and NOC customers? So I mean, broadly speaking, we're looking at the cash generation profile in 2023 as being fairly similar to 2022. So quite a bit weighted toward the back half of the year. Looking at things overall, I mean, the big buckets, obviously, we'll see significantly increased net income driven by growth in our revenue, improvements in our margins. On the CapEx side of things, we finished 2022 on the low end of our range of 5% to 6%. We were at 5%. When I look at '23, we will be at the higher end of that range, primarily driven by supply chain constraints and extended lead time in our supply chain that we talked about on prior calls. And the third element in terms of working capital, again, our business will continue to grow, so we will continue to see some headwinds in terms of working capital essentially and also the impact of growing internationally, which tends to be more bigger consumers of working capital than when we grow our business in North America. So the way all of that is going to land is a little north of 20% growth in terms of free cash flow over our 2022 performance. So Jeff, in North America, I want to start there. In North America, your customer base and the majority of the customers really have three options, you can grow, you can shrink, you can go international. Where do you see, in your conversations with the bigger shale operators -- and you mentioned earlier, you think there could be a surprise to the upside in North America. How do you think they're thinking about the North American market, especially given what's going to be inventory constraints at some point here, whether it's three years, five years, seven years, we don't really know but at some point on wells and what they plan to do over the next couple of years? Well, I expect that within sort of expectations -- within sort of capital discipline levels, I expect growth is really the only path for most of these companies. And commodity price very supportive, the international growth, very, very difficult, and shrink, not really an option. So I think that we'll see increased -- initially increased service intensity, that's the first step and that clearly we benefit from increasing service intensity. The second, if we want to go out 10 years, that's a bet against technology and that's not a bet I'm willing to make. I mean, in fact, I'm very confident in what technology will do. There is a lot of oil in North America and we're already seeing the impact of work harder producing more barrels. And then also that's one of the reasons as Halliburton the SmartFleet, as an example, I talk about it a lot, but that's one of the tools that operators can take. I expect over time and start to solve how to make more barrels and more productivity. And so as we invest a lot of R&D dollars into North America, we're kind of unique in that fashion and we try to put those dollars into what we think are most impactful. So it's not a bigger X or a smaller Y but more a function of what is the technology that I think and the company thinks will really unlock productivity over time. And I think those kind of tools in the hands of our operators, I mean, they are incredibly competitive, smart, technically deep. And I think it's more a matter of getting tools in their hands to allow them to unlock what 10 years down the road looks like. Okay, that's great perspective there. And then if I could just switch to the international side of the business. At this point, are we in a market that is still price driven or have we switched now to a market where it's about availability and service quality? Well, I don't think you have one without the other, James, but I would expect -- my view is service quality and having equipment, quality equipment, is more and more important every day, that ultimately drives prices well. We spend a lot of time focused on how we execute and deliver service quality and our service quality feel very good. And so we are a beneficiary of that. As the market gets tighter, they start to get to the -- the market starts to pull equipment out, but I expect that sort of where we are, we've got a very good equipment portfolio and technology that we're bringing to the market and all of that certainly benefits us. Thanks, Jeff, for the framework around capital returns, and that's kind of where I want to focus my questions here today. Can you talk about why you thought at least 50% of free cash flow was the right number? And then talk about how you -- the definition of that calculation. I think it will be cash flow from -- cash flow from operations inclusive of working capital minus CapEx before M&A, but just to make sure we're on the same page. I think your view is correct, yes. And the 50%, I mean, there's nothing magic in the 50% per se. We think that it's a number that gives some level of certainty in terms of what we're going to return to shareholders while giving us a lot of optionality to continue to invest in our business, to continue to make bolt-on acquisition or to make acquisitions that are complementary to our product line business. And also give us optionality over the next few years to continue to work on strengthening our balance sheet. And that was my follow-up around capital returns. So as you think about the buyback, how do you think about approaching it? Do you want to take a more ratable approach or do you want to be countercyclical in the way that you prosecute it? And when you talk about M&A, are we talking about bolt-on type of transactions that are -- or do you see a scenario where we could be looking at larger scale things? So let me start with M&A maybe. So our philosophy there is extremely focused on adding technology. So it's a bit of a build versus buy approach to complementing our technology budget. It is a bit opportunistic at time depending on what's available and the opportunities that we have. Over the years, we've also invested in complements like smaller businesses that we can easily add to existing product lines. So that's kind of the general view that we have on technology. From an overall strategy standpoint, and I'll let Jeff jump in. But we are where we need to be in terms of the businesses we want to compete in at this stage. So going to the other part of your question, Neil, around buybacks. So I'm not going to go into a lot of details, but generally speaking, we look at buybacks as being level loaded through 2023, which will obviously top off in terms -- in order to make sure that we meet our overall target of 50% or more. So we're thinking about buybacks really as a mechanism to return cash to shareholders. We're not really trying to trade in our shares. Let me just add to that as well. I mean I think the -- no surprises from us, our outlook on M&A hasn't changed, and it will stay that way. As we look at the capital allocation, we also want to continue, as Eric mentioned, opportunistically take out debt. We don't want to be sloppy about it, but kind of in the current market that we see, we have the opportunities to do things that are -- that make returns for the company, but we want to be crystal clear around what our minimum return was. It's clearly -- we'll work through that. But I would expect that by setting that minimum, I think it gives clarity to the marketplace that we will only do things that we believe add meaningful returns to the company. Jeff, your 4Q EBITDA margins firmly hopped in that kind of low 20% range here, basically at 14 levels, which was the target for '23, totally get there are some year end sales there that skewed us higher in 4Q, but you're on the cusp of hitting 14 margins on an annual basis in '23. You and Lance kind of gave us a two year outlook almost two years ago. And I just wanted to see if maybe you could refresh this or expand upon it and how you see margins evolving over the next couple of years? When we did that a couple of years ago, when we looked at published estimates, clearly, we thought they were too low. And so we've made some clear commentary and an effort to correct that. Now as we look at the published REIT estimates today, they seem about right. And so I don't want to try to continue to do that over and over. And what I am is super excited about our outlook. Margins from here are up, revenue is up. I'm as confident in our outlook and our business as I have ever been. But I just want to be clear, in Q2 of '21, we wanted to be clear that we were pointing out what we felt was missing in the future Street estimates. And today, as I said, I think published Street estimates today are about right for the years ahead, both top line and profitability. Jeff, I guess a quick follow-up or a question, maybe we can kind of dig in a little more on the international side. We spoke a little bit about this at dinner, but we get a lot of questions around confidence in multiyear growth on the international side. Obviously, we saw a strong growth last year and expectations are for another year of strong growth. I guess, could you speak to what you see for continued growth on the international side, once you get past '23 and kind of what gives you confidence that we will continue to see growth on the international side post this year? Well, I would just start with the underinvestment that we've seen for the last roughly eight years and really haven't caught up with that. And so if I just look broadly at kind of reserve replacement and availability, that portends a lot of years of recovery and we're in the early stages of that in a lot of ways. It takes time to get international projects up underway, a lot has to be renegotiated with different partners. And so I think that what we see building is the tender backlog and these are tender backlogs that go beyond a year, well beyond a year and that's consistent with sort of the slower recovery in spend that we typically see internationally. But I'm confident that that's basically what's required to recover and produce enough oil to meet demand. Beyond that, specifically dialog with customers, target set by countries, outlooks that nearly all international countries that produce oil have targets that are certainly above where they are today, less clarity about how they get there, which actually really does indicate more service intensity in terms of how they get there, which is more activity certainly for us. If I can pivot a little bit and follow up on some of the North America questions. Obviously, here, you've stated you talked about there's probably upside to North America that you don't see pricing pressure unfolding in pressure pumping, supply chain constraints, probably upside to demand. But we do get a lot of questions around pressure pumping and the risk of pricing. And really, those questions revolve around kind of lower tier fleets and kind of investors kind of asking about who has the high end fleet to the lower end fleet. So I don't know if you could take a moment and just talk about how many -- what percentage of your fleets are kind of Tier 2 diesel where if you were to see some pricing pressure, that's maybe where you would see it if you would see any? Look, I don't see that in our business today at any level of equipment. In fact, all equipment is called for. Clearly, we have a strong environmentally -- a low emissions fleet as well that's probably at the higher end of price deck. But even at the bottom end of the price deck, our equipment -- we've systematically replaced equipment over time. And so we're really pleased with the fleet that we have and even a Tier 2 dual fuel equipment is in demand, most certainly. But what I'm most impressed with actually is sort of the strong market pull that we see around our e-fleets. We've got strong customer demand and especially I'm seeing repeat customers, which is terrific, where it's not one but two to the same customer are all fully contracted. And I think that's just an indication of the strength of our technology, it's proven, proven technology. I believe it's a better mousetrap. And quite frankly, we have a very strong IP portfolio and I think that is going to continue to be important. Congratulations and well done on the quarter. I'd like to come back to some of your guidance and expectations for the international market. As we look at '23, you said kind of 15% but bias to the upside of that. I was just curious what what finished the year strong in '22, maybe better than expectations and sort of feeds into that expectation of, let's say, at least mid-teens to higher as we think about international in '23. Look, I think it's sort of like everything is pointing at busier '23 than '22. That comes in the form of tender pipeline, that comes in form of sort of backlog increasing, product backlog that we've seen strengthened throughout the year and all of that sort of point -- I mean all of it points to '23, maybe even into '24. Discussions with customers, sort of the intensity of customers, view of staying busy and producing more barrels sooner rather than later. It's a very favorable market. And so it just gives me a lot of confidence in the outlook for '23 and particularly from our standpoint where we sit with technology and our global footprint. And then on the supply chain side, not just yours, but the one you see for the industry. Any areas you think continue to have, let's just call it, headwinds broadly as we look at '23, something that would slow project development or acceleration in '23? Yes, I don't see anything that slows things down. Are there things that have extended lead times today, we're still working through some of that. But I don't think anything meaningful gets in the way of getting started. I think we still see inflation in the marketplace. So that's one of the ways that we saw for getting things. But I don't think that it's going to be a headwind necessarily. We're starting to see rigs come back. There will be a lot of work around getting those ready in some places. But clearly, motivated customers and there will be some -- as I said, some inflation to get all of that done, but I don't see those as headwinds. Jeff, you mentioned a very full completion calendar here in the US. A quick question on that topic. Does that pertain to the fleets that the new e-frac fleet will be coming in to replace. My question relates to, is there work already lined up that would keep the legacy fleet fully deployed or those fleets need to be bid on to new jobs? Look, no, we've got everything as spoken for in '23, whether replacement or not, I think over time, e-fleets, replace fleets, but they don't do it initially. And so there'll be some period of time where fleets take the place of legacy fleets, but that's not what we see in â23, we see everything busy in '23. Got you, that's encouraging. And then turning to D&E margins, it's another nice year of expansion there. And obviously, you guys have had internal initiatives that structurally lift those margins, but you also have a number of tailwinds today from pricing to mix. How should we think about any incrementals this year youâre willing to provide some color there? And overall, how should we think about where you could take D&E margins over the medium to longer term. I was looking back at our model and your D&E margins basically match where they were last cycle. So think about whether you guys can get to the 20% plus margin that you witnessed back in the late 2000s if this up cycle sustains? Look, I think that I've always said, we've invested in technology and D&E in a meaningful way. We expect those margins to continue to move up. As you just mentioned, they have consistently moved up and that's on the back of technology and footprint and where we are, and I expect that trajectory to continue beyond where we are today or where we were last cycle. And so the outlook would be to continue to stack year-on-year quarters that are better than the last year. And so I have a lot of confidence in our outlook for D&E where they could go '23 and beyond. So I think two things for me, if you don't mind. Can you talk a little bit on the domestic pressure pumping side. Obviously, I know you guys are pretty much sold out for the year. What are you seeing in the market as far as new build supply demand fundamentals as we look three, four, five quarters out, because I know you guys are -- you got your finger on the pulse there, I'm just curious what your take is on the overall market growth or lack thereof in supply? Look, I think the market is certainly undersupplied today. And I think that attrition is happening every day even if it doesn't happen necessarily at the fleet level, but it does happen at the unit level. And part of the way that got solved in 2022 was through industry consolidation. So that's one method of dealing with attrition is bringing in more inventory and equipment. And then the other, as I look out throughout the year, all of '23, I mean, half the capacity additions that we've heard about are electric. And I think what's being realized in the field is electric is harder to do than it looks. And from our perspective, we have proven technology, we have technology with a track record, and we have a very strong IP portfolio around frac. And so I think that combination gives me a lot of confidence, a, in where we are and also that the market won't be oversupplied. And just as a follow-up, we've seen consolidation in the US pressure pumping space. And some of the larger competitors are doing things to kind of make themselves have a higher revenue content at the well site, right, different types of vertical integration or well site integration. Have you seen any change in the competitive landscape at the well site? I mean, obviously, now everybody is busy. But just in general, has there been any change in the way your competitors are competing with Halliburton? No, I don't see any change there. when I think about sand -- you're talking about sand, and when I think about sand, we've got very good suppliers in the sand business. We work well with them. And then I think about competitive advantage, I mean, real competitive advantage. What are things that we do to create competitive advantage. And we want to spend our dollars on things where we do have clear competitive advantage, which is in this case, pumping technology and then drilling technology, software, things where we clearly have competitive advantage. I view sand clearly as an input, it's an important input, we need access to it but at the same time, don't want to overinvest in that part of the business. Thank you, Catherine. As we close out today's call, let me just close out with this. In this strong market for oilfield services, I am confident that Halliburton will execute on its strategic priorities and deliver financial outperformance. I look forward to speaking with you next quarter. You can close out the call.
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EarningCall_1228
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Good morning. Thank you for joining Dow's fourth quarter earnings call. This call is available via webcast, and we have prepared slides to supplement our comments today. They are posted on the Investor Relations section of Dow's website and through the link to our webcast. I'm Pankaj Gupta, Dow Investor Relations Vice President. And joining me today on the call are Jim Fitterling, Dow's Chairman and Chief Executive Officer; and Howard Ungerleider, President and Chief Financial Officer. Please read the forward-looking statement disclaimer contained in the earnings news release and slides. During our call, we will make forward-looking statements regarding our expectations or predictions about the future. Because these statements are based on current assumptions and factors that involve risks and uncertainties, our actual performance and results may differ materially from our forward-looking statements. Dow's Forms 10-Q and 10-K include detailed discussions of principal risks and uncertainties, which may cause such differences. Unless otherwise specified, all financials where applicable exclude significant items. We will also refer to non-GAAP measures. A reconciliation of the most directly comparable GAAP financial measure and other associated disclosures is contained in the Dow earnings release, in the slides that supplement our comments today as well as on the Dow website. On Slide 2, you will see the agenda for our call. Jim will begin by reviewing our fourth quarter results and operating segment performance. Howard will then share our outlook and modeling guidance. And to close, Jim will then outline our competitive position for long-term value creation. Following that, we will take your questions. Thank you, Pankaj. Beginning on Slide 3. In the fourth quarter, Team Dow continued to take proactive actions to navigate slower GDP growth, challenging energy markets and customer destocking. We proactively lowered our operating rates to effectively manage working capital, implemented operational mitigation plans and cost saving measures and prioritized higher-value products where demand remained resilient, including in functional polymers and performance silicones as well as in mobility, renewable energy and pharma end markets. These actions, combined with our continued focus on cash enabled us to deliver cash flow from operations of $2.1 billion in the quarter. Cash flow conversion was 166%, and we returned $620 million to shareholders. Dow's cash generation reflects our continued focus on operational and financial discipline, which was important as we navigated an extremely dynamic year in 2022, as you see on Slide 4. In the first half of the year, we capitalized on strong demand across our diverse global portfolio while leveraging our derivative and feedstock flexibility and low-cost positions to mitigate higher raw material and energy costs. In the second half of the year, economic conditions deteriorated driven by record inflation, rising interest rates, ongoing pandemic lockdowns in China and continued geopolitical tensions. In the face of these evolving market dynamics, Dow was resilient, generating cash flow from operations of $7.5 billion for the full year. While executing our disciplined and balanced approach to capital allocation. We delivered returns on invested capital of 15%, above our 13% across the economic cycle target, as we prioritized higher return, lower risk and faster payback investments. We achieved credit rating and outlook upgrades as a result of our strengthened balance sheet, and we have no substantive debt maturities due until 2027. And we returned a total of $4.3 billion to shareholders, including $2.3 billion in share repurchases and $2 billion in dividends. At the same time, we continue to advance our Decarbonize and Grow strategy and accelerate circularity to create long-term shareholder value as we meet growing customer demand for more sustainable solutions. I'm proud of how Team Dow continues to deliver for our customers, drive shareholder value and support our communities as we progress toward our 2050 carbon neutrality target, and you can see a number of those highlights depicted on this slide. Now turning to our operating segment performance on Slide 5. In the Packaging & Specialty Plastics segment, net sales were $6.1 billion, down 16% year-over-year as price gains across all regions and functional polymers were more than offset by lower polyethylene and olefin prices. Volume declines were driven primarily by lower olefins and packaging demand in Europe, which was partly offset by a resilient global demand for functional polymers. Sequentially, net sales were down 17% driven by lower hydrocarbon sales and polyethylene prices. Operating EBIT for the segment was $655 million compared to $1.4 billion in the year ago period, primarily due to lower integrated polyethylene margins. Sequentially, operating EBIT was down $130 million as lower raw material and energy costs were more than offset by lower polyethylene prices and operating rates. Moving to the Industrial Intermediates & Infrastructure segment. Net sales were $3.7 billion, down 20% from the year ago period. Volumes declined primarily due to lower demand in Europe for industrial, consumer durables and building and construction applications. Sequentially, net sales were down 10% as seasonal demand increases for deicing fluid were more than offset by declines in building and construction, consumer durables and industrial applications. Operating EBIT for the segment was $164 million compared to $595 million in the year-ago period, driven by lower demand and increasing energy costs, particularly in Europe. Sequentially, operating EBIT margins expanded by 40 basis points as lower energy costs versus the prior quarter were partly offset by lower volumes. And in the Performance Materials & Coatings segment, we reported net sales of $2.1 billion, down 20% year-over-year as local price gains for performance silicones and architectural coatings were more than offset by lower prices for siloxanes and acrylic monomers. Volume was down as resilient demand in mobility was more than offset by declines primarily in building and construction end markets. Sequentially, net sales were down 22% due to seasonally lower demand for coatings, industrial and building and construction applications as well as local price declines for siloxanes and acrylic monomers. Operating EBIT for the segment was a loss of $130 million compared to earnings of $295 million in the year-ago period due to local price declines primarily in siloxane and lower operating rates in the quarter. Sequentially, operating EBIT declined $432 million, driven by lower prices, demand and operating rates. Thank you, Jim, and good morning, everyone. We expect the market dynamics we experienced in late 2022 to continue into early '23. While the pace of inflation has moderated, overall cost levels remain elevated, which has continued to trigger tighter monetary policy in most parts of the world and is weighing on both business investment and consumer sentiment. The majority of economic forecasts are calling for slower GDP growth globally relative to 2022, although dynamics differ by region, with most regions except Europe still forecasting positive year-on-year growth. In the U.S., we see signs of moderating demand and the continuation of year-end destocking trends early in the quarter. Building and construction end markets have been particularly impacted by inflation and rising interest rates with housing starts declining by more than 20% year-over-year in December. Manufacturing PMI contracted for the third consecutive month of 48, while light vehicle sales in the U.S. were down for the full year by 8 percentage points. Easing inflation is leading to improving consumer confidence, albeit from depressed levels in late 2022, while consumer spending remains resilient. In Europe, we expect demand to remain constrained despite recent improvements in regional energy prices. While the move to five-year highs in gas storage is a positive sign, changing weather forecasts are leading to volatility in the futures markets. High inflation and geopolitical tensions continue to weigh on consumer spending and industrial production. December manufacturing PMI has been contracting since July, and construction PMI reached its lowest level since May. In China, while we're very encouraged by recent ships in COVID policy to ease restrictions and open up orders, we expect these actions to take some time to improve economic activity. This is an area we're closely monitoring as it has the potential to provide a source of significant demand recovery following the Lunar New Year. And in Latin America, overall economic growth is expected to slow, driven by political tensions, high inflation and restrictive monetary policy. Given this dynamic backdrop, we will continue to take a region by region, business-by-business approach to managing our operations and adapting our businesses to the evolving market realities. Turning to Slide 7. As we highlighted at our last earnings call, we are proactively responding to the current economic environment with a playbook of targeted actions to deliver $1 billion in cost savings. This begins with maintaining a low cost to serve operating model by implementing actions to optimize our labor and service costs, including a global workforce reduction of approximately 2,000 roles. We will continue to increase productivity with end-to-end process improvements now that our digital foundation is in place, and we will also shut down select assets while further evaluating additional actions across our global asset base, particularly in Europe to ensure long-term competitiveness while also enhancing our cost efficiency. These structural actions are expected to deliver a total of $500 million in EBITDA savings this year. Additionally, we will deliver another $500 million of savings through actions to maximize cash flow while reducing our operational expenses. This includes decreasing turnaround spend, purchased raw materials, logistics and utilities costs. Importantly, we will do this while maintaining safe and reliable operations, which, as always, remains our top priority. These proactive actions will optimize our cost structure in response to the near-term macroeconomic uncertainty while maintaining our long-term value-creation focus. Turning to our outlook for the first quarter on Slide 8. In the Packaging & Specialty Plastics segment, improving logistics and lower operating rates led to the fifth consecutive month of inventory declines for U.S. polyethylene in December. Reduced global operating rates are continuing to drive feedstock and input costs down with ongoing destocking through the value chain impacting functional polymer strength and demand in Europe. While lower turnaround costs will be a sequential tailwind, we expect lower demand levels in Asia to impact equity earnings and lower nonrecurring licensing activity from the prior quarter will impact earnings. In total, we expect a $75 million headwind for the segment sequentially. And the Industrial Intermediates & Infrastructure segment, demand remains stable for energy markets, and we're monitoring demand for deicing fluids with a warmer than average winter. However, inflationary pressures in contracting PMIs continue to impact industrial demand, and we expect lower seasonal volumes in building construction end markets. We also anticipate an approximately $25 million headwind due to a third-party outage, which is causing a supply disruption on the U.S. Gulf Coast from winter storm Elliott. And in the Performance Materials & Coatings segment, we expect demand recovery for performance silicones following year-end customer destocking as well as improved supply availability and lower costs. However, we also anticipate lower siloxane pricing in the quarter as we continue to see pressure from increased industry supply. We expect higher planned maintenance turnaround costs in this segment at our Deer Park acrylic monomer site in performance monitors. All in, we anticipate a $25 million tailwind for the segment. In total, we expect the first quarter to be in line with the fourth quarter performance with the $75 million in discrete headwinds I mentioned. Turning to the full year. We're continuing to provide our best estimates of several income statement and cash flow drivers. I will highlight a few notable year-over-year inputs. We expect lower equity earnings in the year down approximately $300 million to $400 million. Total turnaround spending is anticipated to be down by $300 million as we implement our playbook of cost savings actions while maintaining safe and reliable operations. We expect share count to remain relatively flat as we plan to continue covering dilution. And finally, we anticipate increasing our capital expenditures to $2.2 billion, well within our D&A of $2.8 billion as we continue to advance our higher return, faster payback projects and continue to execute on our decarbonized and growth strategy. Overall, the macroeconomic backdrop remains dynamic in 2023, we see the potential for additional upside from higher oil to gas spreads, reopening in China following the Lunar New Year and easing inflation and supply chain constraints. We also continue to pay close attention to a range of indicators, including pressure from higher interest rates on building and construction, PMI levels, global energy markets and geopolitical dynamics. Dow remains well positioned based on our global footprint, feedstock flexibility and the sustainable solutions we provide for our customers. We will continue to leverage these competitive advantages to deliver long-term value for our shareholders. Thank you, Howard. Moving to Slide 10. While the near-term environment remains challenging, we continue to see attractive secular trends across our market verticals of packaging, infrastructure, consumer and mobility. With resilient cash flow generation and a strong credit profile, we are well positioned to continue advancing our Decarbonize and Grow strategy to capitalize on these opportunities. We Delivered on our growth investment commitments outlined in early 2022. These investments are expected to collectively generate $2 billion in run rate EBITDA by the middle of this decade. In Packaging & Specialty Plastics, we mechanically completed and began final commissioning of our FCDh unit in Louisiana in the fourth quarter. This breakthrough propylene technology features up to 25% lower capital outlay while reducing energy usage and greenhouse gas emissions by up to 20% versus conventional FCDh units. In Industrial Intermediates & Infrastructure, our latest alkoxylates capacity investment in the United States was completed in the third quarter of 2022, and our next in Europe will be completed in the first quarter of this year. These projects will further serve high-value markets in home care and pharma and are just a start. Our next wave of alkoxylates capacity investments remain on track. In fact, Dow has already successfully begun locking in supply contracts with several consumer and pharmaceutical customers to support the next wave of growth. And in Performance Materials & Coatings, we completed 16 downstream silicone debottleneck projects in 2022 to meet demand for high performance, building and construction, personal care and mobility applications. Additionally, we accelerated the delivery of our digitalization initiatives and now expect the full $300 million run rate EBITDA to fully materialize by the end of 2023, well ahead of our prior target of 2025. As a result, we anticipate our digital sales to comprise 50% of total revenue by 2025. Looking forward, we expect to continue growth investments in our global operations, including key capital investments in higher-margin polyurethane systems and additional alkoxylate capacity, incremental projects to expand downstream, high-value ethylene derivative capacity and continued coatings and silicon debottlenecking projects. We will also continue progressing our operating investments to improve production capabilities and reliability as we shift our product mix toward higher growth and higher-value markets. Turning to Slide 11. Decarbonizing our assets and driving circularity remains a significant growth opportunity for Dow. We have a clear road map to reduce carbon emissions by another 5 million metric tons by 2030. We continue to invest in innovative, renewable energy and efficiency technologies, such as our collaborative program with Shell to electrically heat steam cracker furnaces, which is on track to start up in 2025. In Alberta, we reached a preliminary investment decision for our past to Zero project, and we are working with the Canadian government to confirm necessary incentives so that we can make a final investment decision by the end of this year. And our Terneuzen 2030 project, where we have a clear road map to reduce carbon emissions at the site by more than 40% by 2030 is making progress as we secure partner and government agreements and subsidies. We are also advancing our transform the waste target to commercialize 3 million metric tons of circular and renewable solutions annually by 2030. By leveraging our pipeline of strategic partnerships to invest in innovative solutions and scale up production, we are well positioned to meet this growing customer demand in a disciplined and capital-efficient manner. Most recently, Dow and WM announced a bold new collaboration to address hard-to-recycle plastic films by enabling them to be placed directly into residential curbside recycling. By 2025, the program is expected to divert more than 120,000 metric tons of plastic film from landfills. We continue to see sustainability as essential for our long-term earnings growth. Altogether, by 2030, we remain on track to deliver $3 billion in underlying EBITDA improvements while reducing Scope 1 and 2 emissions by 30% compared to our 2005 baseline. Turning to Slide 12. The actions we've taken since spin to strengthen our balance sheet while improving our financial flexibility and operating cash flow generation are enabling us to be more resilient as we deliver on our capital allocation priorities across the economic cycle. Our free cash flow performance is now more than tripled on a trailing 12-month basis. We substantially improved our liquidity position, ending the year with nearly $14 billion. And through our disciplined and balanced approach to capital allocation, we've significantly reduced our liability profile with a combined reduction of more than $11 billion in our net debt and underfunded pension position since spin. Closing on Slide 13, we have a clear playbook of actions to drive resilient performance in the near and long term. We have plans to achieve $1 billion in savings through targeted actions to increase efficiency and maintain a low-cost structure that is best in class. We're maintaining a strong financial position with a continued focus on disciplined and balanced capital allocation, and we're advancing our Decarbonize and Grow and circularity strategies, delivering incremental run rate EBITDA improvements through the end of the decade, positioning us for an economic recovery while lowering our carbon dioxide emissions. As we leverage our competitive advantages, operational agility and focus on cash flow generation that has served us well since spin, we will continue to deliver long-term value for our shareholders. Thank you, Jim. Now let's move on to your questions. I would like to remind you that our forward-looking statements apply to both our prepared remarks and the following Q&A. Operator, please provide the Q&A instructions. Good morning everyone. Wondering if you could just unpack the outlook for Performance Materials & Coatings a little bit. And it sounds like there's just a lot of moving parts right now with weak China in the fourth quarter but now reopening, some issues with new supply coming into the market. So obviously, uncertainty about how far and how fast China will reopen. But could you give us sort of the range of outcomes for how this segment might recover as we move through the year, representing that it could be a wide range? Sure. Good morning, Vince. Thanks for the question. First, I think it's important to look back at the fourth quarter on PM&C and understand the fourth quarter. Coatings and Performance Monomers kind of got back to the normal fourth quarter seasonality that we would see, which a year ago was very different because we were still recovering from all the supply disruptions from winter storm URI and everything else that was associated with that. So I think you'll see that they'll come back to a more normal season in 2023. And you also saw the impact of destocking. Destocking in the fourth quarter represented, and this is across the businesses, about 50% to 60% of the slowdown that we saw in the fourth quarter. So I think the destocking is going to work itself through in the first quarter. And then I think you'll see us get back to normal seasonality there. I do think positively on China for coatings and performance monomers. I do think we're seeing China opening up. We're not seeing issues with people coming to work. So I think we're optimistic that the government will probably try to stimulate the construction economy there, and we'll start to see that take off through the year. On silicones and siloxanes, you had two impacts. One was the market impact of things slowing, which was the lower siloxane prices that hit hardest in China, obviously, at the end of the year. The other one was self-inflicted. We happen to have all three of the silicones pillar plants, the siloxanes pillar plant down at some point in the fourth quarter. And that lower operating rate really hurt us. They're, all 3 back up and running. So I think that issue is behind us. So I would expect you'll start to see siloxanes demand pick back up. We saw destocking in all the downstream areas in silicones, personal care, home consumer goods, and we also saw it, obviously, in building and construction. I think that will start to rebound as the year progresses. Thank you. Good morning. Jim and Howard, given the recent decline in European natural gas prices, how are you thinking about the competitiveness of the European operations going forward? Good morning David. Very good question. Obviously, the European situation has been tough on all the European producers over this past year. In fact, if you think about the year-over-year performance for Dow for the full year, 60% of the decline in EBIT was related to Europe and that energy situation. So this is very targeted. Incrementally, we saw a step change in the fourth quarter, obviously driven by the warmer winter and the inventory levels being back up. And they've done an admirable job, especially in Germany, of switching away from Russian natural gas over to other sources. So that has helped. But we still have to take a look at long-term energy policies and work with the governments, both EU and the member states on energy policies because we're a long way away from long-term competitiveness in Europe. I would say the decisions we announced today around restructuring, right now, we've looked at locations that are going to be challenged in any scenario long term, and we'll take actions on those. But on large sites, like our large cracker sites, we're still able to run cash flow positive, and we're working hard on that energy situation. We'll continue to analyze that through this year and see what kind of work we can do with the governments there to make them more competitive long term. Good morning Jim and Howard. A nearer-term question around your guidance. First part of the question is, it seems you guys, as I look at segment level guidance, you're guiding to Q1 EBITDA of $1.2 billion. So, first part of that question is, is that correct? And then part and parcel with that question, it seems that there are 2 $0.05 a pound price hike announcement for polyethylene in the U.S. for January and February. And then, obviously, we've seen these preceptors declines in natural gas prices in Europe. So, in this $1.2 billion EBITDA guidance that you guys have given for Q1, how much of those U.S. polyethylene price hikes have you factored in? And how should we think about factoring in for Q1, those declines in natural gas are good. Good morning Hassan. Good question. Obviously, the outlook -- I would go back to integrated margins and take a look at our outlook and our expectations for integrated margins in the quarter. We think both in the U.S. and in Europe, they'll be up about $0.04 on integrated polyethylene margins. I would say, yes, natural gas costs have come off. We see a fair amount of benefit in that, obviously, from PMC, which is a large energy user. And so that helps in a location like Stade. But we only really are cracking natural gas to any big degree in Terneuzen and some in Tarragona. So it has a little bit more limited effect there. Most of the rest of the economics are naphtha. I do think prices -- obviously, fourth quarter to first quarter, you've got to remember, we start the quarter with a lower base and then we build up from there. So you're going to have some of that lag effect that bakes into it. That's part of the guidance. And then we also are expecting a little bit of destocking to still continue into the quarter from a volume and operating rate perspective. So those are the big things that went into the guidance. Anything else you want to add, Howard? Yes. Thanks, Jim. And Hassan, thanks for the question. I would say you got the number right. I mean, it's around $1.2 million. At a high level, there's really 3 moving parts we expect Q1 on balance to look pretty much like Q4 with three discrete items. So as you know, our licensing business is lumpy. We had a large sale in the fourth quarter of $75 million that will not repeat in Q1. We're dealing with a third-party gas supplier in the Gulf Coast that's still having issues post winter storm Elliott that's impacting our DIS business, which is in our Industrial Intermediates segment. That's a $25 million sequential headwind. And then there's a $25 million sequential positive tailwind on lower turnaround expenses at the enterprise level. That's a $50 million tailwind in P&SP, but offset by a $25 million headwind in PM&C, which is the Deer Park asset. Yes. Good morning. Jim, it seems like the European chemical capacity is now the high-cost marginal capacity instead of China and European capacity will be flexed with demand ups and downs. Would you agree with that statement? And then in polyethylene, as you mentioned, China reopening is positive. Assuming that do you expect somewhat of a snapback in polyethylene as a result? Or is it more of a gradual recovery in first half? Thank you. Yes. Good morning P.J. Both good questions. I would say in Europe, I would think about it in two ways. First, I would think about the crackers. And I would say from a cracker economic standpoint, yes, on a naphtha basis, they have become incrementally the highest cost on the assets that are able to crack LPGs like Terneuzen and Tarragona and where utility costs are lower like in Spain. They probably are fairly competitive with that Asian situation. So we haven't flexed as much up and down in Europe on the cracker operations. They've run at pretty steady rates throughout. We did flex up and down a bit when it got into our II&I business like polyols, polyurethanes, isocyanates in Europe, where the energy cost at STADA and Germany are much, much higher. And so what you would see there is we have some amount of that energy cost, that is very competitive and at a low rate, but then the increment is much higher. So we would run to that competitive rate. And I think that is what still continues to be in the front window and the thing that we have to address with the government. China. Yes. Look, I think it's going to be positive. We had growth in the fourth quarter in packaging, especially plastics and Industrial solutions. The places that were weakest for us were anything related to building and construction, so polyurethanes, construction chemicals, coatings and monomers, although that was fairly even quarter-over-quarter. And then Consumer Solutions because of the, as I mentioned, siloxane prices and also our asset being down there. For the year, we had growth in Packaging & Specialty Plastics, Consumer Solutions and Industrial Solutions, pretty good growth. And it was really construction businesses that were the most impacted. Construction is 25% of China's economy. It was off 40% last year. I'm certain that the government is going to try to stimulate that and get that going again. I don't know how fast it will happen. As I mentioned, we're not seeing any big COVID spreads that are unmanageable right now. People are reporting into work, and I'm hearing this from other CEOs as well, people reporting into work, things are moving as expected. So I do expect we're going to see a little bit of positive move from China. Thanks very much. Two-part question. Your local price in Industrial Intermediates & Infrastructure was down 1%. Was that a combination of puts and takes, that is some chemicals were up and some chemicals were down? And can you talk about MDI pricing? And then secondly, for Howard, what kind of working capital benefits do you expect for 2023? Can you have a working capital inflow of $500 million or $1 billion? Can you size that? Good morning Jeff. Good questions. On II&I, we actually had higher prices in polyurethanes and construction chemicals and it was volume that was the offset there. And remember, that business has a fairly large footprint in Europe and the input costs are much higher there and so that was part of it. We also saw that Industrial Solutions pricing held up relatively well. And again, it was volume that slowed. So both of them had very resilient prices but saw some volume slowdown and a little bit of currency impact. I'll let you answer the second part of that, Howard. Yes. Thanks, Jeff. Look, let's start with the fourth quarter on working capital. That was actually a tailwind versus the prior quarter, so sequentially of $1 billion and more than $400 million versus the same quarter last year. I would say it really depends on what's going to happen with feedstock costs and revenue growth. We're certainly expecting some volume growth as we move through the year, especially with Jim's comments on China reopening. And overall, global GDP growth is still expected to be positive of around 1.5%, which should drive some industrial production and should drive some growth. You know that since spin, we've been very focused on working capital. We're continuing to target a couple of days of structural working capital improvement. So I would say, at a bare minimum, we're looking at $200 million to $300 million of working capital improvement 2023 versus 2022. I'm very proud of the Dow team on their focus on cash flow. When you look at what we've been able to do since spin, we have actually improved our cash from ops every single year, 2019 through 2022. And last year was $7.5 billion of cash from ops and $400 million better overall than 2021. And so one of the ways we do that is work on working capital. We're also working on other unique to Dow cash flow levers. I estimate that is around inclusive of that $200 million to $300 million working capital, we're focused on $1 billion of pulling on $1 billion of unique to Dow levers. Working capital is certainly one of them. The other one, as you saw in the fourth quarter, we successfully concluded 1 of the 2 big novo litigations that we have. We're hopeful that we can solve the second one or resolve the second one in calendar year 2023. That could be another up to as much as $0.5 billion of unique Dow cash that we expect. And then we've got a few other projects that are in the works to round out that $1 billion. Thanks for taking my question. So it seemed like the destocking was kind of at really accelerated levels in the fourth quarter. Can you give us a little bit of color as to which of the segments do you feel like you're largely through that? And if anything, you may be -- maybe we're even at a balance side or even a restock phase? And I guess tied to that, -- can you speak to the operating rates you saw in the fourth quarter and how you expect that to change as we look to 1Q? Sure. Good morning John. Good Question. I would say it accelerated in December. We made announcement in October that we were going to reduce some operating rates in ethylene, polyethylene because of some logistics constraints and other things that happen. We saw better logistics in December. December was our best export month of the year for marine pack cargo, so that's positive. But at the same time, manufacturing activity in the last half of December really slowed. And so you could see that in the order pattern. And that stayed relatively slow the first half of January. I do think we're seeing manufacturing activity come back right now. We're seeing that in the order book. I would not say that we're at a restocking state yet. But I do think as the quarter progresses, we will get there because second and third quarter are typically our highest volume quarters. And there is not a lot of excess inventory anywhere in the change right now. So I do think it's coming, but it isn't here as we sit here right now today. Hey, good morning guys. What was the impact from the lower operating rates in the fourth quarter on EBITDA, meaning if you were at normal operating rates, what would that be? And then is that impact similar for the first quarter? And when do you think you can see your operating rates sort of improve back to normal rates in '23? Yes. Just to give you an idea, I would say, probably you saw because of destocking, you probably saw a 10% lower operating rate due to destocking. Rough numbers, Howard, where do you think, [indiscernible] million. Yes, I would say 10 percentage points. And that's -- I mean, when you think about every percentage point. Yes, look, I would say it this way, Mike. When you look at the sequential decline in probably two-thirds of that EBITDA drop was because of the destocking. And then the other balance was really the seasonal -- just a seasonal sequential decline because we're in more of a Northern Hemisphere business. And obviously, our coatings business typically is a seasonal low point in the fourth quarter. Yes, thank you. That 2,000-headcount reduction, how much of that is these assets in Europe that you're planning to shutter? Or can you highlight what operations, is this commercial or back-office headcount? And then just one other quick one. Your partnership with Mura, when that's at scale, you're using the pyrolysis oil as cracker feedstock, how would you expect the profitability of that versus naphtha or ethane-based feedstock? Sure. Good morning Steve, good questions. 2,000 headcount reduction is not all specific to Europe, although Europe is a big part of the earnings decline that's driving us to take these actions. The site and asset decisions we've made so far are really smaller locations, smaller scale locations where we know they will be challenged through the year. We haven't released a list of those we're working through that with the European Works Councils, et cetera, but we will be doing that as we get toward the end of this quarter. But -- the $1 billion is really made up of two buckets: $500 million is structural cost reductions. That's the headcount reductions, that's productivity and end-to-end process improvement. So we're really building off that digital work we've done, and that would work on improving processes and customer service and then the asset decisions. And then $500 million will just be reduced spending, turnaround spend, which Howard had mentioned, $300 million, leveraging our volume on lower purchased raw materials, logistics and utilities because we do see some supply/demand imbalances and the ability to do that and just tightening the belt to this environment. So I would say I don't -- it's not a haircut 5% of the workforce. It will be targeted, and we target around asset decisions. It will be targeted around businesses that need to tighten. It will be targeted around -- it's not just Dow headcount. We will have contractor reductions as well at the sites. And so we'll look at it that way. On Mura, on our transforming the waste target. Right now, when we talk to you at Investor Day in 2021, the premiums vary by technology. But they continue to be greater than about $1,000 a metric ton. And the supply demand -- the demand is out there right now, and it's in excess of the supply. I think as the supply increases, there will be pressure on that, obviously. But there's a big imbalance right now between what the consumer brand owners want and what's available out there. So I do think you'll see margin expansion in that part of the segment. There will be some higher costs weâre doing that, but there will -- I think the premiums will more than cover that. Yes, good morning. Jim, I'd welcome your thoughts on the supply side of polyethylene. We've seen spot prices start to percolate higher over the last 3 or 4 weeks. So I was wondering if you could comment on where you see downstream inventory levels among converters at this point? And also if I rewind to maybe September, we had a lot of purposeful throttling back of operating rates from Dow and others that dovetailed into winter storm Elliot in late December. I think at least one of your competitors has declared force majeure on a tornado of all things. So if we look at that holistically, do you think there's enough supply disruption to kind of rebalance the polyethylene market and move higher from here? Good morning, Kevin. I think there has been enough, obviously, to give good momentum to these price increases in the first quarter. And so I think we will see the margins expand, as I mentioned earlier on one of the other questions. From a supply side standpoint, it's also worth mentioning that I'm really proud of the team. After winter storm Uri, we took our playbook and we said, how do we -- if this happens again, how do we make sure that we don't have any production losses due to freeze? And we were able to navigate this freeze with winter storm Elliott, and we had no problems with polyethylene plants or crackers. And right now, as we sit here, about 37% of the ethylene capacity in the Gulf Coast is still off-line. And so that's an advantage to us. And as Howard mentioned, the only issue we've had is with an industrial gas supplier at one of our sites in Louisiana for our Industrial Solutions business. That's been our only blip, and I don't think they did the same kind of work. I do think China, to P.J.'s question earlier, China is making an impact. We saw that in December. I think we're going to continue to see that in the first quarter. Inventories there are managed well. Inventories here, five consecutive months of reduction in the ACC inventory data inventory is 45 days. That's pretty standard inventory levels. And I think everybody, not just converters, but consumers, brand owners, everybody in the value chain at the end of the year was watching inventories and managing cash into a slow end of the year. We had a pretty strong end of the year in 2021, and in 2022, we kind of reverted more to the normal slower end of the year dynamics. We do have to keep an eye on capacity coming on. But I would say our outlook for the year is probably about the same amount of capacity off-line as last year. And so if demand kicks back up here and there's some restocking that happens, that will set us up well for second and third quarter. I would also just add that another bright spot that we see as we head into 2023 is the improving situation marine pack cargo and the ability to export out of North America. I mean, I can't speak for our peers, but certainly, we certainly have ramped our capability. And so that really should not be a bottleneck at least for the first half of the year, and don't have the visibility in the second half, but certainly as we ramp through the balance of Q1 into Q2, we should see increased marine pack cargo exports out of the U.S. Good morning. This is Matt Skowronski on for John. Two commodities that Dow participates in, siloxanes and MDI, have had competitor capacity come online recently. You called out weaker pricing in siloxanes in your guide for the first quarter. But can you just talk about how long you expect it to take for pricing these commodities to recover? Yes, good morning. And thank you for the question. I think we'll see a little bit of demand improvement. But siloxanes prices have fallen to their lowest levels in some time at the end of the year, and so we start the year at those levels. I don't think we're expecting any immediate improvement. The downstream demand still continues to be good. Building and construction will be the thing that I think will start to tip it to the positive. So if we see a good rebound in building and construction in China, that should start to pull things to the positive and lift things up. North America has been fairly resilient. And North America and Europe are typically slightly higher than the Chinese prices, and that continues to be the same case today. So I -- that's my outlook on siloxanes on. On MDI, I would say the biggest difference between what's reported in the markets on MDI in our view, is just what you believe about the RTO timing of some of the Chinese competitions, new plants that are coming online. I think our view is that, that's going to be stretched out over a longer period of time. Most of what's reported would have all that 4 world-scale MDI facilities coming on in 2023. I don't think that's our view of how that's going to happen. That would be more spread over the 2023 to 2025-time period. And so I think that will take some of that pressure off of MDI. Downstream demand for MDI and for systems and the application that it goes into is really good so I don't feel worried about that. That's purely what your assumptions are about -- that our new demand coming -- or new supply coming online and the time frame Great. Thank you so much. You have a very helpful slide given all your growth expansions on Slide 10. And obviously, there's been a lot going on regarding the and the polyethylene side over the last few years. But when we all take a step back, just given all the volatility and the macro headwinds, how should investors now be thinking about normalized earnings that we're thinking about '24 when we're looking out to '25 or even perhaps especially in the context of potentially lower NGL prices. Just do you have any updated thoughts on that? Thank you. Good question, Chris. I would go back that this is the basis of obviously, the earnings corridor slide that we put together and we shared last year and at earnings day back in 2021. And so if you look at it, I think we look at the midrange of the kind of the through-the-cycle range as being what we target for the growth. And that's kind of how we report the growth. And then peak potential would be when you would see those scenarios like you mentioned with lower NGL prices and higher oil prices. Now like we got into with 2021 and the first half of 2022, that was kind of peak levels for plastics. I do think the possibility exists that oil price is going to continue to be driving higher because we've had underinvestment in oil production, inventory is at the bottom of their five-year average. And if you started investing in oil production today, it would be three to five years before you would see any movement in that number. And I do think that any demand pull on that is going to start to move oil prices up, anything speculative that happens will move it up quickly because those inventory levels are so low. Meanwhile, NGL production is continuing to grow at a pretty good clip. I think it's going to be up pretty substantially here in the United States this year. And so that keeps costs down on NGLs. And so that's positive. So Canada, U.S., Argentina, I feel good about the positions we have there. Obviously, Kuwait, Saudi Arabia, we feel good about that. Our cracking into news and Spain. I think that's positive. So you've seen the high watermark for plastics, delivered $8 billion of EBITDA which is right in line with what we've got here with peak potential, EBITDA range. And I think we're trying to get in other segments up to that peak potential as well. So I feel good about where we're going long term, and that's also one of the reasons we wanted to make the investment in Canada, if all the conditions are right, we want to make that investment to continue to leverage that position. Hard to say what's going to happen with all that energy policy, plays a big part in it. I think the one thing that governments aren't correctly addressing is that all the things that we've passed for IRA, for new alternative technologies, that's all great. We're very supportive. It's a fantastic package. We also need some support for conventional oil and gas production because we are going to need a reliable power and natural gas is going to provide the low carbon reliable power for the foreseeable near future. I would also just say that, I mean, when you think about that earnings corridor of 6% to 12% and then moving to the middle of the decade into the $7 billion to $13 billion range with all the CapEx and OpEx investments we're making, if you just want to look at the mathematical average, right now, that's about a $9 billion normalized through the cycle. And then by the middle of the decade, that should be in the $10 billion range by the middle of -- in terms of the mathematical average in a normalized view by the middle of the decade. Thank you. And good morning. And Howard, thank you so much for giving us the mathematical average for 6% to 12% and 7% to 13%. I was having difficulty crunching that number. I want to come back to the cost savings, the $1 billion. You mentioned that in the first quarter, you can take a charge of $550 million plus. And I was wondering how much of that is cash versus non-cash? And then also on that slide, you mentioned that you're going to be reducing turnaround spending in '23 versus '22. And I'm curious if you could order -- give us an order of magnitude there? And does that suggest perhaps that 2024 will see an above average spend on turnarounds? Yes, Frank, you're welcome. I just -- that really -- my answer on the previous question was really targeted, all The Nets and The Jets fans out there. I just want to let you know that, make sure that you can do that math. Just a joke. Look, the $1 billion as we look at the end of the year run rate exiting into 2024, that $1 billion should become about $1.4 billion. We haven't set the turnaround budget for 2024 yet, obviously. But I could imagine if we just revert to a normalized turnaround and that could be -- the turnarounds could be potentially $150 million or maybe $200 million higher in 2024 than 2023 if we do one more cracker turnaround. So that would be the order of magnitude that I would expect. But still improving -- overall, the cost improving versus 2023. Oh, the cash -- we expect the cash outlay over the course of 2023 and 2024 to be roughly $800 million to $1 billion, in that range, about half this year probably and then the balance the other half in 2024. I think that's all the time we have for today. For your reference, a copy of our transcript will be posted on Dow's website within approximately 48 hours. This concludes our call. Thanks, everyone, for your time this morning. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
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EarningCall_1229
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Good morning and welcome to the ITM Power Plc Interim Results Investor Presentation. Throughout this recorded presentation, investors will be in listen-only mode. Questions are encouraged and can be submitted anytime using the Q&A tab situated on the right-hand corner of your screen, just click Q&A, scroll to the bottom, type your question and press send. Due the number of attendees on today's meeting, company may not be in a position to answer every question received. However, the company review all questions submitted, then we publish responses or approach to do so on the Investment Meet Company platform. Before we begin, we'd like to submit the following poll. Good morning and good morning, everyone on the call. Thank you for taking the time to participate. I would like to start by introducing myself. My name is Dennis Schulz and I took over the role as the new CEO of ITM on 1st of December 2022, which was two months ago. It doesn't feel like that I have to say, but just two months ago. Having with me 14 years of experience in the technology and EPC industry and related component in factory. I joined Linde in 2008 and had various positions in the company, among them as Head of Project Execution Services and as Head of Strategy and Mergers, Acquisitions, both in the company's headquarters in Munich. Since 2017 I led the restructuring of one of the site of EPC entities in Dresden, Germany. First as the CFO and then later as the Managing Director, taking over from my predecessor in 2020. During that time, I restructured and reshaped the company towards a new product portfolio, focused on predominantly green technologies in the area of CCUS, which is Carbon Capture Utilization and Storage and hydrogen predominantly, blue and green. In that capacity after Lindeâs investment into IDM, I was -- okay. No, we got the slide up. Thanks. In that capacity, after Lindeâs investment into IDM, I was closely involved in the strategic relationship of the two companies. And we had a great start by securing important customers reference projects and developing a 10-megawatt standard module which will be deployed for the first time in the projects announced today, the 2 times 100-megawatt Linde projects in Germany for RWE. But after a promising start on the sales side and I have to mention that all the ITM projects which were running through Linde were in my profit and loss responsibility from sales to execution. We found that ITM's project performance was falling behind expectations. And after that, I was then closely involved in collaborative efforts to try to overcome the issues jointly and mitigate delays to customer projects. In my role as Managing Director at Linde Engineering, I was also working with other electrolyzer OEMs, despite the most intimate relationship being with ITM. This certainly put me into a position where I have gained significant insight on the strengths and weaknesses of the different electrolyzer OEMs in the market. Personally, I'm a strategist, passionate chess player. I have a track record in restructuring and in turnaround, leading organizations and I'm well connected in the industry with customers and suppliers alike. I will now first hand over to Andy Allen, our CFO, to present you the interim numbers before I continue with the priorities going forward. Thanks, Dennis, and good morning, everybody. Thank you for joining us on the call this morning. So I will go through the interim results, they've been published this morning. They show a performance that's unacceptable and need some measures to address them and that absolutely can be part of the 12-month priorities in Dennis' presentation. So I will also take you through the revised guidance for FY 2023 and give you a steer towards what we might expect in FY 2024. So in terms of the performance, the revenue for the half year was £2 million against £4.2 million the year before. Gross losses were £45.6 million against £2.6 million the year before. And adjusted EBITDA losses were £54.1 million against £12.9 million year before. The important thing here and we'll go into some detail here is that, the bulk of those losses are non-cash movements, provisions based against project cost overruns and inventory costs, but we'll go into some more detail very soon. In terms of cash, we had £318 million at period end against £164 million before a function of the capital market raise we did just over a year ago. In terms of cash flow, total cash outflow for the period was £48 million against £12 million the year before. There's £42 million associated with operating activities and some of that is the buildup of inventory. And in terms of investing activity there was an outflow of £6.4 million, which includes £7 million of expense for capital projects. So the summary is we raised money to pursue an aggressive expansion strategy. And in doing so, we underestimated the skills and competencies that we required as a company to really get that volume going quickly. So that's led us to where we are today and the numbers that we are seeing here and we need to absolutely get from being an R&D company to a volume manufacturer of an industrial product. In the last two months, we formed a deep dive into the contributing factors and I'll share some of those on the next slides and you'll see more in Dennis's plan to follow. The vast majority of these actions will hit and impact FY 2024 and not necessarily make the guidance for this year change. So in terms of the summary, the revenue was £2 million against £4.2 million a year ago. A year ago though, we did have funded prototyping from base £2.8 million for prototyping next-generation stacks. You do see that actually product revenue is marginally up year-on-year. In terms of a case study, the Leuna project is the flagship that we need to talk about. We have experienced both delays and we've also seen a change in our delivery scope. What we're doing is we're splitting our deliveries. So the project consists of 12 2-megawatt modules. In the first half of the year, we completed factory acceptance testing for two modules. But as we've had delays, we've worked with Linde customer to really get the best and optimized delivery schedule. That means that we will split the delivery of the cubes and the stacks for the remaining 10 modules. So as of today all the cubes are on site. They are being installed and they now waste the stacks that we will produce and to sense on site. So for us revenue recognition is about finishing an obligation and an obligation in Leuna is the testing of the module, so cube and a stack. The first two modules tested at FAT as a complete module, means we can recognize revenue. For the last 10, they need to meet on site and we recognize revenue as they are deployed and tested on site. What does that mean for us? Actually, revenue is going to lag behind the work that we're completing projects. And we're also going to see we're now dependent on the wider FAT of the plant. So it's not fully within the control of ITM. This may affect other key projects including Yara and that's one for us to be aware of. So this is not revenue loss, the revenue deferred. In terms of gross margin, the gross loss was £45.6 million against a loss of £6.8 million the period before. There are three contributing factors here: project cost overruns inventory losses and warranty provision uptick. And this slide covers both warranties and the project cost overruns. So against a full portfolio of £49 million worth of revenue, we've seen overruns in the period of £29.9 million. The contributing factors to that, if you look at the graph first, you see actual costs incurred in the period of £10.4 million. We see expected costs that are part of delivering projects of 9.4. And then you see a risk-weighted provision for £8.5 million, which is about really being much more stringent and disciplined with our approach to risk. The very bottom is down there is our provisions for warranty, it's split into two bars. £2.3 million is the warranty for and against warranty provision for products on site. The £1.3 million will sit within contract loss provisions up to the point that the kit is deployed. And then at that point helper warranty vision. So what's driving these numbers? The big thing here is redesign work. We build products at a point where there was an unfinished design and subsequent design changes have required rework of various products. We've also included customization at customer request. And as a company, we haven't fully understood the impact of those customization exercises. Also seeing the split of scope as talked about in the Leuna projects that's actually going to increase cost for ITM and we see that as something we need to do to maintain the customers' time line as best as possible, but it's more on-site work, more subcontract work and more packing. And finally, in terms of testing, we had expected to see improvements within our testing timing, which have not yet materialized based on the fact we're not doing volume manufactured right now. So the costs are related to both among test durations, but also the impact of the energy prices for the company. The other contributing factor to the gross margin loss were inventory losses and that's made up of a total cost in the P&L of £15.7 million. Costs incurred, which is write-offs lots lessons of £1.6 million is one number and the other component is £14.1 million worth of provisions. This is against a generation of stacks, population of stacks that is ring-fenced, let's say 100% provision against those tax. What happened there is there was a legacy design, which included the introduction of an extra component to make tolerances easier to manage within the manufacturing process. That ultimately led to us having a product that we did not want to ship. So at that point is the need for a new tool modification, which was the RNS that we put out in Q4 last year. So the to modification has been done components are being manufactured. Started to be manufactured, it will be easy right now to say we are sprinting towards completing customer projects. But we're not doing that. We're taking it step-by-step and making sure we validate the taxes we do. So we're avoid doing this again. In terms of cash flow for the period, we had an adjusted EBITDA loss of £54.1 million 32 of that were provisions non-cash movements leaving us with a cash outflow from the P&L of £22 million. We saw an uptick in inventory of £29 million. We've improved our working capital position with receivables and payables by £8 million. And then we spent money on CapEx, notably about £3.5 million on assets with investment funds and a similar amount of product development. So our total cash outflow for the period was £14 million. I've got a little box on the left-hand side, which just acknowledges that of the £28.9 million inventory uptick £14.1 million was provided and that's that generation of stats that we've just spoken about. In terms of the guidance for FY 2023 ending in 30th of April. So the result is very much banking from decisions that we made in the first half of the year. And we're not going to see the benefit of the 12-month priorities plan until FY 2024. So the revenue guidance in line with that change of product delivery â project delivery means that we expect revenue to be £2 million for the full year. That's the same number as we announced today in the interims. In terms of the EBITDA loss guidance, we're expecting that to be in a range of £85 million to £95 million. We're expecting to see some inventory provisions in the second half of the year and that will be about FAT success and volume of products going through the shop floor. And we also â we're applying contingency here, which is within that range about project cost overruns we don't know about. It also includes the costs associated with the RWE, and particularly the warranty. And finally, in the overheads at a similar run rate through the first half of the year, but also we're going to have one-offs for redundancies and the impairments of discontinued products. In terms of cash flow, our cash flow guidance hasn't changed for the full year. We guided before £245 million to £270 million. Actually, we also expect that to be towards the lower end of the range, partly because inflows from customer contracts have been deferred in line with delivery profiles. And outflows are impacted by project overruns and an un-winded provision made in to a partial extent in the first half of the year. Final slide for me the outlook for FY 2024. So revenue is going to be underpinned by site acceptance testing and a dependency on that, but particularly our focus here is RWE Lingen getting them down as pilot plant â as flagship plant that we can really use to showcase what ITM can do. In terms of cash flow from operations, we'll start to see the benefit of the 12-month priorities and headcount reductions in cost management. We'll also expect to see an un-winded some of the inventory buildup we've had this year, as we start to see products go out the door. In terms of investments for the future, we are expecting to invest in a power upgrade and fit out of a new unit. And there will also be incremental automation machinery, as we bring that online in FY 2024. Thank you, Andy. Let me pick you up where I left you, which is my introduction. Before I committed myself to ITM and knowing about the issues the company is facing as I alluded to, I ask myself three questions which were important for my questioning if you join or not to the same. These three questions are; does ITM have a technology the potential to outperform its competitors; does ITM has a strong enough balance sheet which means cash to support the necessary strategic and operational changes I was anticipating to strengthen the company's foundation; and does the market give us the time in or needed to solve the growing pains ITMs encountering. And in short answer, yes. I'm convinced that these critical preconditions are met as I wouldn't be sitting here in front of you today. On the technology side as I also said I do know what competitors are doing from my previous role at in and I'm more than convinced that ITM has the right technology to compete in the field. I will shed some more light on answering the questions on the next slide. I know this is content heavy and it's probably difficult to read, but bear with me I will try to guide you through step by step. So first a high-level business update. Discussions around climate change, decarbonization and recently, especially, around energy independence coming from the Ukraine-Russia situation are further fueling the projected hydrogen demand increase. And I can tell you they are really is coming from the customer side of the industry, we would expect the demand to be sustainable at this time. So we will see significant investments coming up. If we look at the landscape of hydrogen production today, you will see that 95% of that is still gray which means it comes with a lot of CO2 emissions not really well-aligned with the decarbonization agenda. However, just the demand increased alone on top of the installed capacity is higher than what electrolyzer OEMs can supply today in terms of green hydrogen stacks even if you take all the announcements out in the market for new factories giga factories, which I have to say are to a large degree shaky. But even if you just believe on all of them electrolyzer OEMs will still not be able to meet the demand at this point in time. So we will see significant investments in that industry going forward. Even if electrolyzers OEMs were able to supply stacks in a sufficient amount. We would have another bottleneck, which is in the availability of green electricity because the ramp-up of renewable energy is lagging behind in most countries nowadays, but also there I think we are gaining speed. Especially for the already installed base of [indiscernible] producing hydrogen we will see a trend towards blue hydrogen for the interim, which means that we capture and store CO2 and sequestrated. And while this is an important interim step to also allow tackling the next bottleneck, which is hydrogen infrastructure, I would expect new installations to turn towards green hydrogen. When I say hydrogen infrastructure as a bottleneck, I mean transport possibilities from pipeline to last mile handling, shipping I think you all know these discussions and also storage for energy buffering, especially, when we talk about higher share of renewables in the energy greater need we need often. Current peak electricity prices and inflation that's no secret to put electrolysis business cases under a lot of pressure, which leads to some delayed investments. That is a temporary effect, which is giving us ITM now the breathing time required to overcome our issues. The big demand spike is yet to come and we will see significant ramp-up of projects in the next years. And we as ITM will be ready for that. While we are working on our foundations I can tell you that almost all competitors in the market are facing similar issues. We were a little bit ahead of the pack in net. We won the first important and larger projects in the market, and we encountered the issues first. I hope that we can also be the first ones to overcome the issues and emerge stronger out of that. When it comes to product demand projection. Order intake weighted today container business so plug-and-play units and stack alone as we would supply for [indiscernible] rather even today, while and this is illustrated in the bottom right graph of the slide, while we would expect container sales to see a moderate increase the demand for stack will be substantially larger and we would expect an exponential growth given the larger scale of projects in the market, which I think you wouldn't buy containers for one gigawatt project obviously, right? Therefore, ITM will focus more and more on stacks going forward, which doesn't mean that we don't do containers, but it will mean that for containers we will try to narrow ITM scope to where we can add maximum value and pursue partnering opportunities for the non-course goal of the benefit into context. In order to develop ITM from an R&D company to a professional delivery organization with volume manufacturing capabilities, we also need to take the inherent overconfidence in the business previously and replaced it with what I would call industry realism. We have developed a 12-month priorities plan to achieve the exact design and to solidify our foundations. I clustered our plan into three focus areas. First one is that we need to concentrate on a core product set to finalize the engineering of our technology, which is in itself performing well, but we need to get to repeatable and reliable volume products. While the previously mentioned manufacturing issues are there, they mostly originate from engineering shortcomings. And when I say that I mean design freezes and not robust validation of product generations prior to lease for purchasing and production. So it's not the technology on the electrochemical side, it's the engineering around that, which is not mature. Second point, we need to stop the financial leading of ITM. And you just alluded to the numbers. And we will introduce a short-term program to reduce cost, and which addresses the key cost drivers of the business, I will say a few more words to that in one of the next slides. On top of that we will review together with Vitol and future for motor fuels with the aim to -- £28 million of already committed investment and we would it back to our core business where we need to sell our production and focus on our core business. We will also work on substantially increasing the quality of our forecast in order to build back market confidence in ITM. And please proceed today as being a first step in that direction. I think the degree of transparency we provide today is a step change for ITM. The third point is debottleneck -- debottlenecking. We will ramp up fabrication and testing and invest into incremental automation. And you just mentioned that I have a part slide on that part. In parallel, we cannot overstate how important it is to deliver on our project commitments. We need to become a delivery organization. We are a commercial company and we want to grow into becoming profitable at a point on our journey and we have to learn from mistakes from the past. We today announced two Linde 100-megawatt project is a very important milestone on that journey, which allows us to scale our business with real contracts and not just towards a precede demand, but with a real demand. With these two projects we have almost 270 megawatts of latest stack generation in actual project delivery today, which is significant for us. I will now give you more details on these three focus areas, on which you see with the blue dots. On the left this is a list of all the products, which ITM is today working on in one or the other form in chronological order of development in existence. I have to say that this was a bit shocking to me after I joined it it's a lot to focus on. And we definitely need to narrow our focus in order to be better performing in our state-of-the-art technology and products, which is those, which we marked in green. The services we are still providing to support older generation technologies are disruptive to our engineering and manufacturing processes. They distract the organization and they have become overall too costly and time consuming. So what do we know about that? We will discontinue product development and ongoing design improvement work for legacy products, which are no longer considered state-of-the-art all the products on top of the green ones with the white background. We will stop marketing and selling of these products and, of course, our customers will and should be able to expect from us and we will have up to that to fulfill our remaining contractual commitments and warranty obligations. We would not back down from that, but we will narrow to after sales services product to the later product generations to avoid distracting the organization too much. The Green highlighted 30bar MEP stack is the one we will scale and deploy in the current and larger installations to come. You see there that cubes are light green colored. We still intend to sell cubes, but we would expect the market to develop in a direction with either a rather small decentralized installation, tending towards Plug & Play containers, which is then a complete Plug & Play unit, as opposed to a cube all then going to the big large-scale projects, which would then rely on this Stack & Skid supply, together with a larger module in that case for example, of the 10-megawatt module developed with Linde. In that sense the strategic relationship, with Linde is very important for us to take the large projects to come. To allow us to narrow focus on that, which is really important. We have consciously prospered on a completely new stack generation for the time being as what I just said the current stack is state-of-the-art in the industry. There's no need to rush to the new project generation instead of scaling up what we have. And we showed you the numbers, which have been disappointing for the first half year, which continue to be disappointing for the second half of the year. In order to stop the financial leading of ITM, we need to tackle the main cost drivers, which are underlying. And I try to come up with a symbolic picture here, a little bit while the ship of ITM, which is it's not really horizontal right now. We are â ship is uplifted by technology, which is great. Huge market demand. Right now, we could sell more than we do. We consciously try to not oversell in order, not to overstress the organization at this point in time. It's not a problem, that we couldn't sell, I can tell you. And a strong balance sheet and cash position. This is certainly, an uplift. But we are at the same time also pulled down by project cost overruns and inventory losses, as Andy just explained and also by overcapacity, as a result of over optimistic recruitment towards unrealistic expectations of fabrication members. So we will have to cut off one or the other of these ways, if not all, in order to steady the ship and try to become faster and more capable companies. Addressing the overcapacity, is an important first step. We will restructure and rightsize our organization towards being leaner, better in hierarchy, and with a structure that's reflecting the true nature of the business. We will strengthen technology and in particular, we will strengthen engineering and product validation focus, which were the reasons for most of the issues we are encountering today. We are bundling our customer interface from sales to delivery, in one customer-facing organization and we will closely integrate manufacturing and procurement, which is essential. We will also increase the oversight and governance function of the CFO organization, especially with focused on getting to better forecast, as I alluded to earlier. Today, we also announced that Dr. Rachel Smith will step down, as a statutory Director from the Board. Let me thank her, this time for the tremendous contributions she has brought to the company, which will continue to work with ITM in another role and I'm looking forward to continue working with us. Coming back to the organization, we will reduce around 25% of head count, which leads to a reduction of personnel cost of £9 million year-on-year, which relates to credit 30%. We will over proportionately reduce in non-scaling functions, which means that these are sustainable savings. And meaning that, if the business is picking up again, these functions were not scale with the business going up. And implementation starting immediately certainly subject to employee consultation starting in February. So, how do we solidify our foundation? On this slide, you see, on the one on the left-hand side mitigation for future inventory losses, which can be alluded to. And then on the right-hand side, you see mitigation of future project cost overruns. And when I guide you through these points, so you will see that most of these are business basics especially in the EPC and manufacturing industry when you look at mature organizations. But this is the topic -- these are the topics which we really need to address now in order to become a capable volume manufacturing company with the required engineering professional result. And by guiding us through these, I think what also comes to the surface is that these are the issues which we need to take it. It's not an inherent technological issue per se. So, let's go through that. In design, we will need to professionalize how we do engineering. This means we need to bring in new capabilities, amend the capabilities we have, and the proved processes. And today, I can announce that we will have a new Head of Engineering joining us. Someone I know from my previous lender career and someone who I am 100% convinced of that he can help me fix the issues we have. And as I said, he will start today, so things are underway. We will introduce design freezes, which is among the most important things we need to change in engineering and very stringent management of change. We need to stop changing products why they are being produced. I don't need to explain you that this leads to additional procurement efforts, delays, and costs. Compliance and validation function and emphasis here on validation with me to and sign-off right to challenge the status we have. We need to properly validate products before releasing them for production and purchasing and selling them to customers. And this is what we have changed immediately. Then we will have to introduce state-of-the-art calculation simulation tools. Also from true landscape point of view, there is room for improvement. And so this will also lead to better engineering results. On the sourcing side, we will improve supplier audits. That is another inherent issue which we encountered I would say full supplier quality on one of the other components and let rework on. And this will also include on-premise inspections at supplier premises and witnessing testing, which will then also reflect the risk profile of individual suppliers. We will strengthen also our standard [indiscernible] with volume and specification flexibility and we need to strive towards back-to-back warranties with suppliers, which cover us especially for container business. Cover us for the complete duration of warrant period also to our customers in order to avoid having to provide to high warranty. On fabrication and warehousing, we will enhance parts flexibility from incoming to shipping and we will work to our newly implemented ERP system, which has been implemented and which is currently being set up for the computing organization. In terms of avoiding project cost overruns going forward, we -- if we look at the product portfolio and sales phase first, we will enhance discipline around selling standard products as opposed to customized solutions. Andy mentioned that already. This is a typical theme which is leading to losses in such kind of organizations like ours. Certainly, we do strive to selling a standard product because it's really hard to estimate accepting clients and contracts and then having to change for each and every client every standard product you have that's on a sustainable model. So, this is one of our key priority areas. Also we need to come to comprehensive costing and pricing and we need to be more realistic on schedule and risk estimation. When I look at the current project delays, certainly, a lot of that has to do with what I just said on the design and immaturity of designs, but it also has to do about being overoptimistic on the capabilities to deliver and not seeing realistic roadblocks on the way. Contract terms, we need to strengthen that towards accepting lower liabilities. Customers will not be pleased to hear that, but that's where we are and we need to scrutinize our performance guarantees and warrant obligations in the contracts going forward. Project governance. So, during the project execution phase then we will introduce a very stringent phase care process model, which we will strictly adhere to, which means if we have not achieved all the steps required to pass a gate, we will not pass the gate, but we will make sure that we have a very stringent way of managing projects, products, and customer delivery from here onwards. We will also strengthen accountability across the business, which is I would say an inherent cultural issue at this point in time. It reflects the R&D nature of the company. We need to come to a point where accountability reflects that of a mature delivery organization. And you will also -- we set one or the other low profile and expectations roles including also project managers to be more accountable for the project performance. And we will also substantially improve the quality of project cost and risk recording and the basis for every forecast which the finance organization can put to the market will be realistic understanding of where projects end and which risks are ahead of us. And by introducing that we will take it as very forecasting to -- and we will also advance our come project management processes and very strict governance and improve also the way we manage contracts through our projects in terms of how we address the changes coming from customers throughout the contract execution period. This brings me to number three of the focus areas which is debottlenecking. I have now picked. The three most important bottlenecks, I have seen for the time being. The first one being testing and power supply. We anticipate and plan for a phased approach to increase test capacity to satisfy the project needs under contract including, the Leuna project which is certainly step change for us. We will see more than a doubling of our capacity in testing within the next 12 months, so until December 2023. From April onwards we will have available 50% increase in electricity supply from five to 7.5 MBA. And we will see a further increase which we have already secured just at the beginning of the year now to 30 MBA in 2024. On fabrication and automation a topic which was oftentimes talked about at ITM, we are making this happen now. So we do have an automation lot that developed and in actual implementation. We will not be able to read now what's on that roadmap, because it's really small here. And I think it's not important to go into each and every step. But the -- what you see here as a small basis is more -- this relates to machines coming in being validated, tested and then released into production throughout the course of this year this calendar year. So some improvements were achieved already and a lot of others will come. And this is a realistic assessment of when we will be able to introduce which change. We will as I said incrementally deploy into production. We will not rush that. We will make sure that before we change the process that we have validated and verified that we can do it. One example is, machine on process automation we will expect for October this year, relating to automated screen printing of catalysts onto the Membranes just to give you one example. This relates to precious metals. We will reduce waste by automating that process step. And we will reduce cycle time from 10 minutes to six seconds. And by that increased production capacity about 300%, especially also on the reduction of process rate when it comes to precious methods that will be a game changer for us. That's just one of a lot of examples of what we have in implementation. On the very right last but not least R&D and validation, we are currently in negotiation to expand our shop floor space with the new fabrication just next to Park where we are today. We do want to build up a dedicated R&D and product validations. So as you see the topic validation comes up again and again. This is really important to me. This we host [indiscernible] and first of a kind of product testing facilities and will also share the electricity I just mentioned across supply. And this is not decided, but we are in current negotiations certainly also assessing other options as an alternative. The negotiation doesn't come to success to conclusion. We do expect a decision still in Q1 this year. My last slide outlook, I talked a lot about the next 12 months because these are essentially the size of ITM. I know that you have questions for the longer-term strategic plans around what about more production volumes. And let me answer that maybe in a way to be able to still focus on the next 12 months. So ramping up stack output is not difficult for us, but it requires robust product variation. We need to make sure before we enroll into volume manufacturing that what we produce is [indiscernible]. If ITM has proven something in the last year it was that ITM was able to produce really quickly a lot of stacks, as any alluded to these stacks were then not fit for purpose. We cannot run into the same situation again. So product validation tests and then volume we will be able to do volume. When it comes to new factories and markets, also a question which was often asked, building a new factory abroad or even different factories in Perlis [ph] also not difficult. It's rather straightforward. One year just be blueprint. But this requires that we do need to have a blueprint at hand and we will make sure that we will get the current Bessemer Park facility with the plant extension to be a blueprint which we can then copy into different world regions, which is then much easier than trying to fix different factories and they use different places. As to profitability, as I said, we do want to become a profitable company. Certainly, we will not be able to do that within 12 months but that is our ambition for the future. But this requires a mature competitive product design, which we will get to it will require incremental automation, which will improve bid quality and cycle time, rigorous cost management, which I alluded to building up our aftersales business important for customers and us and most importantly volume, we can only become profitable this volume. You see it here on the slide we will get there. I'm confident that we will get there. What does count now is though that we implement with discipline and focus our 12 months priorities and to make ITM stronger, more reliable and more capable company. As I said on the first slide or one of the first slides, the large-scale opportunities in the market are yet to come. What we see now is first projects being realized. But as I said, they will go up in scale quite significantly. And by putting these foundations in place, we will be ready on time for that market demand. Thank you very much. Fantastic. Dennis, Andy, thank you very much indeed for the presentation. Ladies and gentlemen, do please continue to submit your questions using the Q&A tab situated on the right-hand corner of your screen. But just while the team take a few moments to review those questions submitted already. I'd like to remind you the recording of the presentation along with a copy of the slides and the published Q&A can be accessed via our investor dashboard. I'd now like to hand over to James Collins to pose your questions to the ITM Power team. James, can I please ask you just to read out the question where appropriate to do so and direct it to the relevant member of the team. Thank you. Okay. Thank you. Okay. I appreciate 2023 focus is UK manufacturing. But how many international sites do you envisage for ITM Power by 2025 and 2030, please? And based on current incentives, what would be your preference for either the USA, Germany or Europe? Can I take that for you here. Okay. Yes, thank you for the question. As I alluded to on my last slide I think â the first priority needs to be that we get our house in order right now as in the park and that we create blueprint. Certainly once we have done that we do want to expand to different quite features. I have not yet had the time over two months to come up with a strategic plan on how to address which world region. But maybe answering to that initial question, I can tell you that the USA was the recent better changes, it's a quite interesting market for us and would be probably very high on this. Okay. I think you've answered this in parts. Could you please explain why ITM need over 400 staff when very little manufacturing is taking place? The used company investors' cash seems to be treated with that in respect and the lack of financial control. Yes, we don't â that is why I announced today the headcount reduction program. The current number of employees does not correlate to the short and mid-term output within the next ones. And we will rightsize now, also considering our obligations towards customers. But I also have to say that certainly, we hope to be able to scale upwards again not only product volume but also employees once â once we solved the current issues of the organization. And once we can really start scaling up manufacturing in a bigger scale. Yes. Yes, okay. So I think we do not have a picture at hand right? But â so you have to envisage a cube as being a mini container so â which is like a housing for the stack. So while a plug-and-play container is like a complete electrolysis plant in the container and the stack is what you have normally seen these different plates on top of each other, which is then producing hydrogen through the membranes, and which is part of the container. And the cube is somewhat in the middle. It's like a mini container version, much smaller than a container hosting part of the balance of the plant. So the stack is like the heart of the electrolyzer. And then from to container, you go more and more into the plug and play and more scope of the balance of plant direction. I hope that answers the question. Okay. Thank you. Okay. Dennis, you mentioned automation is one of the key areas where you will focus across the next 12 months and beyond. Given your knowledge of ITM's peers, where do you think ITM currently stands? And what sort of grand would you like to cover first? So, I think all of -- I would say most of our competitors and then talking [indiscernible] because this is what could be comparable and are looking into automating their securitation. I would say some are more advanced than others. I think -- to be honest, I think ITM is not be off at this point in time. But certainly we have our own ambitions and we don't want to be average or in the middle at we want to be ahead of the pack. So, when you ask about priorities, I said that we do have a road map, which is addressing each and every area of the fabrication process right now and we will introduce these changes, its priorities around where do we need to improve, in particular the quality of assembly. So, I would say either adding manual assembly and by that improving the quality of that bit quality or fully automating certain process steps. And as I also said to reduce cycle times in particular bottlenecks when it comes to building up the production. Okay. Should we assume that all revenue deferred from Leuna and Yara now falls into full year 2024? And when do we get full year 2024 guidance? So the -- yes, the short answer is yes. There's a dependency there, which is about the whole plant with the full scoping SATs for us to recognize our revenue. But yes, the Leuna and Yara plants, we are expected to be recognized in FY 2024. In terms of guidance we will next be talking this level detail in the June trading update. And there'll certainly be some guidance for FY 2024 there. Yes. I think we're moving away from individual projects pricing. It is a commercially sensitive topic and we're actually keen to make sure that we don't detract from what we're doing in terms of commercial relationships with customers. So, whilst we wouldn't say that, it was bid competitively and was one as part of it attain. Okay. Today you announced a 25% reduction in head count, how are you thinking about retaining top talent or hiring new talent and growing companies like ITM require, especially when we look at the new large contracts just signed? So the 25% held reduction takes into account the lot of Lingen projects and these were online negotiation when we took that decision, and certainly we consider that. When it comes to retaining talent, this is obviously important for us and we will make sure not to lose too much talent as part of the process. And I think that's nature I would guess. Would have been worried to be able to scale up the company again in terms of headcount once we scale production? No, I wouldn't. I think we are a very attractive company to our employees and also to applicants. We do see that also in the market. And I think we are in a very good position going forward. Yes. Okay. So the ARO projects, we're doing a similar thing to the Leuna projects, we're choosing a strict delivery model. So that we can get cubes out supporting customer time frames and stacks will follow. So the bulk of those cubes are in production right now and we'll be shipping within this financial year, but the revenue will be dropping into next year. Okay. There's a big demand spike yet to come. Is it a next year event? And what needs to happen for demand to unlock? Are you confident in the seller response from the EU versus the inflation Reduction Act in the US? So, as I alluded to on my market side, there are some bottlenecks, which are ranging from creating massive infrastructure having renewable energy production in place and so on and so forth. I think all of these areas are currently being addressed in the different world regions. The USA is pushing quite strongly ahead right now. But I think the European Union is looking into ways to also speed up the process on the Center European continent. And I have to say that I'm pretty confident with what I see in the momentum is strong, huge. And I would not say these things to be critical roadblocks. I think, it's all [indiscernible], but the next, but we need to address them one by one certainly. Okay. So planned reduction in testing areas did not materialize recurrent product. When can we expect it to materialize? You indicate costs are compounded by high energy prices. Can you quantify the magnitude of higher energy prices on cost overruns? So, I'll say that. So, there's a number of expectations here at the point where we get to volume manufacturing, we are happy with the product, do we need to test every stack 100%. Now, we will start to see a validated product going out. So there's a route which is about, how many tests we do, but there's also a route to shortening test times through various pretesting processes. At the moment, because we are somewhat immature as we go through that process. Testing and test bay activity includes all the debugging that should also happen upstream. So we will see that improve, as we get manufacturing processes in place and improved. So, the costs are associated with running two-megawatt ski assembly with three stacks in it for a period of time. And we run into various levels. So the intention here is over 20 reduce the levels we run out. So we're really running at 100% for a small amount of time. So, I won't put a figure to it right now, but maybe we can answer that as we respond to Q&A. Maybe adding to that. So I mean, that is absolutely right. It's about trying to reduce the time of testing, but also trying to reduce the number of tests we need to perform by improving bid quality and leading to lower failure rates obviously interesting, right? Very good. I understand the focus on near term and simplifying as opposed to diversifying and make it more complex. But do you exclude using alternative technologies, such as alkaline in the longer term? I'm too much strategist to say that I do exclude any strategic option going forward. But I can tell you that we are confident in the PEM technology we have and this is our focus product, which we will get it. And by getting our house in order and doing the homework which we need to do, we will be a very important market player, if not the most important market player in the payment there. What the future brings, will bring the future for sure. So, I think on Gigastack, I did provide an update on this part of the slide I had on the products. We have paused development of a new generation stack in order to be able to focus on our sale of the [indiscernible]. When we talk about Refhyne II, Refhyne II would also be built with the same 10-megawatt standard modules based on the 3 MEP study power technology as the arriving on project which we announced. So these are two separate topics, right? This project is progressing. We are in very constructive discussions with Linde and Shellie Lag [ph] and the project is progressing in the current consumption phase. Very good. So a question for you Andy. Can you give more of a breakdown in the inventory increase of 29 million for the period? What is this for? Can you give a more detailed breakdown of the inventory increase of £29 million in the period? What is this for? So the project cost overrun which is the £29 million, inventory is £15 million. So the project cost overruns, I mean, as we said in the presentation this, some of it has to do with design not having been settled as we started to build, some of it is to do with change in scope and exactly when we're going to be delivering to site. And then some of it is also about reworks associated with on-site working subcontracts and packing. To put actual numbers to it, I think the slide probably did enough. We've got a risk-weighted £8.5 million and the balance is split across all of those categories. Very good. You stopped signing new contracts last autumn given that you've now signed the RWE contract, are you in a position to sign further contracts? And have you received any order cancellations in the meantime? So maybe I'll start answering the second question first. So, no, there were no cancellations, and we do not anticipate to receive cancellations. And we are a very constructive collaboration with all our customers to mitigate the project delays and issues we face in the projects. And we are also thankful for that I wanted to say. When it comes to selling, that is indeed true, where we decided at a certain point to reduced selling activities and not sign new orders in order to get decreasing time and reading space required to tackle our issues. As we announced, we have now signed the world's largest PEM electrolysers in execution, which is two of them at the same time with a phased delivery approach. I think from here onwards, we will very carefully select which projects we meld into our organization from various viewpoints. One is we need to make sure that we don't overstress the organization in particular also looking at what we have been funds for refined to and we will also need to look at profitability of projects going forward. I think we are at a point where we have sold enough reference plants right where I think we are able to prove deliverability of our product and reliability going forward. And I think we need to strive towards a realistic pricing and caustic scheme. And therefore, we very carefully select new projects to sign. Okay. A question for you Andy. Can you give more detail on the revenue recognition timing of the new 100-megawatt Lingen projects? And when do you expect SAT to complete? So, those projects are going to be delivered throughout 2024 and 2025. So revenue not spit exactly where it is will be FY 2025 and FY 2026 with SAT potentially falling into FY 2027 depending on exact timing. So we'll update more as that project develops. Okay. Is the 268 megawatts of latest generation stack mentioned to be in actual project delivery same as the backlog number that you used to disclose previously? Could you please explain the difference? Yes, it's a backlog number. We've historically also included actually the negotiation and preferred supplier status. And actually we think that led to confusion and also in terms of focus what we focused on we focus on delivering what we've contracted. So it's absolutely right to talk about the contracted backlog which is at 268 megawatts. Right, maybe adding to that, I have to say coming from the customer side of the industry it was always a little bit funny to see that so many companies on the electrolyser where we're putting out MOUs, LOIs study projects or study phases projects has big announcement. And I think what we need to narrow that down is to real contracts signed and real orders. So when we speak about these two Lingen contracts this is now lead projects, right? This is not just an announcement. And I think the new ITM way of disclosing information will be very much -- it's fine when it's signed and it's really when it's real. And I think we need to step away a little bit from inflating bubble not only as a company, but as a whole industry of that's more than it actually is right. So let's be down to us realistic about what's going on in the market. Okay. Given the project costs have been so detrimental to the financial performance will you be more selective on the projects that you tended for? Are you going to target those that are already funded or where you can deliver product and recognize revenue? In line with what I just said on the other question right? So we will definitely select projects carefully. We are partnering with Linde for the sales through our joint venture ITM electrolysis. So we do have a very strong sales and business development are in place also to screen projects and to check financial viability of customers and also of our funding programs. However, it is very rarely the case that funding can be secured on time. So normally you have to engage in a pre-phase of the project call it feed or whatever it is. But it's still to a certain degree a gamble, which project then gets the funding it out completely that you engage in a project, which is not receiving funding. But as a rule of summer I think Linde is an organization together with us screening projects. I think we got pretty good at identifying which projects are real and which aren't. Okay. So where are you on the level of trust that customers have right now for the product? Do you think order intake can materially increase across calendar year 2023? So when it comes to trust, I think what customers are looking for right now and having been a customer myself is customers want to see running plants right now. We want to see that us and also our competitors in the market actually deliver on the promises we put out, meaning creating reference plans which show good performance. I think it will be all about delivering reference plants, because this will be the most important determinator for trust and increasing trust. And hopefully, by being able soon to deliver on the projects we have under contract, we can be in a position to actually outperform on the trust point because we do have a product and which is working in which we can prove that it is working. So we showed a slide on FY 2024 guidance where we start to see cash outflows decreasing, partly with the unwind of working capital partly with the impact of the 12-month priorities plan there will continue to be investment for debottlenecking and on that new facility. I mean, short answer yes, we have enough cash. Okay. And a question on revenue. How should we think about full year 2023, 2024 revenue given the significant deferral of full year 2022, 2023 revenue? Yeah. Our focus absolutely is on the Leuna and Yara projects as flagship pilot projects that shows ITM, so if I was looking at revenue now I would be paying mine revenue expectations on those two projects particularly. As I said in the presentation, the Linde partnership is of very strategic nature and really important for us to scale up our business. And by living up to the promises we made with our project commitments and also living up to the Leuna challenge ahead of us of delivering two times 100 megawatts we will I think rebuild some of the confidence and issues which we sort of build back some of the confidence lost over the last two or three years. I mean, as I said, I was on the receiving end as well. However, I mean the relations and tax we are working very collaborative and closely together. We always like at all the year we had in employees here in our factory and our engineering teams to support us on the way. We having joined ITM certainly also a trust-building measure right now in the sense of I think my word does count at Linde being reliable. So I think when I say something people will also trust me, which is building back confidence to a large degree I think, which will be important for a strategic relationship. So I mean don't answer to your short question right? But is the relationship intact? Yes. Is it under stress? Also yes because of the project delays we have. And do I think we can get it fixed and regain the confidence? Absolutely and we will strive for that. So the Head of Engineering who starts today is my previous Head of Product Management at Linde Engineering and a very capable person who I know he would exactly fit into the profile we need in order to overcome the issues I mentioned on one of my slides with regards to professionalizing engineering. So it's a trusted professional now for many years and who perfectly fits into the role profile. And having said that he was also engaged over the last three years heavily with all the projects of ITM. Also with the development of the 10-megawatt standard module I mentioned, so it's not that he needs to find his way into the company for six months. He knows exactly where ITM stands and can start taking the issues on day one. It is â I mean, we just signed a contract or two contracts for two times 100 megawatts which is definitely a very large project. And we will deliver exactly this stack the 0.7 megawatts stack in MEP 3. That's why it's called 3 MEP at 30 bar as part of these 10 megawatts standard volumes to these large projects. So there is absolutely deliverable. I wouldn't say that, we focus on a particular sector. I mean, our sector is selling plants, which produce green hydrogen. And certainly, I will be happy to sell that together with Linde to any customer interest in fact. I wouldn't narrow that down on to certain industries. And, so a question on Motive is ITM moving away from Motive fuels to create a closer liquid Linde in the future? No. So these are two separate topics, right? So as we announced Vitol and us are very collaborative and positive discussions about how we see the future of Motive, we had a section on that in our RNS. It's not that ITM tries to access something low to align better today and that is not the case at all has also nothing to do with Linde. While reviewing the current situation of the business Vitol and ITM came to the same conclusion that the original intends to build a larger network of fueling stations in the UK has limited outlook, and we admit or we see that it would need significant investments, if we were to expand to other world regions potentially for example Europe. And I think for doing so ITM would not necessarily be the right partner, given that we need to get our house in order and focus our own cash on fixing the fundamentals of our core business. Vitol and us as I said, we are in good discussions. This is not a tough negotiation at this point in time. And we are investigating all the options, which are at the table from selling the business as a whole to discontinue it in good faith. And we certainly look forward to maintaining a strong relationship with Vitol, also after that exercise. Okay. Where do you see the business in five years? Where does ITM sit in comparison with other hydrogen tech companies? That is â is it in the premier league of such companies such that it could be the forefront of exposing this commercial opportunity? You will perceive me to be very careful on giving commitments to future, especially when it comes to numbers. But certainly, I wouldn't sit here today, and I wouldn't have joined ITM, if I didn't think that the ITM can become one of the front runner in the industry. So the technology itself is verified and as a stand-alone technology obviously. And as I said, we expect to deploy it in October, which means that we will get it well ahead of time and that we will make sure that we verify and test the stream printing prior to actual deployment into the factory then and replacing the current machines we have in the current way of doing it. So, no we haven't received the machine right? But once it's being received, we will certainly do proper meditation as we do for all incremental automation steps are coming. Okay. The high cost of electricity appears to put it across the disadvantage compared with the cost of blue hydrogen. So, do you see an opportunity to reduce the electricity costs by using the energy of Waste team? This is a little bit mixing up two questions on statement. So I would necessarily say that, high energy price is favoring blue hydrogen, because you also need energy for capturing setting under the earn side, it's not as easy as that as you say just greened electricity, and who doesn't I think on â and what was the second part of the question? Could you read that again, please? Our waste steam. So when it comes to hot steam, I mean there's a certain electrolyzer technology, which is aiming for utilizing hot off steam, which is the SOT, solid oxide technology. This technology does perform well in particular, when you have hot off steam. PEM and Alkaline are considered coal electrolysis. So the relationship. Do you want to take -- so the relationship with Snam is intact. We -- it's a strategic nature for ITM. And we -- I mean, the question is very broad right? So, I mean, it's an intact relationship. We hope that we will receive one or the other order from Snam and we'll be happy to support their agenda on the hydrogen, certainly. I don't know if you want to add, Andy? So we are working on it. I wouldn't be in a position to disclose details about where we stand in the discussion negotiation. And certainly, that's a sensitive topic also for our customer. So I normally do not comment on sales projects in particular, but it's still an ongoing effort. We're doing -- we're doing some work with universities around the UK, but actually there's also an incredible in-house capability in terms of developing the technology that we have. So, yes, there is some work, but also there's a lot of work being done by our team. Okay. Sorry, another question for you Andy. Can you give us the firm orders please, excluding Nordnet and Yara and RWE? Itâs a question from Chris. So can you give us the firm orders please, excluding the Nordnet and Yara and RWE orders? I think he has a calculated 22 megawatts outside of those orders? Okay. Sorry, one question here from Sky. What was the difference in the GEP 30 stack skid produced versus the MEP? The GEP, the Gigastack, would have been a stack run of 2.5 megawatts per stack and the MEP is 0.7 megawatt stack. And we would -- we do bundle three of these stacks for three MEP module which is at 2 megawatts worth of capacity. And the Gigastack would have been 2 Gigastacks bundled to 5 megawatt. Okay. And just a comment on technology, sort of from a technology viewpoint, the stacks would have been similar. So when it comes to membranes and electrochemistry, similar technology performance. Okay. There are a number of private investors that were far from happy with the previous year's reasons for production delays and numerous excuses as to the drain on cash. Does the new CEO recognize that he has to be more transparent and actually give honest opinions on whether ITM will, in fact, be in a position to supply electrolyzers to existing customers in the near future? I would just say, yes. All right. No, I mean, let's be honest, right? I mean, I do see that as well. And the reason why we have -- I hope that you perceive that as a step change in transparency today. And this was also important for us. We will continue exactly in that way to provide you the transparency of the actual situation of the business and of how we see the market going forward, because there's nothing to hide, frankly. Let's just be open where we stand and let's improve the business from here on and sketch a successful story about ITM, we will be able to do so. So, yes, I absolutely recognize the need for transparency towards shareholders. No. This is a different topic, right? So from an organizational viewpoint we have an engineering organization, which so this is technology, the actual engineering which we call product management and the validation piece around engineering. And then we have a separate manufacturing and procurement organization, which is a normal way of how we would organize such kind of business. Okay. I think we're coming towards the end â sorry, some more questions coming in. Just one likely -- just one for you Andy again. I think you covered it, but likely revenue recognition timing associated with the 200-megawatt orders. Dennis mentioned a phasing, but no timings. Yes. So deployment calendar year 2024-2025, such financial years ending April 25 --April 26 with the potential for some to go into 27, but we'll update more as the project develops. Okay. And a question from Roger. Generally speaking do you anticipate that your plans in the near-term will be held back by the difficulty in recruiting? No, I don't expect that. Right now it's about as I said rightsizing. It's not so much about new recruitment efforts. Certainly, we will have to bring in new capabilities in some critical areas of the company. But it's not that there are not people who want to join capable people want to join every 100 companies nowadays. It's a very attractive business for you to be. Okay. And do you foresee problems resistance to change in the culture of the business. And if so how will you address them? I mean, you can never rule it out completely, right? And certainly a certain percentage of the organization will have issues. But overall I have to say what I have seen over the last two months was really promising. We have a hugely dedicated and motivated workforce. I think what we need as a company now is to see into the right direction and especially setting priorities and narrowing focus. It's not that people at ITM and it didn't want to deliver what was sold was just the sheer amount of topics to work on in parallel with limited priorities being set. And I think we will definitely change that and hopefully that will over also the employees to embark on their journey to get [indiscernible] with us. And perhaps if I could offer on top of that we're already seeing a change in the last two months having been before and post Dennis' arrival. That's great, James. Thank you and thank you indeed for the questions. Of course, let me review all the questions submitted and we will publish responses on the Investor Meet company platform where appropriate to do so. Dennis just before redirecting the investors to provide you with their feedback, which is particularly important to you and the team, I just ask just for a few closing comments please. Yes. Thank you. I think, all was said, although what we wanted to say we did say. So this leaves me with maybe reinforcing again that we perceive this today to a certain degree of reset of the way we work with shareholders and we work with the market in terms of transparency and openness also being realistic, about what we do and certainly we will keep you updated on the progress of delivering against our 12 months priorities plan. Thank you very much for taking the time dialing in today and thank you for your very constructive questions. We have a lot to do, lot in front of us, but we will get it done and we will be ready on time for the big months spike to be seen in the market. Thank you very much for your attention. That's fantastic. Dennis, Andy thank you indeed for updating investors today. Please ask investors not to close the session, you should be automatically redirected to provide your feedback in order the team can better understand your views and expectations. This will only take a few moments to complete and is greatly valued by the company. On behalf of the management team of ITM Power Plc, I would like to thank you for attending today's presentation. That concludes today's session. Thank you and good morning to you all.
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EarningCall_1230
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Good morning, and welcome to the United Community Banks Fourth Quarter Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to your hosts. Please go ahead. Good morning and welcome to United Community Banks Fourth Quarter 2022 Earnings Call. Hosting our call today are Chairman and Chief Executive Officer, Lynn Harton; Chief Financial Officer, Jefferson Harralson; President and Chief Banking Officer, Rich Bradshaw; and Chief Risk Officer, Rob Edwards. United's presentation today includes references to operating earnings, pretax, pre-credit earnings and other non-GAAP financial information. For these non-GAAP financial measures, United has provided a reconciliation to the corresponding GAAP financial measure in the Financial Highlights section of the earnings release, as well as at the end of the investor presentation. Both are included on the website at ucbi.com. Copies of the fourth quarter's earnings release and investor presentation were filed last night on Form 8-K with the SEC, and a replay of this call will be available in the Investor Relations section of the company's website at ucbi.com. Please be aware that during this call, forward-looking statements may be made by representatives of United. Any forward-looking statements should be considered in light of risks and uncertainties described on Pages 5 and 6 of the Company's 2021 Form 10-K as well as other information provided by the company in its filings with the SEC and included on its website. Good morning and thank you for joining our call today. We continue to be pleased with our overall performance, we recorded operating earnings per share of $0.75. While that is flat with last quarter, it's a significant increase over the same period in 2021. Our operating return on assets remain strong at 135 basis points and our pretax pre-provision return on assets reached a new high of 2.07%. Our net interest margin continued to expand, increasing 19 basis points over the third quarter, and loan growth reached 12.2% annualized for the quarter. Business conditions for us remained strong, and our Southeastern economies continue to perform very well. However, we're seeing the impact of Fed rate increases. Clients are actively searching for higher yielding investments. And we saw deposit outflows of $445 million, primarily in DDA. Deposit competition and resulting deposit betas have increased and will continue to increase in the near-term. We're assertively defending our deposit and customer base and believe we will continue to relatively outperform in our funding cost. Credit results remain very strong. However, economic forecasts continue to weaken, resulting in reserve bill during the quarter. While net charge-offs did move up to 17 basis points, these results remained below or better than what we would consider normal. Non-performing assets remain low as to our special mention and substandard accruing loans. Notwithstanding the continued good results, we are cautious and have tightened underwriting standards several times over the past year. Finally, on the operating side, while we did have an uptick in expenses, our net interest income grew substantially, leading to another improvement in our efficiency ratio, reaching a new record low of 47.3% on an operating basis. Strategically, while not included in the quarterly results, we're very excited to have welcomed Progress Bank into United on January 3. Progress has a great franchise and some high growth markets, including hospital in the Florida Panhandle, is a perfect complement to our existing franchise and will improve our growth prospects for years to come. David Nast, the Founder and CEO of Progress has built a great team. And we look forward to his continued leadership as United in those great markets. And now Jefferson will share more details for the quarter. Thank you, Lynn. And good morning to everyone. I'm going to start my comments on Page 5, where you see the highlights of the quarter that shows our strong returns, many of which Lynn just went over. But I'll focus on the two notable items that we broke out this quarter. The first is that we have a small number of equity investments on our balance sheet. They are not significant in dollars, about $14 million. And usually, we don't need to break out the gains and losses here. But this quarter, our equity investments were up $3.6 million, which is unusual and likely will not repeat. The second item is that we took a $1.8 million tax charge because we have started the process and intend to surrender $34 million of BOLI investments in Q1. We have had this BOLI investments since before 2007 and it is underperforming and actually negative yielding. By surrendering, we received a $34 million back over five years and can reinvest at higher market rates. Let's go to Page 9 and talk about deposits. We believe we have one of the strongest core deposit bases in the Southeast. As I mentioned, we are seeing the impact of rapidly rising rates and our deposit shrunk in the quarter. The price competition for deposit is also increasing. And we are seeing our deposit betas increase. Our cumulative deposit beta moved to 12% for this cycle from 6% cumulative last quarter. And we expect this to increase in future quarters, both due to higher rates in our various account types and due to a mix change towards CDs. On Page 10, we provide some greater detail on our deposit trends. The biggest overarching trend this quarter was a decline in the average account balance of our commercial customers, specifically in DDA accounts. While our number of accounts increased, we're seeing businesses make purchases, make tax payments, make distributions, sometimes move to institutional money markets or treasury bond funds. We're also seeing some movements to CDs in our business accounts as well. On Page 11, we experienced strong loan growth in the quarter with mortgage being the biggest contributor and fairly diversified growth after that. Moving to Page 12, we feel good about where our balance sheet is in terms of liquidity and capital. Our loan to deposit ratio did increase to 77% this quarter from 73% last quarter. We're still below where we have been running historically and like our positioning from a liquidity standpoint. We talk about capital more on Page 13. We are above peers in our TCE ratio, and in our risk-based capital ratios. We're using capital in the first quarter with the Progress acquisition. But we still expect to be above peers pro forma for the acquisition. Moving to Page 14, we discuss our net interest margin. We had 19 basis points of net interest margin expansion in the quarter, 20 basis points of which came from the impact of higher rates. And one basis point came from positive mix change, the impact from positive mix change this one basis point I mentioned is lower than what it has been in the past few quarters. In past quarters and in this quarter, we have had the benefit of a shrinking securities portfolio funding higher yielding loans and we expect this to continue. But now we also have the negative mix change impact, which is moving us away from low cost DDA towards CDs and other higher cost products and also the deposit pricing lag continues to catch up. While the funding environment is competitive, I do believe our Q1 net interest margin is somewhere between down five basis points and up five basis points, including the impact of Progress coming into the numbers. So, it's a bit unclear whether this quarter was the peak in margin or whether it will be in Q1. Moving to Page 15. Fees were up $1.5 million compared to last quarter, with the main driver being the $3.6 million in unrealized equity gains, I've mentioned earlier. Excluding those gains, the income was down in Q4, mainly due to mortgage and the absence of the large MSR gain that occurred last quarter. Another reason for the decrease in fees was our decision to sell less SBA loans. While we had strong originations, we had $47 million of SBA originations, we sold just $17 million because the gain on sale pricing was less favorable than in past periods. So, we kept more loans on the balance sheet and sold less. We expect to sell this backlog in the first quarter, which will be on top of our normal first quarter sales. Just keep in mind that the first quarter is typically our seasonally weakest quarter for SBA originations. Finally, we had a small amount of realized security losses in the quarter, as well as a small MSR write down. Moving to Page 16, our expenses increased in Q4 by $4.9 million. We have listed the main drivers of the increase on the slide. I would also say in addition to this, that as I look at the just less than $2 million increase in the communications and equipment line item, that some of the items in there were above what I would call a normal run rate after a lower than normal Q3. So ongoing costs would be closer to the middle of where the Q3 and Q4 results came in. Of course, Progress will come into the expense numbers in Q1, and we expect to start getting the Lion's share of the $13.5 million in annual cost savings after our second quarter conversion. On Page 17, we talk about credit, our net charge-offs remained low, but moved higher in the quarter to 17 basis points, with the biggest driver being a C&I relationship, along with some normalization at Navitas that we were expecting. NPAs moved slightly higher. And our special mention and substandard accruing categories were fairly stable. But there were some inflows and outflows that Rob can talk about in the Q&A. All in, we feel good about our credit quality, but acknowledge that we are moving into a period where we expect credit to normalize. On Page 18, we talk about the reserve and show that we continue to build our reserve in the fourth quarter, as we also built our reserve throughout 2022. Specifically, we set aside a $19.8 million provision and took the allowance for credit losses to 1.18% of loans from 1.12% last quarter, and from 97 basis points a year ago. The driver of the increase is similar to what it has been all year, which is the weakening of the Moody's Baseline Economic Scenario. All said we feel great about our pre-credit profitability ratios, and the growth of the bank as well as our credit quality and liquidity. But we also acknowledged that we could be moving into a tougher economic environment and we believe we are prepared for 2023 whether it be a soft landing, or something more challenging. With that, I'll pass it back to Lynn. Thank you, Jefferson. And many thanks to the United team. 2022 has been a great year, thanks to your efforts. Thanks to you, we've expanded into dynamic markets in Tennessee, including Nashville and Clarksville. You earned recognition for being number one in customer service in the Southeast for the eighth time in the past nine years. You gave your time and talent to numerous community organizations across our footprint. You added and updated new systems to allow us to better manage risk and to serve our customers. You continue to develop your teams by recruiting new bankers and leaders through training like Leadership Academy, and by taking action on our All Employee Engagement Survey. Finally, you're recognized as creating a great place to work by American Banker for the sixth year in a row. It's an honor to work alongside of you, and I can't wait to see what 2023 will bring. And now I'd like to open the floor for questions. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Catherine Mealor from KBW. Catherine please go ahead. I'm curious to know what is start on expenses. You mentioned that the run rate to start with is kind of somewhere between the third quarter and the fourth quarter. Can you just kind of help us think through what kind of growth rate we should be thinking about from that level. And it looks like some of the higher FDI expense -- FDIC expenses were in this quarter. But are we going to see more of that next year? And just want to kind of think about what kind of expense growth rates appropriate next year? That's great, thanks for the question, Catherine. When I mentioned between third and fourth quarter, I was talking specifically about the communications and equipment expense. We had several things come through that line item, it's just kind of unusual, write downs of equipment and such that I don't think will recur. So I wasn't so much talking about total expenses between Q3 and Q4 mostly that single line item. The FDIC specifically was an increase of the assessment and late Q3, so we had our Q4 number and a catch up for and a little bit of a catch up on the assessment, but does not include the biggest increase that is happening for, that is two basis points higher on the assessed net assets. With that, I would expect because we're a little higher than usual this quarter, instead of being a million dollars higher next quarter, maybe it's $800,000 higher next quarter. So the FDIC will be a higher semi-permanent run rate by $800,000 is my best estimate right now. The bigger question you're asking probably is the run rate of expenses, and again off a slightly lower base, than Q4, I think it's a 4%, 4.5% growth rate, given the inflation rates that we're seeing, again the last fee cost savings coming from Progress. Great, super helpful. And then you gave some good margin guidance kind of a range that we might pick this quarter or next, how much in terms of size of the balance sheet and how you're thinking about loan growth into next year, it feels like your competitors have started to pull back loan growth expectations, just given the economic uncertainty, but just kind of curious how you're thinking about growth this year? So I'd like to start just with the size of our balance sheet, which I expect to be relatively flat. It was a -- we had a little growth this quarter, which was surprising a little bit, I thought would be flat. And with that, I'll pass over to Rich on our forecast for loan growth. Sure, good morning, Catherine. We're still thinking about mid-single-digit loan growth for this quarter and really 2023. We probably originally kind of thinking the range of 7% to 8% and probably per last quarter thinking more in the 8% range, but probably lower into the range now into the economic headwinds that we're looking at. Any change in the composition with that, I know Navitas has been relatively larger piece of the of the loan growth over time, if you expect that to pare back and be supplemented in other ways, you're counting on the composition of your loan growth? Yes, I'll address that. So I think Navitas will continue to be similar. In terms of the loan growth, what we do expect to see a little bit go down is mortgage. We've seen Q1 will be down a little bit. Also, we've continued to tighten some of our underwriting criteria, particularly on the construction to permanent product. Maybe just to follow-up on Catherine's question. If Rich is right, you guys grow your loan book maybe a billion dollars or so. Jefferson, if I recall is still about $200 million per quarter coming out of the bond portfolio? Is that the right number? And I guess, what would be the plan, to sort of maybe bridge the rest of loan growth, would you kind of lean into the FHLB a little bit more or in your mind, you think it's an environment where you can kind of stop some of the deposit runoff and maybe stabilizes or even grow deposits a bit? Right, so I'll start with that, Rich can jump in, especially on our deposit thoughts. But yes, maybe it's a little less than $200 million a quarter. But we do plan on funding a lot of our loan growth with a securities shrinkage. I think this quarter, you'll actually see the FHLB come in a little bit. We've done a lot to try to stoke our deposit growth. We've been doing it all year, but given the environment we're also doing a lot of energizing the footprint in the geography as well. We have some higher rates out there to help spur deposit growth. I might pass it to Rich on some of the things that we're doing on the deposit side. I can also step in there too. Yes, just to give you some specifics. Like we're -- we generally pick a certain time period for a CD in this case happens to be 11 months that are special and 415 range and then we have empowered the field so that's going to be the State Presidents to Presidents and the retail management in terms of a product, the Special index based off Fed funds. So we put that authorities out in the market so they can make those decisions real time. And that's in the mid-3s. And that's been really geared towards our best relationships. So that's our main lever that we want to pull is the really press on the deposit growth engine that we have some confidence in at the bank. And the -- if it's not there, what do we do to define that, our FHLB is there we want to, we don't want to lien on it too hard, we have a broker CD lever we can pull on, we also could sell some available for sale securities at small losses that create some liquidity if we wanted to. So we're looking at really all things but the main, we're happy where we are because of the securities funding most of the loan growth and we have a lot of options beyond that if the deposit growth isn't there. Got it. Thank you. And maybe just switching gears to Rob, curious if you could maybe give us a little color, maybe on the movement within the non-performing list and then maybe some of the key drivers, underlying your provision this quarter and obviously, we're in a dynamic environment where the assumptions can change rather quickly. But as best as your crystal ball can tell us, do you think you sort of built the reserve to a level where maybe you feel more comfortable now all else equal, or do you think, as we think about next year, there's more of a bill to come is, maybe you guys close the gap to peers a little bit? No, you hold a little bit more capital, but just any additional color around credit would be helpful. Yes, glad to. Hey Brad. So just on the NPA side, I would say the drivers for NPA that we saw Navitas was up a couple of million, and our manufactured housing was up a million. And then really, it was the C&I credit that we took a charge on that drove the rest of that. So those were the three elements in the NPA that drove the dollars up. On the provision, the economic forecasts really caught up with the Fed's strategy around increasing rates. And when rates are rising, the investment in equipment and investment in real estate is expected to decline. And so we saw increases in our C&I and equipment finance and commercial construction categories driven by the expected increase in rates. So that was really the driver this time, of course, we had the loan growth is also a driver and the charge-offs play a role as well as they begin to normalize. In terms of expectations, you just have to remember that the way CECL works, it's procyclical. So, you end up building before you get into a recession. If Moody's expectation of the scenario is accurate, then I think absent changes in loan growth and asset mix and charge-offs that, it would feel like, I would expect the scenarios to be stable, but this quarter, they were catching up a little bit. And it's not entirely as you know, it's uncertain economic times. And so, they're trying to predict something as well that's fairly uncertain. Got it. Thank you. Jefferson, just a housekeeping question. That BOLI surrender charge that you noted in the deck, is that buried in other expense? Or is it -- is that housed elsewhere? Hey, good morning. Thanks for taking my questions. Just wanted to circle back into Navitas. Obviously, things are normalizing. Can you just remind us if you've changed kind of the mix of what they've done since you've acquired them both in kind of what you sell and what you keep on balance sheet? And then also kind of what we should expect for kind of a normalized through the cycle level of charge-offs for that business? Thanks. So, I can maybe start on that. I think that when we bought Navitas, they were a standalone company. They had a higher cost of funds and as they came on to UCBI, over the years, they have moved upstream in terms of credit quality, so all in, they have a stronger credit quality than they had in 2018, where we bought them. Rob, do you want to take the credit piece of it? Yes, so if you look at Slide 21 in the deck, Michael, we've kind of have included the '19 and 2020 loss rates. So it would be, I could see us getting into the 70 basis points to 80 basis points range as things normalize. Okay, helpful. And then I wanted to circle back to the kind of expense, some of the commentary there, obviously, understanding, there's a lot of moving parts, but it seems like there's potentially a lot of very variability from kind of a starting point. So would you be able to just kind of because, I think their expense run rate was somewhere around $13.5 million a quarter, I just want to see if you could, if you could verify that. And then kind of what would be kind of a core number without that, that base just to kind of begin to forecast off of. Again, I know, it's hard, because there's a lot of moving pieces and systems conversions coming up in the second quarter, et cetera. But just wanted to see if you could provide a little bit more finer point on the starting point for expenses this quarter? Thanks. Yes, so I think it's a $1 million to a $1.5 million lower than what our operating number was this quarter. And I think you have the Progress number about right. And so, I think you add those together for Q1, now you have some FICA coming back in Q1. So, you have some -- so you have some seasonal Q1 things that happen. But then you have cost savings of the $13.5 million that we expect to get probably starting some in Q2, it's pretty close to the full realization in Q3, full run rate realization in Q3. Okay. Thank you for that. And then just finally, just more broadly speaking, obviously, the Progress deal is just closed. There's a lot of dislocation on the market. I know you guys have been pretty active on the acquisition front. But the economic backdrop at least is deteriorating. So that kind of put additional acquisitions for the time being on hold? Or will you just be, continue to be opportunistic like you said in the past? And obviously, I think you've identified some end market opportunities within your footprint, whoever knows -- who knows when they can come, but any reason that you wouldn't continue down the M&A path, just in light of the backdrop? Thanks. Yes, thanks. This is Lynn. So, I would look at it a little bit like, like lending money, we're going to always lend money, but in different environment where we've got to be more selective. So, I think, we have always liked smaller transactions, always liked transactions in great markets. We've always liked conservative lenders out, but I would say, we'd probably put a little extra look at that, we'd probably look a little extra look at liquidity. And because at the end of the day, the sellers are the one that take -- that determine the timing. So, all that to say is, we would potentially still be in the M&A game, but you would want it to hit all those. Anything we announced, you'd expect it to hit all those triggers in terms of small size, great market, high liquidity, conservative underwriting, it'd be one that you'd want us to do. Hey good morning, everyone. Most of my questions have been asked and answered. One question about the -- I think when you were talking about the loans and the type of loans that might be dialed back a little, I believe that was mentioned -- residential mortgage was mentioned. Is that and if that's true, is that simply that it's getting to a size contribution to the loan mix where you're less comfortable taking that up? Or is it something changing in the market, just curious? Good morning, Kevin. This is Rich, and I think we've been very disciplined about concentration risk. And that's really the biggest part of the CEP portfolio that we're doing. Other areas, probably two years ago, we started slowing way down on senior care. The underwriting criteria for Multifamily has certainly become tighter. And also just the mere facts that you're stress testing, interest rates has made that a little bit more of a challenging product. But we continue to look at different aspects with, we're talking about office deals, we haven't seen an office deal in senior credit committee, I can't tell you how long. So those are just some thoughts. I'll just add in there and Rich did mention it. But some of it is just interest rate risk management, you're putting on a five year, seven year or 10 year paper, and what might be a rising rate environment, and we'd rather just have a little bit less of that coming on. Okay, that makes sense. And appreciate the range on the margin, it's certainly going to be noisy in first quarter with the deal coming on. But if we're, say getting beyond first quarter, and now we've got this whole Progress in, fully in and now, let's say we're done with Fed hikes, but not yet to a point where the Fed is cutting in that kind of environment, do you think you can hold the margin steady? Would you expect to hold it steady? Or would it be more likely that we see some modest grind down to the margin, given the lack of deposit costs increasing? I think it's more likely the latter. And that's what we're modeling is a slight grind down. Again, we have some defenses and that you'll be seeing the loan-to-deposit ratio, I think increasing a little bit, you'll see the mix change between securities loans that we've been talking about for a few quarters now. But I think the lag effect of funding and the price competition that we're seeing out there, combined to grind slightly down for the rest of the year. And Jefferson, just on that point about the loan-to-deposit ratio, so with it up to a slightly above 77%. So it's still very liquid balance sheet relative to pre-pandemic. How would you think about that ratio in terms of, when you're assessing when, and whether to get more aggressive on deposit pricing? How comfortable are you taking or to what level are you comfortable taking that ratio up to? That's a great question we have. We have been running in the low 80s for very long time, pre-COVID, where we felt comfortable, we feel comfortable moving that higher into the mid-80s, you're going to see some movement at the loan-to-deposit ratio next quarter, Progress coming in, takes you to 79 on its own, so wouldn't see -- I wouldn't be surprised to see a tick a little higher from there. So we like -- again we like where we are, we're comfortable in the mid-80s. But the balance sheet management and how we're thinking about liquidity and deposits, it really starts now. So we're not waiting for it to get to 85%. We're managing and energizing the deposit franchise now to try to protect the loan-to-deposit ratio best as we can now. Good morning. Question maybe more for Rob, I know you mentioned. I think it was maybe the senior component in terms of office but just hopped off a call where there was another bank, maybe not your footprint, but maybe the size, we're seeing some deterioration or some concerns around the Office segment, just provide us maybe what your exposure is there, and maybe what you're seeing in terms of the health of your portfolio? Yes, hey, David, this is Rob. So it's around a $660 million portfolio, criticized and classified in that portfolio at the moment is about 1%, just over 1%. So we're really not seeing a whole lot degradation there. It is a fairly granular portfolio, so not a lot of large dollar projects. Traditionally, we have focused on medical office buildings. Rich's favorite phrase around this is that the office building needs to be able to fall down on the hotel if it falls down. So that's kind of the -- that's kind of been our emphasis, but it's a very granular portfolio and we're not seeing really not seeing a lot of change in its performance. Got it. And then a follow-up question on the -- from Kevin. Just curious securities book the bond portfolio were on is, but of the quarterly cash flows. Thanks. I'll hop off. Curious, you just closed the Progress deal. Curious how you feel the Reliant transaction has gone after a year. I know you had an unexpected leadership change. But was your largest acquisition, I think your most expensive just curious how you think is going so far versus your plan? So I'll start and then let Rich run with that. I mean, we've been pleased with it. Certainly, the vans passing was a blow to all of us and all the team there. But they've really banded together. We think it's a long-term. Great place to be, we think we've got the great, right people to be there. Rich is heavily recruiting together with John Wilson there. So look, we're very pleased we're there. We're very pleased that this was the franchise that got us there. Yes, we hit a few speed bumps along the way. We don't mind saying that. But long-term is going to be a great spot. Yes, and I would add that I do feel that John Wilson and Mark Ryman have turned the ship around, it took a little bit, but we're seeing it both. And the other comment I would make is there were certain credits in there that weren't our credit appetite. And we believe that we've kind of worked through almost all of that during this past year and feel really good about 2023 and the opportunity. Great. Second question is on asset quality, you said loan losses are coming closer to normal levels? What do you think normal levels are for UCBI with the loan portfolio mix it has today? So that's an interesting question, I would say, I've always sort of targeted through the cycle losses of 30 basis points. For where we are today, in a normal environment, if I go back to 2020, we were at 18 basis points this quarter, we came in at 17 basis points. I felt really good in 2020 with the 18 basis points, but somewhere in that 18 to 30 range seems like a sort of through the cycle, normalized type range. Thanks. Good morning, Jefferson on the loan yield improvement we saw this quarter, did the SBA had any influence on that just retaining those? I didn't know if that was meaningful at all? Okay, fair enough, and Rob, just a big picture credit question, kind of continuing Jenny's line of credit, or thought rather, do you think that the stress testing that has now gone on higher yields and possibly being higher down the road, to what extent does that influence just the way you think about the reserve, the ability for customers to sustain these levels, LTVs, cap rates, et cetera. So, it's interesting when you talked about higher interest rates. So what we're seeing is that the higher interest rates, and the stress testing is just requiring on the front end, certainly requiring stronger capital, I don't think we've done a deal in the last 90 days that didn't start with 50% or 45% equity number in it and 50% to 55% loan to cost. In terms of, if you're just talking about the standard portfolio, what impact does higher interest rates have, I'm not sure we're seeing all of that fully yet. But I think overall interest rates are a component of increasing costs, right? So there's wage inflation, there's cost of supplies are up and interest rates are up and what we see is some of our C&I borrowers, over the last year and a half have just needed to raise prices. And if they're on top of that, and doing that proactively, it works out fine. And we've had a couple of them that haven't been proactive and they're needing to catch up. And this concludes our question-and-answer session. I would like to turn the conference back over to Lynn Harton, CEO for any closing remarks. Okay, well, just in closing, I would thank you all for joining the call for your support. As always, if you've got additional questions, please reach out to us and we'll look forward to talking again soon. Thank you.
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At this time, I would like to welcome everyone to the Enterprise Financial Services Corp. Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Thank you. Colby, thank you and thank you all very much for joining us this morning and welcome to our 2022 fourth quarter earnings call. Joining me this morning is Keene Turner, EFSC's Chief Financial Officer and Chief Operating Officer; and Scott Goodman, President of Enterprise Bank & Trust. Before we begin, I would like to remind everybody on the call that a copy of the release and the company presentation can be found on our website. The presentation and earnings release were furnished on SEC Form 8-K yesterday. Please refer to Slide 2 of the presentation titled Forward-Looking Statements in our most recent 10-K and 10-Q for reasons why actual results may vary from any forward-looking statements that we make today. Throughout 2022, we stressed our commitment to building partnerships with our clients, the execution of our strategic initiatives and our diversified business platform. This cadence of consistency produced record results for both the fourth quarter and for the entire year. The financial highlights for the fourth quarter begin on Slide 3. We capped the year with tremendous momentum, both for loan growth as well as earnings. We earned $1.58 per share for the fourth quarter which resulted in a 1.83% return on average assets and a 23% return on tangible common equity. This is inclusive of our tangible common equity to tangible assets ratio expanding during the quarter and we closed the year at 8.43%. Additionally, our robust earnings helped to contribute approximately $2 per share to our tangible book value during the fourth quarter which closed at $28.67 per share. Turning to Slide 4. You can see that we had an outstanding quarter with respect to loan growth. On an annualized basis, we were able to grow the loan portfolio by 16%. Moreover, the diversification on which we have focused was on full display as just about every market in business line contributed to these outstanding results. Scott will provide much more color about these markets and businesses in his comments. Our posture on deposits has not changed. We continue to actively manage deposit rates and focus on the relationship aspect of this side of our business. The goal is to find the appropriate balance between retention, growth, competitiveness and stability. I'm really pleased with how this has played out as evidenced by the De minimis amount of runoff, a relatively low cost of total deposits and a stable DDA percentage right around 42%. This level of discipline, coupled with the rise in short-term interest rates resulted in a net interest margin expansion of 56 basis points. Our credit statistics remain outstanding as both non-performing loans to total loans and non-performing assets to total assets improved from the very low levels that we reported at the end of the third quarter. We did record a modest provision expense in the quarter due to our strong loan growth outpacing the risk reduction in the portfolio during the fourth quarter. Slide 5 provides a recap of our highlights for the full year. On a fully diluted basis, we earned $5.31 per share in 2022 an increase of 38% from 2021. We grew portfolio loans at a rate of 11% for the year, with contributions from all of our regions and businesses. Along with our balance sheet performance, this growth supported our record financial results. Our pre-provision net revenue expanded 25% over the prior period. This helped drive a pre-provision net revenue return on average assets that easily surpassed 2% to end 2022. All in all, 2022 was an incredible year for EFSC. We entered the year with a focused mindset of delivering consistent results. The record earnings per share that we produce is a product of a well-executed plan that focused on diversified revenue growth, disciplined pricing within our deposit base, consistent credit and pricing fundamentals, patient and thoughtful capital and investment management and responsible expense management. As we turn the page and head into 2023, our areas of focus which are found on Slide 6 have not changed. Despite the continual change of our operating environment which include ongoing short-term rate increases, intense deposit competition and the likelihood of a mild recession, we are confident of our ability to perform at the high level that we have become accustomed to. The conversations we've had with our clients gives us confidence that 2023 should be another outstanding year for EFSC. For the most part, backlogs and order books of the operating companies that we serve are strong with corporate balance sheets that provide ample room for continued growth. They are still dealing with some of the same issues that have become commonplace such as sufficient competent labor and reliable supply chains. However, we do not see these issues as derailers to the success of these businesses. We feel good about the continued growth of our investor CRE business due to the many projects that have broken ground in late 2021 and throughout 2022. New projects have been slower to materialize as the sharp rise in interest rates require the owner developers to recalibrate their input metrics inclusive of additional equity. On the deposit side of things, we believe that we will continue to see a bit of pressure on rates throughout the year. There's always a lag on rate increases, especially for higher balance commercial accounts. We've been hard at work throughout much of 2022 identifying specifically where we need to make proactive movements to preserve these highly valued relationships and feel very good about where they stand. With that said, I feel very confident that we can fund our expected loan growth with the various deposit generators that we currently have. With that, I would like to turn the call over to Scott Goodman, President of Enterprise Bank & Trust for his insights about our markets and business lines. Scott? Thank you, Jim and good morning, everyone. As you'll see on Slide number 7, loans at year-end totaled just over $9.7 billion, representing an 11.3% increase from the prior year, net of PPP. Although, $984 million of core growth was well diversified across the major loan categories as detailed on Slide number 8. Strong growth in C&I reflects continued success in attracting new operating company relationships across our footprint. Specialty business lines contributed a similar level of growth overall as C&I and also continue to perform consistently. Growth in commercial real estate, while more modest overall generally reflects an intentional approach to partner and go deeper with a select set of strong investors and developers in each market rather than chase projects or transactions. Q4 was a period of strong loan growth as reflected on Slide number 9 with contributions by nearly all markets and lines of business. Originations for the quarter were up nearly 15% from the prior period. Q4 is typically a seasonally strong loan production quarter for us but this was further bolstered by wins on a number of larger new C&I relationships and nice performance out of the gate by our new team in Dallas. The specialty lending units contributed roughly 1/3 of the growth this quarter with an aggregate increase of $141 million. SBA finished strong, posting growth of $43 million in the quarter despite the continuing headwinds of higher short-term rates. The team is focused on proactive steps to moderate payoff activity with existing borrowers and continued consistency in our product offering to the market with a relatively stable pipeline heading into 2023. Life insurance premium finance had a seasonally strong quarter, based on the timing of premium renewals in the book. But growth has been further accelerated by additional new referral partners in 2022, including new opportunities from the legacy First Choice book which we've been able to nurture and grow. Tax credit also executed well with $52 million of quarterly growth, pushing the total to $73 million or 15% for the year. Strong quarter mainly reflects advances on the existing projects in process along with several new ones. The necessity for affordable housing and the continued adoption of these programs by more states should provide continuity of our opportunity pipeline in this business looking forward. Sponsor Finance posted a small decline in the portfolio for the quarter, mainly relating to slightly lower origination activity and some churn in the existing book through to the sale of platform companies. Year-over-year growth for this business has been quite strong at $127 million or 25%. Much of the activity in this channel is timing contingent due to the aspects of the M&A process and the lower origination volume reflects some delayed closings which will carry over into Q1. In general, though, the pipeline of new deals for the specialty remains healthy and active. Turning now to the regional results which are on Slide 10. Our Midwestern markets of St. Louis and Kansas City grew $99 million in Q4 and posting year-over-year growth of 9.4% both markets experienced a modest increase in revolving line outstandings and had solid new origination activity in the quarter. Notably, we onboard several new middle market C&I relationships along with a nice volume of refinance and new commercial real estate development loans in the Kansas City market. Our Southwestern markets grew by $81 million for the quarter, resulting in solid year-over-year growth of 14.6%. This includes $27 million in growth from our new Texas team, bringing their production to $43 million for 2022. This office which opened midyear is off to a strong start and with a nice balance of both new C&I and commercial real estate clients. The Arizona team also had some nice closing this period including a large retail center for a new investor relationship and a development loan for a large, well-known community-based organization serving children in the Phoenix Metro under a new market tax credit structure. In Southern California, we grew $51 million in the quarter and are building nice momentum heading into 2023. We continue to execute a strategy in this market of expanding the legacy relationships from predecessor banks and developing a larger C&I portfolio through talent acquisitions. This period, we onboarded several new C&I relationships, assisted a large legacy franchise operator with an acquisition and materially expanded a credit facility with a legacy CRE investor. Moving now to deposits which are on Slides number 11 and 12. Total deposit balances were down $229 million for the quarter and $515 million or 4.5% year-over-year. Breaking this down, non-interest-bearing accounts were stable for the quarter and up year-over-year. The declines were really isolated to the interest-bearing categories, with the majority of the funds being a limited number of higher cost transactional accounts or idle balances of larger businesses. As you heard from Jim, we've taken an intentional approach of selectively managing our deposit pricing to prioritize retention, deepen our key relationships and attract new ones. We've also developed a number of competitive deposit options for clients and our bankers are having proactive conversations to mitigate outflows. The deposit breakdown on Slide number 13 provides some clarity by region. Larger impacts tend to be within our more concentrated C&I markets and legacy portfolios. In the Midwest, for example, a large portion of their $281 million decline for the quarter is attributable to a single upper middle market company that we had assisted with a Main Street loan. Upon recent repayment of the Main Street loan, we were unable to retain the full relationship which moved back to a national bank along with the accompanying deposits of roughly $120 million in the quarter. More generally, though, we have been successful in growing relationship-based balances, originating over $1 billion of deposits from new relationships during the year, with average balances for these new accounts, materially exceeding those in closed accounts. Lastly, I'd like to point to the growth of our specialty deposit verticals which are detailed on Slide number 14 and which continue to enhance our flexibility to optimize our funding strategy. During Q4, balances grew within each of our specialties, community associations, property management and third-party escrow. Specialized deposits in aggregate grew $102 million in the quarter and $302 million or 13.6% for the year. Thanks, Scott and good morning, everyone. My comments begin on Slide 15, where we reported earnings per share of $1.58 in the fourth quarter on net income of $60 million. Organic growth in earning assets and continued margin expansion drove a meaningful increase in operating revenue in the fourth quarter. This led to record earnings per share that expanded 20% from the third quarter. Non-interest expense and the provision for credit losses both increased in the quarter but these increases were more than offset by the 16% sequential increase in operating revenue. For full year 2022, we reported net income of $203 million and earnings per share of $5.31 compared to $3.86 in the prior year. Turning to Slide 16. Net interest income for the quarter was $139 million compared to $124 million in the linked quarter, an increase of $15 million. The increase came as a result of higher average loan balances, along with the benefit of increasing interest rates, driving our asset yields higher. The increase in net interest income was primarily driven by a $21 million increase in loan income and was partially offset by a $6 million increase in deposit expense. With the current composition of our balance sheet as of December 31, we expect the full impact of the existing interest rate increases will result in a quarterly net interest income in the range of $143 million to $146 million. As noted in the earnings release, approximately 17% of the variable rate loan portfolio reprices on the first day of each quarter and did not benefit from the fourth quarter interest rate increases. We expect that with the Fed reducing the magnitude of interest rate increases, that first and second quarter actions will be largely offset by lagged deposit costs. We're experiencing better-than-expected pricing on interest-bearing deposits. However, we do expect that we will continue to address deposit costs and competition in 2023. That is to say that net interest income growth will be correlated with loan growth and any additional actions by the Fed. Moving on to Slide 17, net interest margin on a tax equivalent basis was 4.66%, an increase of 56 basis points from the linked quarter. With an asset-sensitive balance sheet, we continue to benefit from rising rates and asset yield rose more than liability costs in the period. Earning asset yields improved 78 basis points which included 77 basis points of loan yield improvement, including a 6.64% origination rate on new loans and the investment yield improved 26 basis points as reinvestment rates continue to increase to a 5.2% fourth quarter tax equivalent rate. Asset yields were also aided by an enhanced asset mix as we continue to grow loans and investments while reducing cash balances. The cost of interest-bearing liabilities increased 40 basis points from the prior period, driven mainly by higher deposit rates and variable rate borrowings. Our deposit portfolio remains more than 40% non-interest-bearing balances which allows us to be more deliberate with deposit pricing compared to prior rate cycles. The loan portfolio is our largest driver of asset sensitivity as 63% of loans are variable rate. More than 60% of those have interest rate floors. And essentially, all of those with floors are currently priced above the floor. While our variable rate loans have enhanced earnings during this cycle, we executed several interest rate swaps in the fourth quarter to protect future earnings if rates should begin to move in the opposite direction. Our interest-bearing deposit beta was approximately 30% in the fourth quarter. And while it is higher than the previous period in 2022, it remains below our expected and historical level. While we expect this lag in the deposit pricing to abate, we believe our ability to control deposit costs through this rising rate environment has been greatly enhanced versus prior interest rate cycles. We remain committed to funding asset growth through relationship-based deposits and our specialty verticals. On Slide 18, we demonstrate our credit trends. Annualized net charge-offs remained low at 9 basis points in the fourth quarter compared to 2 basis points in the linked quarter. For the full year, net charge-offs were $3.9 million or 4 basis points compared with $11.6 million or 14 basis points in the prior year. Overall, asset quality improved in the quarter with non-performing assets and non-performing loans declining in dollar and percentage terms, from both the linked quarter and the prior year-end. Non-performing assets were 8 basis points of total assets and non-performing loans were 10 basis points of total loans. In addition to the improvement in the non-performing category, we also experienced a decline in past due loans in the quarter. On Slide 19, we demonstrate the allowance for credit losses. The allowance for credit losses declined $3.6 million in the quarter to $137 million, primarily due to net charge-offs and the overall improvement in asset quality. While the economic forecast factors used in our CECL model generally worsened in the fourth quarter, the loan portfolio mix shifted to areas that carry a lower reserve. A provision expense of $2.1 million was recognized in the quarter which primarily reflects an increase in the reserve for unfunded commitments. The allowance for credit losses represents 1.41% of total loans compared to 1.5% at the end of the third quarter. When adjusting for government guaranteed loans, the allowance to total loans was at 1.56% at the end of December. Turning to Slide 20. Our fourth quarter fee income was $17 million, an increase of $7 million in the quarter. The increase was led primarily by a $6 million increase in tax credit income. As you recall, this line item was negatively impacted in the third quarter by rising interest rates on tax credit projects carried at fair value while fourth quarter results did not see the same negative impact as rates were steady in the quarter and benefited from seasonally strong sales of tax credits. Tax credit income will continue to be seasonal and subject to further interest rate movements. However, fair value adjustments that reduced tax credit income are more than offset by higher net interest income in a rising interest rate environment. The fourth quarter also saw fees earned on community development investments compared to the linked quarter increase and they were partially offset by a decrease in deposit service charges driven primarily by an increase in earnings credits to clients based on recent interest rate trends. Turning to Slide 20. Fourth quarter non-interest expense was $77 million, an increase of $8 million compared to $69 million in the third quarter. Deposit service expenses were the main driver and increased $6 million from the linked quarter due to rising interest rates and growth in certain specialized deposit businesses. Compensation and benefits increased $1.2 million from the linked quarter, principally from higher performance-based incentive and bonus accruals due to the company's strong financial results. The fourth quarter's core efficiency ratio was 48.1%, an improvement of 170 basis points compared to the third quarter. This reflects the continued momentum in operating revenue, outpacing the rise in non-interest expense during the quarter. Looking to 2023, we're expecting the core efficiency ratio to be in the 50% to 51% range as we expect to see margin expand further from our fourth quarter levels. First quarter trends typically include an expected seasonal decline in fee income as well as higher compensation expense. Overall, for 2023, we expect salaries and benefits to increase around 6% and from the fourth quarter annualized run rate. The next big driver of expense is from increased deposit service expense from both rate and growth in certain specialized deposit businesses. We view this space as competitive and evolving and there may be some opportunity for us to manage throughout the year but not necessarily in the next couple of quarters. Our efficiency ratio guide reflects our posture on how we expect this line item to trend in 2023. Our capital metrics are shown on Slide 22 and the record earnings we generated in the fourth quarter of $60 million combined with an improvement in accumulated other comprehensive income, resulted in tangible book value per share of $28.67, an increase of 8% from the third quarter. During 2022, we still increased tangible book value per share by roughly $0.40 with our strong earnings level while returning $67 million to common shareholders through dividends and share repurchases. We announced another increase to our dividend for the first quarter of 2003, marking the seventh consecutive quarter of the dividend has been increased. In 2022, we paid common dividends of $0.90 per share a $0.15 increase or 20% compared to the prior year. While our dividend has increased, our dividend payout ratio of 17% in 2022 remains at a level that provides flexibility in our capital structure moving forward. The tangible common equity to tangible asset ratio improved to 8.4% at the end of the year. After the initial decline in the first quarter, when market interest rates increased and negatively impacted accumulated other comprehensive income, the tangible common equity ratio has improved in each of the last 3 quarters. While the tangible common equity ratio is now within our target range of 8% to 9%, we do not plan to execute any meaningful share repurchases in the near term. With the uncertainty on the path of interest rates and the potential economic impact of further short-term rate increases, we intend to let our organic earnings further strengthen our capital base. When market conditions and our capital position align, we still have 2 million shares available under our Board-approved purchase program. We had great momentum throughout the year and finished 2022 with a strong quarter. We delivered a 23% return on tangible common equity and a 1.8% return on average assets in the fourth quarter with a 19% return on average tangible common equity and a 1.5% return on average assets for the full year 2022. We believe that we are well positioned and look forward to carrying this momentum in 2023. Thank you for joining the call today and we'll now open the line for analyst questions. Yes, I just wanted to kind of get a sense for the variable deposit costs. Keene, we got your kind of high-end guardrails on efficiency and expectations on margin and how that all flows through. But just wanted to narrow in on the variable deposit costs. Is that sort of a onetime catch? Is that seasonal in nature? I know you had referenced kind of rate driven but is there anything kind of year-end? Just trying to predict that line a little bit better and how that -- from a run rate perspective? Sure, Jeff. I'm happy to give you some color there. So there was a little bit of catch-up that was in there from year-end and it really related to a competitive decision we made in the fourth quarter. Obviously, everybody is fighting for liquidity now. And I think the specialized deposit space is one where we're seeing some of the key players there. They've had some major deposit outflows and really trying to get aggressive. So we're just holding our ground there. I think we had a good quarter in terms of balances and we were responsive to some competitive pressures that had a little bit of an effect on some of what was earned throughout the year and there was some catch-up. I would say going forward, when you look at 4Q to 1Q sequentially, we're thinking that, that line item is up maybe $2 million to $3 million, just depending on what happens with balances and rates and sort of everything that we know at the end of the year. So maybe based on December run rate itself, it's probably $2 million. And then, based on growth and maybe some more leakage from a competition perspective, that increases up to $3 million sequentially. And then I think if you layer that in with our efficiency ratio guide, I think you can kind of see how we think that plays out for 2023. Okay. If I catch that right, you're referencing the variable deposit cost line item specifically and that's in addition to the... And then we got your salaries and comp in Q1 commentary as well. So it looks like an up in Q1 but again, kind of use that efficiency ratio to back in for the full year? Yes. I think Q1 obviously won't compare to the 48% efficiency with the seasonal fee income and a little bit shorter day count from a net interest income perspective and you have some seasonal expenses there. But I think with that $2 million to $3 million for the first quarter sequentially on that, tax credit line -- or sorry, the ECR line item, that should give you some good starting points for modeling the expenses for 1Q. Okay. I wanted to jump over to the margin? I think you referenced putting on some swaps in the quarter, I can't remember if that's the first we've heard of that. I mean just trying to get a sense for have you been putting those on in quarters prior and/or just trying to get the strategy of -- are you trying to be more aggressive in moderating or locking in, again, margin to the downside, should we flip on rates? Just trying to sense for the appetite of could we see more? And how far do you go? Obviously, clearly benefiting on the asset sensitivity front but I want to see what the other side and what you plan to do into '23? Yes. Jeff, I think -- so certainly, we were -- we've been focused in '23 on various strategies to essentially take some asset sensitivity off the balance sheet. Initially, I think that was cash into securities. And I think just moving the loan to deposit up in and of itself did that to a degree with soaking up some of that excess liquidity and letting some of that go. And then once rates were up, what we would say is meaningfully, call that late second quarter, early third, we started looking at a hedging strategy to take somewhere between 50 and 100 basis points of asset sensitivity to the downside off the table. I'd say we're about halfway there. We've done a couple of hundred million so far and we might have $200 million to $300 million to go. We're not getting -- we're not going to be incredibly aggressive. We would have liked to be maybe a little bit more assertive earlier on putting the hedges on but quite frankly, the loan hedges move the same direction as the fair value of securities in comprehensive income. And so that was a guardrail that caused us to be a little bit more cautious. So now with TCE in a little bit better spot, we're layering some of those in. And with the way the rate curve is, those are probably shorter-term hedges but we're not going to take 3% sensitivity off the table. We're probably going to take the better part of 100 basis points and we'll probably end up sitting there. So that's the way we're thinking about it. And then all of our net interest income and margin guidance is reflective of that, that we provided on my comments earlier. So first, I want to kind of continue on the margin commentary there. So Keene, do you think you guys kind of peak here in the first quarter for your margin? And then kind of are able to defend it and hold it as you progress through '23? Or do you think you still see a rise as far as the second quarter of this year? Yes. I think based on my comments, I think that seemed to reflect more defensive with first quarter peak, I think, when you really look out at how we forecasted it. I think that margin on a monthly basis peak sometime in the third quarter but I'm not saying that, that would actually result in third quarter margin being higher than second. And again, that's all dependent on what -- when we get the 7 basis points of Fed funds increases " that we're expecting to get, if that's all layered into the first quarter, then obviously, second quarter is probably more like the peak. But if that's a little bit more drawn out, I think maybe the peak is lower but maybe it's later. So we're thinking about it, call it, June, July time frame in terms of peak and probably first to second quarter is when you get what you guys will see as peak margin. Got it. Okay. That's helpful. And with regards to the outlook for loan growth, can you just provide a little color on what the expectation would be for next year. the commentary seemed pretty positive. Do you think you could kind of replicate the level you had in '22? Or do you think we start to see a bit of a pullback? Yes, Damon, this is Jim. I'll handle that. We're very comfortable in the mid- to high single-digit number with everybody contributing we talked about the fact that we don't want to jump into transactional lending or do the last project in any market. Just keep to the game plan, then we're going to have quarters like we had in the fourth quarter when it all comes together but we're comfortable that mid- to high single-digit growth going forward. Great. And then do you guys -- do you do much in the office space in your commercial real estate portfolio? Yes. Damon, it's I wouldn't say it's a focus. It's a function of those relationships that I talk about in each of our markets. But it's not a large focus or a concentration for us. And I think the portfolio we do have it seems to be performing well. Generally, it's like neighborhood type offices. We don't have a large metro Class A type portfolio. Yes. It's roughly $450 million to $500 million kind of sitting here today. So pretty diversified in terms of industry as well. So relatively small in terms of the whole. Maybe I'll just add too. We had done a targeted review on that portfolio not too long ago. And we're talking about LTVs averaging in 50% range. Debt service coverage is above 150%, so also performing pretty well. I just wanted to find out, just get a little bit more insight on just you talked a little bit, Keene, about the tax credit business and kind of the rebound and the seasonality at one point and maybe there's some seasonality going away and then last quarter, the issue. But just in general, that kind of tax credit or fee income, just kind of some guidelines as far as how to think about how you guys are thinking about that this quarter. Obviously, the CDE this quarter was a little bit of inflator but just any input or thoughts you have on the fee income would be helpful. Yes. I mean I think year-to-date, Brian, I think for this year, we're at, call it, $2.5 million for tax credit income in total. And I think that without any material movement in what we'll say, are longer-term rates, I think we look at -- that as probably a similar level for the upcoming year. If 10-year SOFR moves further down, I think there's opportunity for more fair value and vice versa. So we're kind of teetering at that point. And I think there are some cash sales that we do expect will offset some of the start-up and operating costs of that business for us. And then you asked about the kind of other income CDE private equity. I think we generally think about that annually as, call it, $2 million to $3 million that we feel comfortable. And then there's upside in some of those depending on how some of those projects ultimately work out and are exited. So that -- both of those businesses, I think, are seasonal. And we probably think that their second half weighted with obviously the tax credit business is fourth quarter weighted for us. So Hopefully, that gives you some perspective on where we think it is and what those, we'll call variable line items look like in '23. Yes. And just if you take out the tax credit line, Keene, of volatility, this fee income kind of in that when you look at all the line items, maybe kind of a mid-single-digit type of grower. Is that how you're thinking about it if you strip out the -- at least one item which had a lot -- had more noise in it last year. Or is that a -- on the low end where it was reasonable? Yes, if you're looking at third and fourth quarter, call it, recurring fee income, I think we think of those as kind of mid-single-digit businesses together overall. And I think there's maybe a little bit of pressure in competition in their traditional earnings credit space in some of our cash management and treasury management products but we're working to mitigate that. So we sort of think between card wealth deposit service charges that 5% from where we're operating in the second half of the year gets you in the ballpark. Yes. Okay. That's perfect. That's what I thought. And then just on the capital, kind of getting back here. As far as the buyback and potential M&A, I guess, the organic growth sounds like it's there. I guess when you look at the other options, how are you guys thinking about the buyback today in the M&A.? I mean you talked about the dividend already. So just any feedback on how to think about those or how you're thinking about those going into '23? Yes, sounds good, Jim. I would say, Brian, that we're trying to be thoughtful here about all the volatility that we've been through that investors have been through. And I think the idea is to create a really, really strong balance sheet. We already have it. The earnings power and the dividend profile give us the ability to do that. I think the allowance is maybe a little bit lighter than we would want it to be if there is a recession coming but asset quality is so good that, that's a struggle. So I think the next line of defense is, besides earnings and the allowance of capital -- and I think our goal would be in the near term to just to let that build and be a little bit conservative. And if we're operating with a little bit too much capital, I think that as we'll say, the environment improves and valuations improve. We are clearly a strong acquirer and we can deal with excess capital in a deal structure or something like that? And then, Jim, if you want to talk about our appetite for M&A, thatâs now probably the perfect time. Brian, it's one of those things we've got such great momentum in the business. And M&A is on the list -- it's further down the list in 2023 than say it was in '19 and '20. We still do our normal calling and meetings and things of that nature but it's going to be pretty dynamic and pretty special to stop what we're doing now to put something on top. But we've talked about this in the past, M&A also includes lift-outs. M&A also includes teams and new businesses and that's always an ongoing opportunity for us. Got you. Okay. That's helpful. And maybe just on the deposit beta, I guess any change as far as where you think the cumulative beta kind of shakes out here given -- and I think it sounds like your outlook is for a couple more rate hikes here in February and March but I'm not sure if that's -- if those play out, how are you guys thinking about that deposit beta cumulatively? Yes. So I've got. I'm looking at it here in front of me and honestly, the cumulative beta has obviously been increasing but it's not dramatic. Deposit pricing, particularly in interest-bearing accounts have behaved extremely well. And even in December, the beta is cumulatively under 25%. And even, we made some pricing adjustments late in the year and even the monthly beta is 50% and under. And if you look at it for the quarter, it's kind of 30% and under. So I think we feel good about the stability of the deposit base and where the current rates are and what we've done to be responsive to it. And I think we generally feel good about how we can generate enough funding to fund high single digit, call it, 8% organic loan growth in 2023 with contribution from commercial specialty and then business and consumer banking. So we're cautious about it from a lag perspective. I think all the guidance we give has some caution above where it's currently performing. So if we're at high 20s cumulatively or mid-20s cumulatively, we think of marginal beta moving forward is 40%. But the reality is we haven't -- we've had that view since the third quarter and we haven't seen it. So, I think we feel like we've got a really good sense of what the account types are used for where we need to be responsive and where we just have good, stable core funding that really doesn't have to move from a rate perspective. Got you. No, that makes sense. And maybe just last one for me was on the -- just the funding of the loan growth this year, given -- I mean, the liquidity levels has obviously come to way down. So is it fair to just think about the balance sheet or just the funding loan growth is coming from the deposit growth this year? Is that how you're looking at a little bit more liquidity to come down but that's how... Yes, Brian, we're thinking about -- we'll fund it through everything can just mentioned all the various units and teams and specialties that we have. We feel confident that we can do that. Just wanted to follow up on the last question. Can you give us some color surrounding kind of the leftover runoff of potential rate-sensitive deposits on the balance sheet right now? Yes. It's kind of what I've said in the comments, James. A majority of the decline is really a handful of larger commercial clients that are redeploying excess funds and into nonbank alternatives, T-bills, maybe what I'll call competitive specials. We see that in certain markets. But I feel really good about how we are having conversations with our clients. We know that handful of clients. We've also developed some products that we can use and we're proactively approaching with clients that we know have those excess funds and we've been able to really moderate that. We're also having really good conversations with other deposit prospects in the market as well. And I feel good about our pipeline of being able to bring in new deposits. And I think the results that I talked about in the quarter show that we've been successful there as well. So hopefully, that helps. Yes, that's super helpful. And then my follow-up question, you kind of just touched on with the outlook growth but do you think it's reasonable to repeat specialty deposit growth this year compared to last year at that same pace? Yes. We think this. We think that those businesses for us are consistent providers. We've added some new sales people there. So we feel good about its ability to contribute appropriately for the total funding growth for our company. Just a follow-up. The nonaccrual decline. Any color on the loans that were either back on nonaccrual or paid off, just looking for some detail there. Jeff, it's Scott. I can take that one. It's really -- the majority was in 2 credits, not new. They've kind of been in our workout process most of the year or maybe even in the prior year but really successful conclusions to both. One was an ag credit that we completed a charge-off and work out on and then a C&I credit that we actually had a recovery on as well. So that's probably the bulk of the reduction in nonaccruals for the quarter. Got you. And then Keene, did that reduce the margin at all in that recovery? I mean is that meaningful at all? Yes. No, the recovery, Jeff went through the allowance. So I think that's what Scott is referring to. So that was part of the net but it didn't meaningfully impact margin. I think margin and net interest income were fairly clean in the quarter. So nothing too consequential either way that you need to think about for 1Q or anything like that. There are no further questions at this time. I will now turn the call back over to Jim for closing remarks. Colby, thank you and thank you all for joining us today and for your interest in our company. We look forward to speaking to all of you again at the end of our first quarter. Take care and have a great day.
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EarningCall_1232
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Good afternoon. I'm Chris Schott at J.P. Morgan. And it's my pleasure to be hosting a fireside chat today with Albert Bourla, Chairman and CEO of Pfizer. Yes, I can do that. But first, I want to say that last time we met was in this place the two of us just before COVID. So, how many things have changed since then? It's unbelievable, which sets also the stage for some opening comments that I want to do. What I want to discuss, it is, what is the future of Pfizer in the post-COVID crisis? And I'm using on purpose the post-COVID crisis era, because I don't think that COVID is stopping this year. In fact, I think that COVID will remain for the next multiple years, a serious health issue, and as a result, will be a big part of our R&D line that we are going to invest, and it's going to be an even bigger part in our revenue line. So, although our revenues from COVID in both treatment and vaccines will go down, clearly, will remain both of them, each one of them, the two largest products of Pfizer in the long run. But the business clearly has two components. And the only distinction between the two, it is that one is way more predictable, which is the non-COVID business. This is a business, all of us, us, you, everybody there, can model way more -- way easier, because we have benchmarks, we have analogs. And then there is the COVID, which is more uncertain, because the assumptions if the disease will exist, what would be the treatment rate, they don't have a precedence. So, I'm going to try to isolate the two. And the first and only slide, if I can have the next slide, please. Please read all of this in our website, then we can speak. I'm going to start with the non-COVID business. And this is a graph that more or less we put out during our last quarter's earnings. And this is basically the growth strategy of Pfizer and why we believe that it's going to be a very strong growth strategy. In 2020, we set a goal that our business will grow at 6%, starting from '19 as a baseline. If you see the midpoint of our guidance that we gave for the end of '22, we will give a real number in a few weeks, we must be around $44 billion. This is the midpoint. The $44 billion in constant exchange rate is exactly 6%. This $44 billion of non-COVID business, which is exactly at 6%, will continue growing at 6% all the way to year '25. And we are very confident about it. So, which means that if you do the math, that in year '25, the non-COVID business, excluding business development, should be at $52 billion, which is the first graph that you see there. However, most of the analysts were in line with these expectations. Some were saying it's 5%, some were saying is 6%. Now, I think everybody goes closer to the 6%. But the challenge that we're raising was that after '25, you are facing a very big cliff of LOEs that basically will take away all the growth prospects that you have. And that's why we try to build this graph to demonstrate how the situation will go. Indeed, between '25 and '30, we estimate that we are going to lose $17 billion because of products that will go LOE. The analyst expectations about this number is pretty much the same. They think $18 billion. We think $17 billion. But with the consensus that I'm reading, it is $18 billion. In the next 18 months, the most important 18 months in the history of Pfizer because we are going to do something that has never done before, we are going to launch 19 new products and indications. Most of them are new products, and some of them are indications -- new indications of existing products. Those collectively starting from now all the way to the mid of '24, we estimate that we'll produce revenues of 2030 of approximately $20 billion. The analyst expectations on that is, surprise, surprise, slightly lower. So, they are at $16 billion on that, but there are not huge differences between the two. Following that, we made a commitment, we put a goal out there that we are going to purchase through the extraordinary firepower that we are having, projects and science that will deliver eventually products that will deliver $25 billion of incremental revenues by year 2030. So far from this goal of $25 billion, we have achieved 40% of it in the first year of implementation. We have approximately, with the four acquisitions that we did, $10 billion. The analysts think that the $10 billion is $8 billion, by the way, as I think the same thing. So, they are all hard cutting it a little bit. And then, post that 18 months of launches, we have an entire pipeline that is maturing and is going to give launches that will occur in the second half of '24 and in the year '25, '26, '27, '28. Products that are included in this box over there, which we call X, are GLP-1. And it is the gene therapy portfolio. We have three projects that are in this X category. And we are -- just announced results from one. We have the vaccines against Lyme. We have vaccines against shingles. We have all the combination vaccines between COVID and flu; COVID, flu and RSV; flu and RSV. We have multiple oncology launches, et cetera, et cetera, et cetera. We have made estimations occasionally for each individual products, but they don't quantify it here in this box how much those are, because they are a little bit earlier. I'm sure that the difference between us and analysts will be even bigger. But what is the punchline here? That if we will be able to execute in our plan of delivering $25 billion of revenues and $20 billion of business development and $20 billion of risk-adjusted revenues through the launches that we are doing, we should be reaching a situation that we will have a growth that will exceed the 6% benchmark that we set in the beginning of '20 all the way to '25. So, our revenues should grow comfortably between '25 and '30 at the 6%. And based on the success of the pipeline, could easily exceed the 10% mark. And those are the numbers. Of course, if we make 6% from $52 billion all the way to '30, that means $70 billion. If we make 10% from $52 billion all the way to '30, $84 billion. So, this is the growth story of Pfizer, and I believe it is pretty well de-risked. The $20 billion, they don't have any technical risk other than the flu product that we haven't seen yet significant results. All the other big components of the next 18 months launches have been de-risked technically, at least, so there's only the commercial risk. And the $25 billion, we have invested so far $26 billion to buy revenue of approximately $10 billion, which gives us a very good value for money and a good rate of 2.6x revenues through our acquisition. So, with that, I feel that the non-COVID business, it's very, very solid. Do you want to discuss that and then we go to COVID? Let's do that, absolutely. A lot on COVID. So, as one of the questions I have, I totally -- I mean this framework is very helpful to, I think, help contextualize not only your organic business, but how you think about putting capital to work. But I guess I always get concerned if I see a company putting a revenue target on acquired assets and that I just this idea of like how do you ensure attractive returns on the business. Now so far, I think we certainly like the deals you've done, it seems like the Street's like the deals you've done. But how do you think about the risks that get introduced by incentivizing the organization to be looking at a revenue target versus just looking at returns on transactions? More or less, you gave the answer to that, but I will elaborate on that. It is -- many people advise against setting a goal about that. One, it is because that makes you accountable and then you need to deliver. So, be careful before we set a goal. But we felt very comfortable that we plan and we will deliver, and we wanted to be accountable against that. But the second was exactly what you said. Many people will say, if you put a goal, you give the impression to the Street that you are after a number, so in order to make your number, you're not going to be disciplined in allocating the capital. And I knew this risk. And I took it and indeed, people talk to me like that. But however, then we did one after the other. And the three big acquisitions that we did following this announcement, because ReViral was very small, in each one of them, the stock went up, in each one of them. So, each one of them received the confirmation if you're going to the Street, that it's a good allocation of capital, we like what you did. So, this is less of a concern now, still I think is there. So, I'm sure that everybody of you will be looking at us next year, this year, actually, and we will see how we deploy, what will be our next move. And we will see how much of that $25 billion we can achieve to start with, and what is the means of achieving it? Is it 2.6x, or it is different numbers? Is it good value for money. So, everybody will be judging us on that. If we wouldn't put that number there, people wouldn't have this discussion that we are having right now ourselves that you need to count when you value Pfizer stock, the firepower that the company has developed that it is a different league than basically any other pharma company right now in the industry, which is a significant advantage that is not counted unless if you translate it to something tangible, which is billions by 2030 revenue and CAGR. On the BD front, if I think about those three bigger deals we saw in 2022, is that a good proxy for how you'd envision capital allocation for Pfizer going forward? So, I guess the question is were those kind of unique assets? Or can we think about either deals skewing larger or smaller? I'm trying to get a sense of kind of what's your sweet spot right now for M&A? First of all, sizes, we are agnostic to size. We can execute big. What we don't want is to execute big business development of the typical, we buy another pharma company and then we give a high premium to the shareholders of the other company, and then, we cut costs so that we can justify the premium. That is not going to happen. Why? Not because it's bad strategy in general, right? But it is a bad strategy for the time of the company. Look at that, in the next 18 months, we are launching 19. And in the next 18 months, we are having a significant R&D pipeline, but it is developed. Do I want to shut down research centers, shut down manufacturing sites and reallocating reps because we are reducing the field force? No, I don't want to do it. So, it's not good for the company right now. But if it is a biotech of a large size, it could be part of that. But when you see the targets out there, I would say that there are three distinct groups. One, it is some usual suspects, few big biotechs that usually they have a few products and a very big pipeline. Usually, they are very expensive. And they are very expensive because there's a lot of value in their platform, the mRNA platform, for example, something like that. This is a lot of money to get a company like that, but has the benefit that it comes a significant chunk of revenues in one transaction. And also, it's very expensive in terms that comes with a lot of R&D cost. Then there is a middle level, which is companies like more or less the ones that we did, which is they're having one leading asset that it is quite developed, maybe before registration, maybe just after registration, and then a follow-up molecule that looks very promising. Arena was the same. Biohaven was the same. They are coming with less R&D expense, which doesn't affect your leverage as a result, and they are immediately accretive in most of the cases. And the question is if you get them in a good price so that you can add value either through your bigger commercial presence, your ability to manufacture, your ability to develop the follow-up molecule faster. And then there is a third, which are smaller in size biotech. They don't have any product yet, but they have platforms. Those are very cheap to buy compared to how much you pay in terms of molecules, simply everything is relative in America. But it's relatively cheaper. I don't think that to make the $25 billion and then also continue growing further, we can do it by focusing only one or the second or the third [category] (ph). It's going to be a portfolio of all three with different, of course, size. So far, was mainly in the middle level. But it's going to be a portfolio that we'll de-risk it as a result. And will likely aim non-risk adjusted more than $25 billion, so risk adjusted will be $25 billion. Okay. That makes a lot of sense. Maybe just on the core business growth itself, I know you're targeting 7% to 9% top-line growth for 2023 ex your COVID business. Can you just elaborate on what are the biggest drivers of that growth we should expect this year? And if I kind of break it into how much of that's core, how much of that's new launch, how much of that's acquired revenue? Yes. It's coming. You are right. We almost gave guidance, 7% to 9% for the non-COVID business. And we are going to give the official guidance in -- but will not be any different numbers than that, right? We're not going to change our mind in a month. The driver, it is approximately one-third of this, let's say, 9% growth, comes from already launched products, one-third comes from business development-acquired products and one-third comes from newly or about to be launched next year from our own pipeline products. It's almost one-third, one-third, one-third. If you take out -- that's very indicative. If you take out the business development, the remaining, it's exactly 6%, as we have promised, always will be, which means the in-line products plus our own pipeline that we are launching. All right. And then, I think with that, you talked about OpEx stepping up and that you're making investments to support these new launches. Should I think about this as a multiyear increase in expenses? Or is this more of a one-time kind of rebasing of OpEx and then we can think about maybe slower growth going forward? I would say it's rather the second. Let me explain. Look, we are in a unique situation. No other company, including us, have ever launched 19 products in 18 months. So, it's a very big thing. And you need to do it right, because the future of our company, it is so successful, we are going to execute. So, just look at these bars. Clearly, in order to support 2020 -- excuse me, the $20 billion expectations of new product launches, we will have to make sure that we have enough [indiscernible]. Already, we restructured months ago our commercial operations, so they are already and better aligned with this new portfolio that is coming, and we are going to other resource for those launches. Well, I'm not going to take any chances. Then, let's go to the last one, which is all these products that they are continuing now with R&D. We have very high expectations for those products. And I just said some of that, in addition to all the flu and mRNA type of things that are happening, and they are not included there. So, R&D is to go up to support the game this point there. And then, the third is, of course, we're going to progress from the 10 that we are now, let's say -- I don't want to give a number, but we are going to progress significantly towards the goal of $25 billion. And that could come with more or less R&D expense, because we're not buying just products, right? We are buying also projects. So, with all of that in mind, to support this plan next year and the year after, but especially next year, you need to have a significant number of expenses. That should not be needed in the [work post] (ph) those launches, which is where the vast majority of the expense goes when we launch new products. So, we kind of have this window where that steps up and then as top-line continues to grow, we can think about that investment kind of... Actually, they should divert. The top-line should continue to grow, but because -- exactly. We did all of that at one big chunk, so you should expect big top-line growth because 19 products is driving, not three or four, and also big -- also more stabilization of expenses in the outer years, because you are out of this extraordinary situation that you are investing to support 19 launches altogether. Yes, that makes sense. I know you hosted a broad late-stage pipeline day in December. I guess, just maybe taking a step back, just the thoughts on the overall state of the pipeline at this point, I think it's something we're talking about ahead of time of how much of the company has changed going back from last time. We're sitting here in 2019. It just kind of a lot of progress. So, just talk a little bit about how the R&D portfolio as a whole and just R&D within Pfizer has changed over the years, and how comfortable you are with the business here today. To assess that, you need to assess, first of all, with some of the current benchmark's metrics that we are using to assess interest. As you know, all of us, all the companies participate in benchmark studies, but we are giving very detailed numbers of our R&D productivity, and then they are coming to results. We are standing out as one of the best most-productive R&D machine right now. We are having the best success rates. Our success rates, end-to-end, from first in humans all the way to approval, is around 22%, and that's five years rolling, right, so it's a difficult to change measure. The same measure for the industry in this benchmark is 11%. So, a double the success rate. When it comes to time to complete from first in humans all the way to approval, we were able to take out almost three years in the last three years, 2.6 to be accurate, right? We were at 9-point something and we are at 6-point something now in terms of how long it takes. And we are very pleased about that. That's why we are showing and we keep investing in our R&D machine, so that you have these -- because we believe the return will be very high. Now, you don't measure metrics, you measure revenues. And if we arrive at that will give us $20 billion. It's a very phenomenal productivity of R&D. And the fact that we are launching 19 products in the next 18 months says that we did something well in the last four years. So, in general, I believe that we are in a very good state. And as I said, in the next 18 months, it's not everything we have. I just listed the things that are not included there. And there are multiple, multiple projects that are triggering the attention of everyone. So, I feel very good about our R&D productivity. When I look across the pipeline, what are you most excited about when you all think about what's coming to market? And what do you think is most underappreciated in the portfolio? First of all, I try to understand what is the most unappreciated. When I see we have $20 billion, they have $16 billion, what is going on? And a lot of that comes that a lot of the analysts, they don't forecast all the way to '30, frankly, right? So, we have a number. You, for example, I think you go all the way to '27 most in your numbers, right? You're not, because you want to be accurate and everybody's way more accurate than more, let's say, professional when he can defend what he says. So, a lot of the discrepancy comes in that outer years, right? And now, there are some that we think is more than others. The one that I think is the most underappreciated, it is the elranatamab, which is our lymphoma. I believe when we see the data that it is best in class, and we are coming, of course, now early next year -- early this year, I'm sorry, we changed the year -- with a new launch for a category of triple refractory, which is a smaller indication, but we have eight -- six indications in eight pivotal studies running right now. I think that could be double-digit blockbuster, right? Now, we will see how things will evolve. But that's one -- clearly one. GLP-1, clearly, everybody is excited about that. I believe that it is something that could -- we said that we think it could be $10 billion product for us in a market that could be $90 billion. So, it's not part of this calculation, but it is a major upside if we get it right. Again, we think there will be very few players that will play in the oral GLP-1, us and Lilly, clearly, we are going to be one of them. We think the data should show which one has a better profile. We believe and we hope that we will have. But no matter what, it's going to be so big a market that it's going to be a very big product for both of us, I think. Also, the mRNA vaccines, because, of course, we speak about -- and I was hearing Stephane before speaking about the potential of mRNA, and I agree with everything he said that it can have on flu, but also how that can unlock the combination products, flu and COVID, flu and RSV, how can unlock dramatically the utilization of COVID or of RSV because with the combination product, you can immediately raise it into the flu utilization, which is 50% in these countries, so very, very big. So, these are some of the very exciting opportunities. Yes. Can I just go to a different one, RSV. You had some very interesting data as to the second half of last year. How do I think about that market developing as kind of a new kind of vaccine coming to the space? There's obviously a lot of RSV in the news these days, but talk a little bit about market development of that asset. I don't think it's rocket science. It's very standard, and we have seen this type of markets developing with other diseases like Prevnar, like pneumococcal. I think there is a component which is a pediatric component how to protect the infant, and we have come with a very evolutionary way, which is maternal immunization. You -- let's say, you immunize the mother and it's passing the protection to the baby in the first six months. The results were very good. So, we are expecting approval based on that. And then, there's another market, which is the adult market. And the adult market in RSV is going to look more like flu rather than pneumococcal, because pneumococcal creates immunity almost for life. We have it -- it's once in a lifetime in the adult, although we are looking at it right now to see after five years you need, but it's very long, right? I think COVID is very short, flu is very short, and RSV likely will be the same. So, a combination product of the three, particularly when in this country, there is no co-pay for any vaccines by law based on the new IRA that was voted effective January 1, no matter in which plan you belong, if you are commercial or Medicare or Medicaid, if a product, a vaccine -- if a vaccine is recommended by ACIP, then the zero copay for patients. So, people will be going to get their flu shot and they will be presented with the options you want through flu and RSV and COVID. The question will be how much it costs. They will tell you zero. I think you will do three. So, it's very clear. I think. That's why I said it's very important because right now, if you see the booster market of COVID, it stabilized around 30% utilization, right? So, around 30% of the people did booster. Let's go with 30% in this, let's say, last -- the fourth booster. The Omicron or not omicron, but fourth booster, right? So, if you take that as a goal, I don't think we need to go to crazy calculations. But a 30% booster with one -- between 1 and 1.5 doses like per individual, because some other people will do 2 or 3 during the year, is giving you a certain number. If you combine it with flu, this 30%-plus will go to 50%. It's a step growth that would unlock significant value. Yes, that makes -- that's an interesting opportunity. Maybe one last one on the -- you mentioned oral GLP-1. Just talk a little bit about the competitive landscape there. I think we're all kind of -- it's all early days, but trying to... It's early days, but I wanted to be very respectful also to competitors, particularly, I don't want to speak in the absence of competitive direct study comparisons, right? But I would say that this is a market that will grow to $90 billion altogether. And we are very confident on that given the current size of the market and the current growth rates. Very big part of the value and the ability to go to $90 billion, I think, will be the introduction of oral medications. In all the market research that we are doing, we see that there is a preference in the diabetic population for an oral compared to injectable. But when it comes to obese population, this is what really makes -- unlocks the market. It's significantly more important, the oral in the obese market than it is in the diabetic population. But even diabetic, there is a preference. So, the question is, are the oral products going to deliver the same efficacy with the injectables? If the answer is yes, then I think this market will be very big and at least $30 billion of the $90 billion. And in this market, there have emerged three competitors right now, right? Us, Lilly and another. Lilly and us, particularly, we're slightly real -- or we don't have any diet restrictions, et cetera, when you take the oral medication. So -- but let's say, three are there. It will depend on the profile. We believe, based on what we have seen, that we have way stronger profile. We believe we are a full agonist. We see that there is a dose dependence. So, the more we increase the dose, the better the efficacy in our molecule. We haven't seen that with the other molecules. They plateau after a certain point. They don't help. So -- and we believe that by titrating appropriately, we will be able to take the dose to higher levels. Our studies that we are running around are at way higher dose levels that we think will yield better results. Okay. In the event that you're, let's say, in the same ZIP code as competition, certainly, if you got a premium profile, it's a huge opportunity. As a third entrant to the market, is there still a big opportunity for Pfizer to let's just say you're at parity with where Lilly is in as an example? Yes. First of all, I wouldn't sign that we are third entrant to the market. We have done in eight months what others did in eight years with COVID, and this is the same clinical development machine. So, I wouldn't underestimate that. And the studies are moving very fast. We will try to come, if not first, at the same time. I can't promise that, right? But this is our goal. This is right now. And secondly, I truly feel that even if the profile is not as good as Lilly's, that the market is big enough so the product will be a multibillion-dollar product. Yes. Pivoting over to COVID. You've talked about 2023 being a transition year for the business. Can you just elaborate on the dynamics that are contributing to that? Absolutely. What I think will happen in the COVID, one, there is a fundamental question, is COVID going to continue? And our scientists' answer to that, in the foreseeable future, yes, it's going to be flu. There is -- they can't make a scenario that COVID disappears from the world. It's all over the places. The virus keeps mutating. And the virus -- irrelevant if it is a natural infection or a vaccine, creates very short-lasting immunity. You get COVID today -- forget if you are vaccinated, you get COVID, you can get the same strain after six months, right? So, this indication says that the virus will be there for the years to come. So, this is our planning assumption. If this is correct, how I think things will play out? Social distancing will disappear. Already has been disappeared. Look at us, even during live, I see a couple of people with masks. I don't think we will see many of them as we move forward. Vaccination rate, as I said, will stabilize to way lower levels than the levels that we saw when we launched the product. So, first dose, 80%; second dose, 75%, right? So that's the prime. Then in the booster, we went down to 50%, 60%. In the second booster, the fourth dose, we went down to 30%, as I said. I think we'll stabilize somewhere there. This is not enough, because as the population is -- as time passes, the population will be less immunized, less current. And as a result, the waves that will be coming will come in with higher -- the clinical manifestation of these waves will be more severe disease and more hospitalization, basically. That will drive higher level of treatment demand. So that on volumes, how we see that happening. What I said that our assumption is now will stabilize at around 30% in the U.S., and hopefully, we'll make it bigger, we're saying dramatically if we bring a flu COVID combination, right, but that would come, if it comes, in '25. So that comes, let's say, a step. Now, what is why -- that will be the same utilization, I think, in '23, '24, '25 going forward, right, as it is with flu. Why '23? What is the characteristics? In '23, we have very specific risks. It's the year that we are transitioning from governmental purchases to commercial market. This means that at the center -- and we believe that for both products, this will happen this year based on all our expectations. This year will happen to both products. In order for it to happen, we need, first, to absorb the stocks that the government has purchased, and there are significant stocks here and in other places, right, that needs to be absorbed this year. And then, once you start launching, there is a different price, right? We have announced our price for the vaccine. We haven't announced the price for COVID by the government -- for PAXLOVID, but the governmental price for PAXLOVID was based on gigantic commercial costs, right? It's not going to be the retail price. '24 -- so '23 will be impacted by that. It is difficult to predict because you don't know when the transition will happen. Also, you don't know if the government will take any stockpiles or not strategic stockpiles. I believe, like, they will, but I don't know. I can't speak about that. But all of that needs to make sure that this year, '23, we'll suffer from those two. The utilization, though, will be the same. It's just that we are using the stocks that we sold $56 billion of revenues in '22 of those two products, a significant number in the U.S. And then, we will go to the remaining of the year, we will sell in new price. '24 will be the same utilization like '23. We don't see any difference, but all will be paid at the new price. So that's the difference. So, I expect '23 will be the lowest ever because it's the only one that will be affected by this transition. Correct. I think '24, normally, if I'm right, and no big changes are happening, should be 2022 and 2023 together, divide by two more or less, right? Okay. Yes. That's fair. On PAXLOVID, there's been a lot of headlines, I think, around China and what's happening in China and the role that PAXLOVID could play over there. Can you just talk about your approach to that market? And maybe just comment on some of the headlines we've seen over the last few days in terms of what's happening with either negotiations or just the Chinese government's willingness to kind of engage with you? Let me tell you what's happening in those and what are the two headlines that I read, right? One was that Pfizer is in discussions to give a generic version of PAXLOVID to China. This is not correct. We are not in discussions to give a generic version. But we are not in discussions. We have an agreement already for local manufacturing of PAXLOVID in China. So, we have a local partner that will make PAXLOVID for us, and then we will sell it to the Chinese market. So that's already signed. And this production is gearing up. They haven't produced yet. We were calculating that this will take us all the way to the end of the year to be able to have local manufacturing. But with the progress that I see and the effort from the Chinese authorities to clear the production, that will happen way earlier in the first half of the year. And that wouldn't be a surprise if it comes three, four months, all right? So that's one. There was a second that we applied for a -- to be in the list basically of the reimbursed products, and we were rejected. That's correct. And I will give you all the elements about it. The PAXLOVID was registered in China months ago. They use very small quantities. Now because they are opening, there is a lot of treatments needed. So, now we are trying to bring to China products from all over the world. And we are very successful. So already in the whole '22, we supplied a few thousands. Now, we have supplied already in the last weeks of December, which counts next financial year for us in China, and the first days of January in the millions, not in the thousands, right? So, we are bringing PAXLOVID to the Chinese market. The tender of all, let's say, this governmental, let's say, listing is for April 1 and go beyond. And indeed, we gave them the price that we have, which is we have a price for high-income countries. Then, we have a price different -- tier pricing for middle-income countries, and that's 60% to 70% lower than the price of the high-income countries. And then, we have a price for the low-income countries, which is at cost. That's how we do vaccines. This is how we do PAXLOVID, the same equity principles. So, they want it lower than the lowest of the middle, and we didn't agree. They are the second highest economy in the world. And I don't think that they should pay less than Salvador, right, which is a poor country. So, this is where we are now. What are the consequences of that? All the way to April, nothing, we will continue selling. When this is applicable in April, unless something changes, which is one of the possibilities, and we are back in discussions with them, we will continue with the private market in China, which is significant. Okay. So that's still -- can that be like a $1 billion-plus market on the private side? Or can you put any numbers around what that would look like? We tried. A couple of other ones. Just on the vaccine side, as the market moves to a commercial market, is there an opportunity for Pfizer to gain market share in terms of the capabilities you have and the scale that you have? I was listening Stephane saying that they are building their capabilities, so that will be difficult to get more market share. I don't count on that. We will try, right? But in my projections, I don't count on that. We have, right now, globally, 70%; in the U.S., 63% of market share. So, basically, it's two-third, one-third the market. And I assume that, that will continue for both of us. Hopefully, we can get more, but I don't count on that. Okay. And as I think about the ex U.S. market for the vaccine, does that, at some point, go commercial as well? Or will that always be kind of a government contract that... The thing is that ex U.S., the government has multiyear contracts. In the U.S., they purchased just for the next season. So, they have several purchases. So, they purchased now for Omicron. I don't know what is their final decision, but I doubt they will purchase another one, so in the U.S. However, in Europe, in other places, we have contracts, but they are already signed years ago that they cover '23, maybe '24, '25 that we are discussing now with them because they have too much. So, we're discussing maybe to spread it over a year. So, this is the situation outside the U.S. Great. And maybe just in the last minute here. Just not to give the specific numbers, but how should we think about Pfizer kind of helping the Street understand the dynamics around this business? So, should we expect from a guidance perspective, you're going to get -- should we expect a wide range of revenue for this year on the COVID business? Or how are you thinking about approaching that? Frankly, we are still discussing with Dave, who is sitting in front of me, our CFO, how to best -- in the -- of uncertainty, explain that to all. I think the fundamental with COVID is not what will be the revenues, because the assumptions that I told you, everybody will agree. Well, it is 30%. You think we'll continue 30%? Yes, at 30%, yes. Do you think that the price will be accepted? It is. We are signing already the contracts, right, with [indiscernible]. All of that are very predictable, all right? I think what is the doubt in the minds of many, it is -- is it going to, in '24, disappear COVID. There is no COVID. So, you stay. There is no scenario that COVID is the same. And instead of 30%, only 1% will do the vaccine. That, I cannot resolve those that they doubt. They cannot put their finger on the whole of my palm, right? So, it is a scientific belief. It's scientifically almost impossible for a virus with these characteristics to sunset, to disappear, right? And will come back -- coming back as I described. So, this is where we are. We will try to do our best to explain, but people eventually will have to put their assumptions into test and see if this is a revenue stream that needs to be given one-time multiple, or revenue stream that needs to be given the normal multiple that everybody is getting. Sure. Well, We're about out of time. Obviously, tremendous progress the company has made over the last few years, so congrats on all that. And thank you for joining us today.
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EarningCall_1233
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Greetings and welcome to the Independent Bank Groupâs Fourth Quarter 2022 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ankita Puri, Executive Vice President and Chief Legal Officer for Independent Bank Group. Thank you. You may begin. Good morning and welcome to the Independent Bank Group fourth quarter 2022 earnings call. We appreciate you joining us. The related earnings press release and investor presentation can be accessed on our website at ir.ifinancials.com. I would like to remind you that remarks made today may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and expected results to differ. We intend such statements to be covered by Safe Harbor provisions for forward-looking statements. Please see Page 5 of the text in the release, or Page 2 of the slide presentation for our Safe Harbor statement. All comments made during today's call are subject to that statement. Please note that if we give guidance about future results, that guidance is a statement of management's beliefs at the time the statement is made and we assume no obligation to publicly update guidance. In this call, we will discuss several financial measures considered to be non-GAAP under the SEC's rules. Reconciliations of these financial measures to the most directly comparable GAAP financial measures are included in our release. I'm joined this morning by our Chairman and Chief Executive Officer, David Brooks, our Vice Chairman, Dan Brooks; and our Chief Financial Officer, Paul Langdale. At the end of their remarks, David will open the call to questions. Thank you, Ankita. Good morning, everyone and thanks for joining the call. In 2022, we reported full year adjusted net income of $209.7 million and adjusted earnings per share of $5.02. Reflecting on 2022, we're pleased that our results illustrate the through cycle nature of our business model of healthy loan growth, strong earnings and excellent credit quality. We are in 4 of our nation's strongest markets and we remain encouraged by the economic fundamentals in both Texas and Colorado. For the fourth quarter, we reported adjusted net income of $49.4 million and adjusted earnings per share of $1.20. During the quarter, we were able to achieve continued loan growth across our markets, while simultaneously maintaining resilient credit quality metrics. Though deposit costs remain a near-term headwind, the sustained repricing of our fixed rate book should provide consistent tailwind to the interest income as rates remain elevated over time, even as payoffs and pay downs slow. Notably, we entered the quarter with a deliberate focus on achieving better expense discipline. In pursuit of that objective, we undertook targeted expense reduction initiatives across our business to position the organization for an uncertain economic environment. We will continue to focus on strategically managing expenses into 2023. The strategic focus on discipline is consistent with our long-standing history of conferring macroeconomic challenges early on and conservatively positioning the bank to perform throughout the cycle. We also announced yesterday that our Board of Directors declared a dividend of $0.38 per share and reauthorized our stock repurchase plan for an aggregate amount of $125 million for 2023. We believe these capital actions are consistent with our owner-led mentality of providing consistent returns to our shareholders. Thanks, David and good morning, everyone. As David mentioned, full year 2022 adjusted net income was $209.7 million or $5.02 per share and fourth quarter adjusted net income was $49.4 million or $1.20 per share. There were several onetime items during the quarter embedded in the non-interest expense line that I'll discuss momentarily. Net interest income before provision decreased by 3.7% or $5.5 million from the prior quarter to $141.8 million. While interest income increased by $16.1 million from the prior quarter, funding costs increased by $21.6 million versus Q3. This more pronounced increase in funding costs drove the bulk of the differential in net interest income over the linked quarter as the FOMC raised rates 275 basis points in the last 155 days of the year. The increase in interest income versus Q3 was driven by floating rate loans repricing as well as net loan growth combined with new production funded during the quarter to replace normal amortization, paydowns and payoffs. Payoffs and paydowns slowed modestly in the fourth quarter but the consistent repricing of maturing loans should continue to provide a sustained tailwind to interest income even as deposit costs are expected to peak shortly after the FOMC reaches the expected terminal rate. Our assumptions for modeling NII in 2023 include a peak in the Fed funds rate toward the end of the first quarter, consistent with the FOMC's dot blot, we expect the Fed funds rate to subsequently hold flat through year-end. In this scenario, our NII line should benefit from sustained fixed rate repricing dynamics throughout the year even as deposit costs present a near-term challenge. The overall yield on interest-earning assets jumped from 4.30% in the third quarter to 4.67% in the fourth quarter, an increase of 37 basis points. The core average loan yield, net of accretion and PPP income, was 5.01% in the fourth quarter, up 39 basis points from 4.62% in the third quarter. The total cost of all deposits was 112 basis points in the fourth quarter compared to 57 basis points in the third quarter, an increase of 55 basis points. The cost of all interest-bearing liabilities was 181 basis points in the fourth quarter, up from 102 basis points in the third quarter, an increase of 79 basis points. As Slide 20 shows, we have been successful in playing both defense and incremental offense in our core deposit book, maintaining branch deposit balances despite a slight shift of noninterest-bearing balances to interest-bearing balances. Year-to-date fluctuation in specialty verticals is mostly a function of managing liquidity needs strategically in the current interest rate environment. Deposit competition remains intense as we near the Fed funds terminal rate and we will continue to remain nimble and opportunistic in funding the balance sheet. Deposits are likely to continue to be a headwind near term to near-term NII growth until the terminal rate is reached. Still, over the medium term, our loan book should continue to serve as a tailwind even after deposit costs peak. Provision for credit losses was $2.8 million for the fourth quarter and looking ahead, we are budgeting for provision that represents about 1% of net loan growth. This assumes all else being held equal in the CECL model and no material changes to the macroeconomic forecast and other model factors. Non-interest income decreased by $2.3 million compared to the third quarter which was mostly driven by lower net revenue from our mortgage warehouse -- mortgage businesses due to lower mortgage volumes across the industry as well as lower other income. For the first quarter, we expect mortgage fee income to remain flat at current levels. Adjusted non-interest expense was $88.3 million for the fourth quarter which was down approximately $386,000 from the linked quarter. Adjusted non-interest expense excludes approximately $10.4 million of onetime charges related to the targeted expense reduction initiatives undertaken during the fourth quarter. Of this, $7.1 million is related to severance and accelerated stock listing and $3.3 million is related to the write-off of certain assets related to discontinued technology projects as well as the termination of a correspondent banking relationship. The fourth quarter's expense reduction initiatives will help us achieve our goal of holding the quarterly expense run rate flat through 2023. As we enter the new year, we remain focused on strategically managing the expense line and we will explore additional opportunities to realize savings over the coming quarters. Slide 22 shows consolidated capital levels over time. All capital ratios, including the TCE ratio, increased slightly from the linked quarter. And capital levels remain well above regulatory well-capitalized minimums. These are all the comments I have today. Thanks, Paul. Loans held for investment increased to $13.6 billion in the fourth quarter, up from $13.3 billion in the linked quarter. Loan growth, excluding mortgage warehouse and PPP loans totaled $320 million or 9.6% annualized for the quarter. New production during the quarter was well distributed, both geographically and by product type and we continue to underwrite with the same discipline that has guided us through past economic cycles. Average mortgage warehouse purchase loans decreased to $297.1 million in the fourth quarter, down from $402.2 million in the prior quarter. Volatility and interest rate increases more broadly have resulted in decreased demand, lower volumes and shorter hold times across the mortgage industry. Our expectation is for this business to remain flat at current levels through early 2023. Credit quality metrics saw a notable improvement during the quarter with several large commercial credits achieving final resolution with minimal losses. Total nonperforming assets decreased to $64.1 million or 0.35% of total assets at quarter end. Other real estate owned was flat at $23.9 million during the quarter. Net charge-offs totaled just 2 basis points annualized during the quarter. Our loan book continues to be bolstered by a multi-decade history of strong underwriting as well as the underlying strength of our markets in Texas and Colorado. Even so, we are continually stressing our portfolio for the impacts of higher rates and mindful of the evolving macroeconomic situation. Currently, we remain very confident in the strength of our underwriting and the ability of our borrowers to navigate the current environment and we remain ever vigilant against emerging risks in the economy as we enter 2023. These are all the comments I have related to the loan portfolio this morning. So with that, I'll turn it back over to David. Thanks, Dan. As we enter 2023, we continue to be very encouraged by the strength and resilience of our markets across Texas and Colorado and we have been pleased to see sustained demand for high-quality business from our long-time customers even as the FOMC approaches the expected terminal rate. This sustained borrower demand, combined with our strategic focus on the disciplined management of our expense base, helps fuel our continued pursuit of through-cycle performance and healthy growth. Our priority remains to deliver value to our shareholders by running a high-performance, purpose-driven company dedicated to serving our customers and communities each day. Maybe, Paul, I wanted to start with the margin and net interest income. You kind of offered a lot of color there on kind of how you guys are thinking about it. Just maybe bigger picture, do you think most of the significant margin compression is behind you? And is there a chance that you could start to see maybe NII begin to trend up maybe in the back half of the year based on some of the fixed rate asset reprice you have? Just kind of wanted to get a better sense of kind of how you're thinking about the trajectory of the NIM and NII as you move through '23. That's exactly the right way to think about it, Brad. As we went into the fourth quarter, we were really trying to play incremental defense and offense in the deposit book. So if you look at Page 20 in our slide deck, we were really focused on ensuring we were able to grow those branch deposit balances, even though we knew there would be a bit of remix from noninterest-bearing to interest-bearing. We were successful in doing that and preserving our contingent liquidity options going into 2023. So as we look through the directionality of NIM in 2023, we expect it to bottom out at current levels flat to down just a couple of basis points for the first quarter. And then we should see that dramatic inflection in the second quarter accelerating through the third quarter as those fixed rate repricing dynamics should offer us some significant lift in NIM for the year. And just maybe as my follow-up, on the fixed rate loan repricing, where are you seeing those new loans and those loans to reprice to in terms of rate. Just wanted to kind of get a sense of the potential pickup. And maybe David or Dan, how are those new rates may be impacting loan demand out there in terms of where I think you've sort of guided to 7-, 8-ish percent type loan growth. Just kind of curious what -- how those rates are impacting appetite out there? Sure. Brad, this is David. I'll talk about from a high level, we're seeing rates come on in the mid-7s, upper 7s now in the current environment. And we expect that will slow. The Fed will likely accomplish their purpose of slowing the economy. So that's kind of in our thinking that overall loan growth will slow a bit as we head into 2023 here. One of the things and I think you're alluding to it and I'll let Dan speak to this but one of the challenges will be if there are loans in the low 4s rolling to the mid-7s or upper 7s or 8s if the Fed continues on here, then that might pose one-off challenges for certain borrowers and cash flows and things. Yes, I think really, I would think about it this way. Conservative underwriting on the front end is really the best defense against that risk. And so we have put material interest rate shock tests in our underwriting, even a year -- 4 years ago when rates are in the 4s and now they're rolling up for maturity. But we're looking at every credit that's maturing in the next year and stressing it for impact on higher rates. Our early look at those has been that we see very few issues. For the few credits where a conversation will be required, we'll do what we always have and we'll get in front of it with our borrowers early on. So if loan growth is going to slow a bit here, what does that mean for 2023? Are we thinking more of like a mid-single-digit level potentially for this year? Well, it's seasonal as well so it's a little tricky to try to forecast. I think 6% to 8% which is the guidance we gave at the end of the third quarter, still looks about right to us for the entire year. But it may be a little slower in the first quarter, just a lot of people are looking around here trying to figure out what their plan is for '23. We've got good demand and good pipeline but I expect, based on what we know today, Brady, that we'll probably start out with a mid-single digit here in the first quarter and then accelerate a little bit, a little bit, emphasis on little, in that 6%, 7%, maybe 8% range. And look, there's a wide range of possibilities for 2023 and what happens with the economy. And as we've said over and over again and I don't want to say it had nausea and maybe we do but the markets we're in should give us some insulation, right, even if it's a pretty difficult overall economic slowdown, we still expect our loans will grow and it just becomes a magnitude of how much. Okay. All right. And then the decisions that were made on the expense base, what was the impact of those decisions? Like how much annualized expenses were taken out of the bank? So Brady, this was really a prerequisite for us to meet our expense guidance of holding expenses flat from that run rate. So if you think about expenses, heading into 2023, I would expect them to remain in that $89 million to $90.25 million [ph] range. And this was a crucial part of heading off some of the expense headwinds we're going to have in terms of increased FDIC assessment and things like that in 2023. Okay. And any -- should we expect you guys to consider continued changes in the expense base? Or do you feel kind of good with where expenses are at this point? We're going to continue to look across the footprint for opportunities to have targeted reduction of expenses. I wouldn't expect anything programmatic like we did in the fourth quarter. But obviously, as we as we navigate, what David mentioned, is shaping up to be a very uncertain economic environment, we want to be really mindful and disciplined about managing the expense base on an ongoing basis. All right. And then so the $125 million of buybacks, the stocks at $1.9 million [ph] at tangible book value, tangible common equity is kind of in the high 7% range, do you expect to be active on that $125 million this year? Make a lot of that depends, Brady, on what happens with the markets and the economy and stock prices. But we'll be opportunistic and continue to look for opportunities to buy our stock at attractive prices. I'd say that, obviously, we're all watching to see what's going to happen. Capital is precious. We do like the way our balance sheet has held up, with tangible equity, as you mentioned, still in the upper 7s. That's quite different than a number of banks in our peer group. You have handles and 4 handles on their tangible capital ratio. So we do think we've got some room and we'll be opportunistic but we're not anxious to give away capital in this environment either. All right. And then last question for me is just I know you guys have been focused on improving the profitability profile of the bank. Any color on where you would like to get ROA or ROE or efficiency ratio or whatever metric you're focused on, any color on what the targeted profitability ratios are for Independent? Sure. again, every question, I guess, we answer and I'll put [indiscernible] but every question we answer is in light of everything we don't know about 2023 to come. And so our discussion right here has been about being nimble and everything we do from expense base to growth to the credit side, all of that, just being nimble watching what is coming our way and acting accordingly. But you asked the question last quarter and I appreciated it which is, you guys have historically been a high-performing bank. Your numbers right now wouldn't fit in that category and what are you going to do about it? That's not exactly how you asked it but it was -- I think the answer is, Brady, we -- you can't -- you can't turn a ship on a dime, so to speak. So we've been undertaking the things that we believe will return us to the kinds of metrics that we want to be at, that we have traditionally been at. So I would expect that our return on tangible common equity to be mid-teens and up from there and our ROAs to be in the 120s and 130s and rising. We won't be there in the first quarter of this year given the continued pressure on deposit rates and things. But I think when you get to the back half of this year, Brady, those are the kind of numbers come third quarter, fourth quarter, we should be able to generate given our base economic assumptions of what's going to happen this year. So I think if you had an ROA in the 120s and 130s and return on tangible equity in the 15% to 18% range but that would be where we've been traditionally and where we expect to be back to by the end of this year. Just wanted to go back to Slide 20. I appreciate the color here but the loan-to-deposit ratio at the warehouse is creeping up there a little bit. Just can you walk us through in more specific detail some of the strategies? I know there's a push-pull with the nonprimary sources of deposit funding. But can you just update on some of the initiatives you have in place? And maybe if you change incentive structure, just anything that you're doing more specifically on the deposit side to kind of balance that loan-to-deposit ratio with the funding needs as you continue to grow? Sure. Thanks for the question, Michael. I will say this, we were very deliberate in the fourth quarter about preventing runoff in our core deposit book and we were successful at doing that and defending with rate, some of our core deposit relationships that we've had. As a relationship bank, we're always keen to make sure that if we have to pay for deposits, we're paying it to our customers and we're taking care of them. That being said, we have incentivized the teams with very explicit deposit goals heading into 2023. It's an all-hands-on-deck approach in terms of ensuring that everyone is focused on making sure that we keep our costs down on the deposit side of the house as much as possible. Our expectation heading into the first quarter is that as the Fed hits the terminal rate, we'll see the deposit cost pressures abate and we'll be able to, especially as the curve points a little bit further down in both the brokered and the FHLB arenas, we'll be able to selectively take some different tenors of deposit there. We obviously want to keep the deposit book short but we're going to be opportunistic in using the significant capacity we have in both the broker, the specialty and the other wholesale verticals in order to maximize our rate outlook on deposits for 2023. Okay. That's helpful. And then just maybe separately, just on the loan growth outlook, obviously, keeping the guide just about the same but it does seem from the tone that maybe things are going to get a little bit more challenging just with rates, as you mentioned, David, in the 4s going up to the 7 or 8? And how much of the growth is kind of intentionally maybe pulling back a little bit, just given uncertainty in the economy? Or is it truly just rates moving a lot higher and your customers may be looking for alternative options out there for funding their own growth? And then just separately, if you can just give us an update, I know this has been a multiyear process but where you stand on some of the C&I initiatives. It looks like growth was double-digit annualized but if you back out the energy loans, looks to be a little bit softer. So I know a lot in there but just any color would be great. Yes. Thanks, Michael. I may not remember all the questions embedded in that question, so you may have to help me remember some of them. But yes, the -- we believe, overall, at the highest level, the amount of economic activity and the amount of deal flow is going to slow. It is already slowing deals, income-producing well at 8% as they do at 4% [ph]. So there's -- that's going to be a bit of a drag. The positive side of that has been the payoffs and refinancings and sales of assets and all that have slowed. So therefore, we don't have the payoff headwind that we had in the last couple of years. So we won't have to generate as many loans to net that mid-5%, 6%, 8% -- 7%, 8% that we expect for the year. So that's it at a high level. We continue to be committed to diversifying our balance sheet. You mentioned the energy loans. We think that's a positive for us. We're seeing great opportunities there. We threw only about 4% of -- about 4% of our overall loan book in energy. So we think that's an area that can continue to grow a little bit as we go forward. And we'll continue to look at other lines of business but it's not as easy as this -- it's not as easy as snapping your fingers and making it happen. But, yes, we're committed to continue to diversify our lines of business. But your other one comment, Michael, was embedded around are we intentionally being cautious and the answer to that is yes. In this environment, heading into the uncertainties ahead, there's no easy button here. And as a long time shareholders and owners of this company, we've been running for 35 years and we're not going to start in our 35th year, 36th year here looking for an easy button to go, "Oh, gosh, let's go hire a team and book a bunch of this kind of loan or this kind of loan." We're -- and obviously, our credit sizes being lower generally, our hold sizes being well lower than our peer averages, those are things that are core to our credit philosophy and risk management philosophy and we're not going to change that in our 36th year. And yes, there are avenues, Michael, out there which some banks may take, where you can go book a lot of really big loans or you can get into lines of business that you haven't been in historically. And we think that's a uniquely bad thing to do at this point in the cycle. So we're not going to be doing those kinds of things. We're going to be growing our loan book with our customers and our markets and continue to watch our risk. Okay, great. Maybe 1 last 1 for me. I'm going to try. I don't think you're going to answer it but I know you guys are involved in the Stanford Group litigation which another bank in the Southeast just settled. Just wanted to get any comments from you see if there's any update. I know a trial is for 1 of the classes is set for February 27. Again, I don't think your comment but I thought I'd try. Thanks for the question, Michael. Correct, we don't comment on pending litigation, as you know. But we always assess what's in the best interest of our company and our shareholders, as I said a moment ago. There are details in specific -- on this specific case that you asked about in our normal public disclosures and filings and you can read up on that as well and we'll continue to update that accordingly. I wanted to first circle back to fee income. And you mentioned that you think mortgage banking will be flat in the first quarter. I wanted to see; one, if you think -- obviously, the market is helping for a pivot, we'll see. But wanted to see if pass that, you felt like there could be some optimism for that to maybe pick up a little bit. And then also the decline in the other bucket due to the correspondent fee, if that has fully run its course or if there could be any additional atrophy related to that? And then if you just basically saw any other opportunities to maybe have growth in fee income lines of business. Let me say from a high level, I'll let Paul comment on some specifics, Brett, of your question. But at a high level, our view of the mortgage business right now is that it's hitting its lows and will linger there for a prolonged period of time. So in our numbers and assumptions, we don't have any increase or acceleration in. Obviously, that would be great for everyone if it happened. But in our decision-making in the fourth quarter of last year about around our cost base, included our view that it was going to be a very difficult year in mortgage. We've got great teams running both of those businesses and we feel good about it long term. But we think it's going to be very hard in '23 and maybe longer. And until we see real evidence that there's some environment that will allow a return to normal kind of volumes, we don't bake that in any of our forecasts. In terms of the correspondent and specific things you asked about, I'll let Paul comment. Yes, Brett, that was just a onetime charge related to the severance of a correspondent banking relationship that won't recur in future quarters. And as far as the other fee income items, we expect them to remain relatively stable over the coming quarters. Okay. That's helpful. And then I wanted to make sure I understood kind of the flavor, so to speak, of the commentary around the cost of funds from here. And it sounds if I'm getting it right, it sounds like you feel like you've maybe taken some -- big chunk of the pain, so to speak and what it took to keep deposits to keep relationships on balance sheet and maybe the deposit beta, so to speak, might slow on a relative basis going forward. Is that a fair assessment that you feel like you've taken some of the lion's share of the pain in terms of the cost of funds increase and maybe any thoughts on how we should think about the deposit beta from here? Sure, Brett. We've been very deliberate in making sure that we play defense in our core customer base. And consistent with our history as a relationship bank, that's been a focus of ours. I think there's still going to be continued pressure on deposit costs near term until the Fed hits the terminal rate. Our expectation, though, is that once the Fed hits the terminal rate, we should see some significant abatement of pressure on deposit costs that help us in the back half of the year. Okay, fair enough. And then maybe a question for Dan. You guys mentioned you look at the commercial real estate loan portfolio and I think a lot of investors are worried about commercial real estate. And maybe there's a couple of credits to think about from a loan repricing perspective that you'll get in front of. I wanted just to hear if you look at Slide, I think it's 17%, your credit has historically been much better than peers. Wanted to hear maybe what you might worry about in terms of the environment, maybe not even your own loan portfolio but just the environment around commercial real estate, if it's rents, if it's something else, if it's the change in rates, what's the big factor you're kind of concerned about for the environment? Yes, Brett, great question. I think, in general, let me say it this way, it might help you as you think about certain asset classes that we think are under pressure and will continue to be under pressure this year. Spec industrial, spec office, those may seem a bit obvious to you but I would say there's been a lot of that activity in the last couple of years. And as a rule, we've just stayed away from that type of lending and keeping with our core principles here. I would say, in general, people are watching certainly occupancies in the office space. I think rents certainly continue to be pretty solid. It seems on the multifamily side. So I don't think there are any primary concerns there that we're seeing. But, in general, I think we're just continuing to be very vigilant about stressing our portfolios for the rate increases and then mindful about what could happen in a downturn. And I think in general, again, our structure with granular book which is limits exposure on any individual credit and the way we've underwritten those with the same standards we have over the last 3 decades, I think positions us as good as we can be. And while we're watching that, I think we feel very good about our portfolio at the present and continuing to monitor what that would look like. I guess that's why I would ask that for you. Yes. And I would say to Brett -- this is David. At a high level, Brett, one of the things as we thought about these loans rolling 5 years in that were underwritten at 4% interest rates. One of the things that has really helped in our markets, if you're thinking about the markets that we're in and the in-migration of people, whether it's office or multifamily or professional office buildings, the demand and the rents have increased materially in the last 5 years. So the cash flow that we underwrote 5 years ago are much higher today in almost every property and that goes through our philosophy to a high-quality property in great locations and great markets. It just has risen, if you will, with the tide of the economic activity in our market. So that's making it actually much better than we had feared maybe 6 months ago as we began the process re-underwriting these credits. So the great markets we're in. And also Dan and his team have done a great job of avoiding kind of the hot idea. And so spec industrial, office warehouse, that kind of space has been across the country around every airport and everything, given what's going on with Amazon and delivery and all that has been just built by the tens of millions of square feet. And look, we're a little cautious around that as an example. We think there could be some pain in that if we have a significant economic slowdown. So we just have not bet the farm, so to speak, on any 1 asset class. Multifamily is great. It's strong here. But even then, you have to be cautious not to overbuild submarkets within these good markets. So those are the kinds of things we think about and talk about. So yes, could you please talk a little more about your confidence in the assumptions that deposit rates will peak soon after the rate pause, in particular, in an environment where we could be in a higher for longer rate environment [indiscernible] still be long out there and a lot of your competitors are still finding and scratching for deposits? Sure, Brandon. And back to what I had mentioned on the previous answer to a question, we were deliberate in getting in front of the rate increases. So we wanted to make sure we could retain our core deposit relationships, those relationships that we've had for some time upwards of 3 decades. And the way that we did that is we were very focused on making sure we paid a higher rate as the Fed was hiking not waiting for the noise after the Fed hit the terminal rate and then as you mentioned, scratching and clawing and trying to play hand-to-hand combat for deposits against our competitors who are trying to take our customers. So we've been more generous on the front end with deposit increases for those core customers with the expectation that once the Fed does hit and hold at the terminal rate, that, that should provide us some alleviation of pressure on deposit rates as we continue to see that higher-for-longer environment that you mentioned. Okay. And does that also -- are you also assuming that kind of the non DDA noninterest-bearing mix stays kind of cost from here? Or are you also assuming kind of a mix shift from noninterest-bearing to interest-bearing as well? Okay. Okay. And then a question on expenses, just as far as how you evaluate the expense run rate going forward? How do you feel about kind of your current headcount? And do you still see potentially room for there to get more efficient going forward? Look, I think, costs, Brandon, are going to be on everyone's plate in 2023. And so everyone is going to be -- our industry has been through unique time where from PPP revenues to the liquidity and system keeping interest rate, deposit costs down, et cetera. We've had a season here the last 2 or 3 years where costs haven't -- people have been able to invest as we have in our infrastructure and building out business lines and things like that. But we're entering a time now where if we're going to have an economic slowdown, rates are going to level out at a higher level, then the only of the lever that financial institutions are going to have to use their cost base. And so we took a hard look at ours in the fourth quarter and trying to position ourselves for what to be nimble and be able to react to what could come our way in 2023. I think other banks will do similarly as the rates level out here in the second quarter. I think our headcount is right where we need it to be. We've invested in a lot of businesses. We have the best teams out customer-facing teams we've ever had and we're going to take great care of our customers. We're going to grow with our customers in our markets and we'll invest and hire more people as we see the need to do it. So we're -- but I think, right now, we're right where we need to be and looking good here as we go into '23. Want to go back to the outlook for the NII and I appreciate all the comments on the funding. On the other side, you mentioned the loan repricing tailwinds that should provide some offsetting benefits. Any more color you could give us on how quickly this book will turn? Just trying to appreciate why this would be a offsetting some of the funding headwinds as you move into, I think you said 2Q of '23 at the back half would offset some of the funding [ph] headwinds? Sure, Matt. Thanks for the question. As David -- to echo a theme that David spoke to, there are a lot of potential outcomes for the broader economy in 2023. And obviously, the macroeconomic picture is going to influence the payoff and paydown trends. That being said, we have a bulk of our book is those fixed rate, 5-year CRE loans. And the contractual maturities for those will continue to provide a tailwind even in an environment with subdued payoffs or paydowns. As we look back on the fourth quarter, we did see payoffs and paydowns slow a little bit. Some of that is typically a seasonally slower Q4 that we see but some of it is a slowing of paydowns more broadly. Our expectation is to see some blend of the 3Q and 4Q rates on a go-forward basis from a payoff and paydown perspective. So we are optimistic that we will continue to have a pretty good lift from the repricing of those fixed rate loans, especially as contractual maturities happen over the course of the next 4 to 8 quarters. Okay. I appreciate that, Paul. And then I guess, David, in the past, you've talked about the bank's goal of achieving the positive operating leverage every year. And looking to 2023, is that still a reasonable goal to achieve this operating leverage given the macro headwinds that you're facing in the industry spacing? SP1 We believe it is. Matt, given, again, everything we know today, we believe it is. We think our cost. We've got a very good handle on our cost structure now. And we'll continue to look, as Paul said, for ways to incrementally improve. We're taking a hard look at all our contracts and all those things that you would expect the bank like ours to do on an ongoing basis. So we'll continue to look for things like that. That will be helpful, I guess, as we fight that there are so many things, as Paul mentioned, from FDIC to contracts and contractual increases in pricing and things like that. And obviously, increases merit and pay increases to our teams and all of that we're creating the headwind. So we tried to get ahead of it in the fourth quarter by having some cost reductions across the company and then positioning ourselves to hold the line here, if you will, in 2023. But it's a continued, not only focus of ours, Matt but it's a commitment we have to our shareholders to continue to improve the operating leverage of the company. Okay. I appreciate that, David. And then I guess, lastly, for -- a credit question for Dan. I think there was a sale of nonaccrual loan in the fourth quarter. Would appreciate any comments you have on the market appetite for loan purchases? And how did the pricing of that loan compared to the appraised value? SP1 Yes. Good question. As you noted there, we did have an opportunity to move out to nonperforming credits, large ones, large for us anyways. We tend to have small ones which is a good thing but we also had some additional small ones. And one of those was in a note sale. It was an energy loan, in particular. I would say the percentage of discount which I think is what you're really looking for there, is going to depend on the asset, right? Real estate assets, if you're selling those notes, could be different than C&I assets or others. And I would say relative to the value that we saw on that and the balance on it, it was a slight discount, really off of what we would have expected at that point. Certain that other banks may be looking at or have done the same things. And again, depending on the asset class and the condition of the credit, it's very much depends on those variables when you're trying to determine that. Just one follow-up on that repricing of loans question. I think last quarter, you originated $326 million of commercial real estate and had $950 million reprice. Paul, do you happen to have those numbers maybe for the fourth quarter and I think that -- or the CRE portfolio has a 3-years duration, I was just curious if that was still kind of an effective number? Those are the duration assumptions that we're using. As far as repricing is concerned, the bulk production in Q3 was higher than it was in Q4. I don't have the exact number off the top of my head, Brett but I would estimate that it was about 20% less. Again, some of that is seasonality and some of that was an additional slowing of repayments as the Fed's printed up the forward curve. Our expectation, though, is for the future forward rate of the fixed rate repricing to be somewhat blended between what we saw in Q3 and Q4. Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Brooks for final comments. Yes. I appreciate everyone being on the call today and the active back and forth. I feel really incrementally positive as we enter 2023, I think we're well positioned versus our operating leverage versus our ability to continue to grow the company. And I think we're well positioned for whatever happens and excited to take on the challenges ahead. Thanks, everyone, for being on today and I hope everyone has a great day.
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Welcome to Invescoâs Fourth Quarter Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer session. [Operator Instructions] As a reminder, today's call is being recorded. Thanks, operator, and to all of you joining us on Invesco's quarterly earnings call. In addition to today's press release, we have provided a presentation that covers the topics we plan to address today. The press release and presentation are available on our website, invesco.com. This information can be found by going to the Investor Relations section of the website. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP. Finally, Invesco is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcast are located on our website. Marty Flanagan, President and Chief Executive Officer; and Allison Dukes, Chief Financial Officer, will present our results this morning. After we complete the presentation, we will open the call up for questions. Thank you, Greg, and thanks everybody for joining us. And I'm going to start on Slide 3 if you're following along, which is the fourth quarter highlights. The fourth quarter concluded a year of significant headwinds and volatility in global markets. Seemingly, no geography or asset class was immune to the S&P experienced the worst year since 2008, NASDAQ Composite declined over 30%, MSCI Merchant Markets Index nearly 20%, and bond markets, typically the safe heaven when equity suffer, declined significantly due to rise in interest rates with the global aggregate bond index declining by more than 15% for the year. This resulted in the worst markets we've seen in decades. Rising COVID infections in China and tax loss harvesting in developed economies as the year came to a close made for a challenging organic growth dynamic in our industry. Despite industry challenges in 2022, we're pleased to see key capabilities in areas with high client demand continued to deliver organic growth, offsetting net outflows and capabilities that experienced redemption pressure as investors express a preference for risk-off assets. Key capabilities that delivered net long-term inflows for the year included ETFs, fixed income, Greater China and the institutional channel. The firm's ability to deliver these outcomes demonstrates the strength and resilience of our diversified platform in the face of extraordinary market headwinds. Although, market showed signs of stabilization in the fourth quarter, the uncertain backdrop continued to weigh on investor sentiment and impacted client demand. Invesco separated itself from most industry peers by generating net inflows in key capability areas led by strong growth in ETFs in the quarter. Our fixed income business and institutional channel continued to build on our track record of organic growth, generating net inflows for 16 and 13 consecutive quarters, respectively. The depth and breadth of our investment capabilities that Invesco brings to market that position the firm to return to organic growth when investor sentiment improves. Invesco ETFs delivered $4.3 billion in net long-term inflows during the quarter. For the full year, ETFs brought in $28 billion of net long-term inflows, the equivalent of 11% organic growth rate. Our ETF lineup remains differentiated for most competitive offerings with a focus on higher value, higher revenue market segments like smart beta, and we continue to drive innovation in space with products such as our QQQ Innovation Suite. Fixed income capabilities in the institutional channel have been pillars of organic growth for several years now and growth persisted in both of these areas in the fourth quarter with $800 million and $900 million of net inflows, respectively. As Allison will discuss later, our institutional pipeline remains at healthy levels. And as interest rates stabilize, we have a significant opportunity to capture growth in fixed income capabilities in 2023. Our business in Greater China performed exceptionally well during 2022, building on our leading position in the world's fastest-growing market class asset managers. We experienced modest net long-term outflows of $600 million in the fourth quarter due to significantly higher redemptions in fixed income throughout the industry in China and rising bond yields stroke net asset values for fixed income securities lower. Despite these challenges, we raised over $3 billion from new product launches during the quarter in China. For the full year, our China joint venture delivered $7 billion of net inflows, the equivalent of 11% organic growth rate. Market sentiment in China will be mixed for the next few months as the country works through the transition period of higher COVID infection, stabilizing interest rates and redemptions turned to more moderate levels. That said, there are also signs that the outlook for the remainder of 2023 is improving, and I'm optimistic for a return to organic growth rate throughout 2023 in China. Although, we maintain momentum in key capabilities, the firm experienced net long-term outflows this quarter of $3.2 billion. Active global equity remains the biggest drag on organic growth with $6 billion of net outflows in the fourth quarter, including $3 billion in our developing markets fund. As we discussed previously, client appetite for these assets have been lower than in the past, but I'm optimistic, redemptions will slow this top client appetite for risk assets will eventually return. We entered 2023 with a strong balance sheet, giving us the needed flexibility to operate strategically in this environment. Long-term debt remains at low levels, the lowest in 10 years, and our cash balance increased to over $1.2 billion at year-end. As we discussed last quarter, we continue to be disciplined in our approach to expenses, tightly managing discretionary spending and limiting higher roles that are critical to support the organization and future growth. We are thoughtfully managing market headwinds while investing for the long-term. We remain focused on identifying areas of expense improvement that will deliver positive operating leverage as the market recovers and organic growth resumes. We are being extremely thoughtful about capital resource allocation in this environment, and we will be well positioned to maintain investments in areas that deliver future growth. Looking ahead, we are partnering with our clients to meet the most pressing needs in this dynamic environment. We've dedicated the past decade to build a breadth of investment capabilities and solutions mindset and operating scale at Invesco that few in the industry can match. I'm proud of our talented â what our talent employees have accomplished in 2022 on behalf of clients and stakeholders, and I'm optimistic for return to organic growth when market sentiment eases. Market direction may be uncertain, but I'm confident that Invesco is prepared to meet challenges that will arise in 2023 and well positioned for future growth. Thank you, Marty, and good morning, everyone. I'm going to start with Slide 4. Overall, investment performance improved in the fourth quarter with 61% and 63% of actively managed funds in the top half of peers or beating benchmark on a three-year and a five-year basis, up from 57% and 62% in the third quarter. These results reflect strength in fixed income and balanced strategies where there is strong client demand. Performance lacks benchmark in certain equity strategies, but we experienced improvement over the past quarter in several key funds and short-term performance is trending positively in several U.S. and global equity strategies. Moving to Slide 5. We ended 2022 with $1.41 trillion in AUM, an increase of $86 billion from the end of the third quarter as most market indices partially recovered from prior quarter lows. Global market increases, foreign exchange movements and reinvested dividends increased assets under management by $61 billion, and total net inflows were $25 billion, inclusive of $30 billion into money market products. As Marty mentioned earlier, the firm experienced net long-term outflows of $3.2 billion this quarter, equivalent to a 1% annualized organic decline. Despite some stabilization in global financial markets, industry growth remained subdued in the fourth quarter and Invesco's net flow performance was among the best in our peer group. Passive capabilities returned to net inflows this quarter was $7.3 billion, while net outflows were $10.5 billion in active strategies. Several of our key capability areas continued to deliver positive organic growth, including ETFs and fixed income as well as the institutional channel. These capabilities also delivered positive organic growth for the full year along with our Greater China business, which enabled Invesco to offset outflows and strategies that experienced net redemptions as investors sought risk-off trade throughout 2022. Invescoâs ETF lineup was once again a driver of net long-term inflows in the fourth quarter with $4.3 billion. Net inflows were inclusive of $2.4 billion in maturing BulletShares ETFs, which are included in our gross redemptions. Growth this quarter was broad-based. Our top-selling ETFs included the S&P 500 Equal Weight, the NASDAQ 100 QQQM and Invesco Senior Loan ETF. For the full year 2022, net long-term inflows into our ETF capabilities were $28 billion, equivalent to an 11% organic growth rate and we gained market share. Excluding the QQQs, Invesco captured 3.8% of industry net inflows, higher than our 3.1% share of total industry assets under management. Institutional channel has been a steady source of growth and that continued in the fourth quarter as the channel has now achieved 13 straight quarters of net inflows. For calendar year 2022, the channel achieved net inflows of $13 billion or a 4% organic growth rate. We sustained new fundings across geographies, asset classes and the risk return spectrum throughout the year, despite the very challenging market backdrop. This demonstrates the diverse range of client relationships we have nurtured as well as the differentiated set of capabilities that we bring to the market. Retail net outflows were $4.1 billion in the fourth quarter, a meaningfully lower pace of outflows than the prior quarter as the channel achieved positive flows in Asia-Pacific and ETF flows improved in both the Americas and EMEA, despite an uptick in investors harvesting tax losses as the year ended. Moving to Slide 6. Net outflows declined quarter-over-quarter in Americas and EMEA, primarily due to improvement in ETF net flows. Net inflows in Asia-Pacific were $3.3 billion, led by Japan and Australia. Our China joint venture experienced modest net long-term outflows of $400 million in the fourth quarter as fixed income products experienced a meaningful industry-wide spike in redemptions throughout China and a rapid rise in COVID-19 cases impacted the Chinese economy and financial markets. Despite that, we raised over $3 billion in the fourth quarter from new products and investors showed signs of shifting back into equity products where we garnered $1.8 billion of net long-term inflows. Looking at full year 2022, our China joint venture delivered $7 billion of net long-term inflows, an 11% organic growth rate, and we're gaining market share. Building on Marty's points from earlier, the Chinese market may remain in transition in the short-term and through the first few weeks of 2023, the higher redemptions we experienced in the fourth quarter have persisted driven by fixed income. This dynamic may be a drag on net flows in China through the remainder of the first quarter, though we expect to be launching new products after the Chinese New Year, and there is increasing optimism for the rest of 2023. Longer term, we remain one of the best positioned asset managers, and what is expected to be, the world's fastest-growing market for asset management. Fixed income capabilities sustained organic growth in the fourth quarter with $800 million in net inflows. The firm achieved net inflows in this area, despite the heightened redemptions on the Chinese fixed income products as well as a $2.4 billion outflow related to BulletShares ETFs that reached their planned maturity last month. As interest rates stabilized, we have a diverse platform of fixed income offerings with strong investment performance across the full range of risk appetites and durations that are positioned to capture future growth. Alternatives experienced net outflows of $3.6 billion in the fourth quarter. Liquid alts accounted for more than two-thirds of the net outflows driven primarily by commodity focused ETFs. These strategies experienced net inflows for the full year, but gave back gains from the first half of the year. Private markets net outflows were $1.6 billion, primarily due to outflows and bank loan strategies. Net outflows in the active equity strategies have been concentrated in global and developing markets equities, which experience $6 billion of net outflows in the quarter, including $3.1 billion from our developing markets fund. Moving to Slide 7. Our institutional pipeline was $30 billion at quarter end, an increase from $23 billion last quarter. Despite the challenging environment, we are winning new mandates, notably in fixed income and active equity in the fourth quarter, which contributed to the increase. Our pipeline has been running in the mid-$20 billion to mid-$30 billion range dating back to late 2019, and weâre pleased to see the pipeline this robust given the uncertain market environment. As weâve noted previously, that uncertainty is causing some mandates to take longer to fund and we would estimate the funding cycle of our pipeline has extended into the three to four quarter range versus the two to three quarters prior to the market downturn. Our solutions capability enabled one-third of the global institutional pipeline in the fourth quarter, and it remains a differentiator with clients. The pipeline reflects a diverse business mix that has helped Invesco sustain organic growth in the channel throughout the full business cycle. Turning to Slide 8. Markets partially recovered in the fourth quarter, but the significant market declines that we experienced in the third quarter, especially in September, drove assets under management lower at the start of the period. Net revenue of $1.1 billion â $1.11 billion and the fourth quarter was flat the prior quarter and 19% lower than the fourth quarter of 2021. Thatâs primarily due to lower active assets under management. Total adjusted operating expenses were $769 million, an increase of $28 million from the prior quarter, and a decrease of $27 million as compared to the fourth quarter of 2021. Compensation expenses increased by $8 million as compared to the third quarter, inclusive of incentive comp paid on the $56 million of performance fees earned in this quarter. As weâve discussed, we manage variable compensation to a full year outcome in line with company performance and competitive industry practices. Historically, our compensation to net revenue ratio has been in the 38% to 42% range on an annual basis. During periods of revenue decline, as we experienced in 2022, the ratio tends to move towards the upper end of this range. For the full year 2022, our compensation to revenue ratio was 41%. At current AUM levels, we would expect the ratio to trend towards the higher end of the range for 2023. As a reminder, looking to the first quarter, we expect seasonally higher compensation taxes and benefits of $20 million to $25 million consistent with prior year trends. We would expect this to be largely offset by lower incentive compensation on performance fee revenue after seasonally high revenues received in the fourth quarter. Marketing expenses were $4 million higher than prior quarter, consistent with the seasonally higher activity we typically see in the fourth quarter. Though marketing expenses were $9 million lower than the fourth quarter of 2021. Property, office and technology expenses were $6 million higher than the prior quarter. As weâve mentioned previously, weâre in the process of moving to our new Atlanta headquarters, which we expect to be complete by the middle of this year. However, we may experience moderate delays as a result of flooding that took place when bitterly cold temperatures cause pipes to burst around Atlanta in December, and weâre working with relevant parties on a resolution. In fourth quarter, we also incurred $2 million of expenses related to the decommissioning of our current office building. These expenses are not repetitive in nature. Technology expenses in the fourth quarter included investment in ongoing technology programs that will benefit future scale, such as upgrading our human resources operating environment and the move of our financial systems to the cloud. G&A expenses were $10 million higher than prior quarter, influenced by $4 million of foreign exchange rate revaluations associated with the impact of currency movements on our balance sheet, and an additional $2 million of value added taxes paid in non-U.S. jurisdictions. As I mentioned earlier, we are investing in foundational technology projects that will enable future scale in our operating platform. These expenses span SG&A and property, office and technology expenses, and they are included in our results. Weâre investing in our key growth capabilities, while balancing the need to diligently manage expenses in this uncertain environment. We have focused near-term hiring in the growth areas that weâve outlined and deferred hiring for most other positions. Over the longer-term, weâre building a platform that will rapidly and efficiently scale, delivering positive operating leverage and margin expansion as markets recover. Now moving to Slide 9. Adjusted operating income was $339 million in the fourth quarter, $30 million lower than the prior quarter due to flat net revenues combined with higher operating expenses. Adjusted operating margin was 30.6% as compared to 33.3% in the third quarter and 42% in the fourth quarter of 2021 prior to the steep market declines that we experienced in 2022. Earnings per share was $0.39 as compared to $0.34 due to higher non-operating income driven by gains on our seed capital and co-investment portfolios as markets increased from third quarter lows. The effective tax rate was 26.9% in the fourth quarter lower than 28.7% in the prior quarter due to losses and lower tax jurisdictions last quarter that did not recur. We estimate our non-GAAP effective tax rate to be between 25% and 27% for the first quarter of 2023. The actual effective tax rate may vary from this estimate due to the impact of non-recurring items on pre-tax income and discreet tax items. Iâm going to conclude on Slide 10. Maintaining a strong balance sheet remains a top priority, further underscored by the volatile environment that we have been navigating. Total debt was managed lower to $1.5 billion as of December 31, which is the lowest level in 10 years. We built cash in the fourth quarter as we ended the year with over $1.2 billion in cash and cash equivalents, an increase of more than $200 million from September 30. Our leverage ratio as defined under our credit facility agreement was 0.8x at the end of the fourth quarter, slightly higher than the 0.7x the third quarter as declining markets have led to lower EBITDA. Our leverage ratio was flat in the fourth quarter of 2021. If preferred stock is included our fourth quarter leverage ratio was 3.2x. In the face of one of the most challenging markets of the past half century, Invesco continues to capture client demand in high growth areas, and our net flow performance has been among the best in our peer group. Meanwhile, weâve been building balance sheet strength and financial flexibility needed to navigate these uncertain times. We will be extremely disciplined in expense management and resource allocation, while ensuring that we are meeting the needs of our clients and positioning the firm for long-term growth. Hi. Thanks very much. Just my question is on great trend. Iâd like seeing obviously opening up a little bit, getting the $3 billion new flows on the new products. I guess my question, as we watched this develop over the last couple of years, you seem to get great flows when you launch new products. We donât talk much about the legacy or the older products. I wonder if you could just give us a little more color on. Is the bulk of the flows come through the new issued pipeline? And the reason why I ask it is, historically youâve done best from a profitability standpoint when your products hit real scale. And you seem to be developing a huge set of new products, but most of the flows come through on day one. So I wonder if you could help with that color thatâd be great. Thanks. Yes. Glenn, let me start and Allison, please chime in. So look, itâs very â thatâs really how that market is operating right now. In time you had to get a little mature to something more similar to the United States where youâll have your launches, there will be fewer of them and youâll have the ongoing flows into those capabilities. But there are follow on inflows, but really the bulk of it comes through these launches. And again, itâs just unique to the market. That said, I think itâll evolve over time. But I just want to â again, Allison hit on this, I did. Itâs a really volatile time over the next few months here, but we just think the future is very, very bright in China for us. And when the COVID transition completes itself, we anticipate 2023 being a very strong year in China. Yes. Glenn, I would maybe say if you think about the flow drivers in China, I mean itâs maybe with these new product launches, maybe somewhere half to two-thirds in any given quarter might come from these new product launches. Itâs not all of it, but it is as Marty said, it is a â itâs really the way the market works there right now. Itâs certainly a less mature market. And for now that is a large driver of flows. I donât want to leave anyone with the impression thatâs 100% of the flow drivers each quarter. But itâs an important part of functioning in that market and is an important driver of market share growth overall. To your point, itâs nice to see flows coming from beyond China and across the region. But itâs an interesting time in China right now. Okay. Thanks, Allison. Maybe one quick one for you on expenses, so the â or I guess margins in general. Market was up â your AUM was up 6.5% in the fourth quarter, so some of thatâs going to flow through into the first quarter revenue. So maybe you could start, just help us with the jumping off point on starting the first quarter. Because sometimes thereâs some seasonal items on the expense side, so just how to think about the jumping off point in Q1? Thanks. Sure. There are many puts and takes. I think as we think about the revenue side of it, youâre right, markets have been a little bit better only a few weeks into January. Thatâs certainly a positive. But I do think itâs really important to underscore the mix shift that we saw in our portfolio overall in the fourth quarter. We pointed to the $6 billion of outflows in two particular active equity strategies, developing markets as well as global and international funds. Those are â that has an impact overall in the jumping off point as we think about the revenue dynamics. At the same time, a lot of encouraging signs as weâve pointed to, as we see real strength in inflows, in our ETF capabilities and fixed income in particular. But as you certainly understand that comes at a different revenue level than what weâve experienced as we see some of the remixing of the portfolio. So while market could be a positive this quarter, thereâs also a bit of a headwind in the jumping off point in terms of remixing relative to prior quarters. As we think about expenses, overall I noted in comp expense, you should expect a usual seasonality of $20 million to $25 million in the first quarter. That would be offset by what we would â would not expect any recurrence and performance fees like we saw in the fourth quarter just given the seasonality there. And of course the market will be what the market will be, weâll adjust for that. So hopefully that gives a little bit of color as you think about some of the puts and takes. Overall itâs a difficult environment to navigate because you see a lot of forces moving at the same time and weâre trying to get our arms around that as well. Great, thanks. Good morning folks. Thanks for taking my questions. Maybe just one more on expenses, Allison, just to finish that thought, just the â I missed the number I think that you said in property office and technology that seemed like it was one-time in 4Q. So did you also want to get the jumping off point there? I realized that youâre going to have some duplicate expense I think in the first half, as you transition to new headquarters. But maybe just an outlook in that context for 2023 if you can. And then also in G&A considering that spiked up in 4Q, but it sounds like youâre working on some cost saves during the year in G&A. Sure. Let me do my best to try to walk through a few of these. On property office and technology, a couple of points on some of, what weâre experiencing really specific to our Atlanta headquarters. As a reminder, weâre carrying the cost of two headquarters right now. That will persist for a few more quarters. Thatâs somewhere between $2 million to $3 million of incremental expense. We had a $2 million non-recurring charge in the fourth quarter related to decommissioning the existing, or Iâll say outgoing headquarters we are in. We also pointed to some uncertainty, because we had a pipe burst in our new building on Christmas Eve and that happened around Atlanta and that will cause some delay in moving. And so there is a little bit of uncertainty right now as we try to work through what all of this means. That combined with G&A, in G&A, we pointed to a lot of FX revaluations and higher VAT taxes in the fourth quarter obviously FX has been a pretty meaningful driver in some of the significant movements we saw over the last few quarters there. I would say, overall as we think about property office and technology, and G&A, I will just continue to underscore a lot of these key foundational projects that we are working on and they really spam those two categories in terms of both technology and professional services. We have been â we are working on installing in a new HR environment. We are wrapping up moving all of our financial systems to the cloud, and we are in the early stages of Alpha NextGen. And so as these projects are rolling off and rolling on there is quite a bit of investment and focus right now and really creating scale for the future. Overall, as I think about G&A for the year and the fact that we do expect to be back in a full travel mode this year, and we do expect the reopening of China to allow us to get back to a really important region that we have not been able to get to for the last three years. I expect G&A this year on an average basis is somewhat consistent with G&A last year on an average basis, when you think about some of the efficiencies and our â discretionary expense management weâre trying to manage, but at the same time, the reopening of travel as well as some of these foundational investments we are making. Thatâs fantastic color. Thank you. And then just to follow up on the revenue side, obviously the revenue yields pressured, sounds like a lot of that came in the Oppenheimer Funds complex given just the outflows there. So two part question would be, are you seeing increasing demand or risk appetite given you foreign markets and especially emerging markets are starting to year off pretty well in performance? Are financial advisors that youâre speaking with starting to warm up to that are seeing some risk on appetite from their clients and can that help their revenue yield if that rebounds? Probably not in 1Q, but as we move through the year. Yes. Iâll make just a comment. The contrast is dramatic, right? If you went through last year there was really no interest at all in emerging markets in particular very much risk off and the like, itâs too early. But what we are seeing is, starting to be some early interest in emerging markets in China, driven by China, quite frankly. And developing markets in Q4 had some very, very, very solid performance, which needs to have, and itâs a really talented team. So the answer is, if the client appetite is there we should do quite well, which would be a nice change from this past year. Thanks. Good morning. I wanted to follow up on the alternative suite of products. You saw some outflows. This is the second consecutive quarter of a little more elevated outflows. But you did highlight private credit? Or as seeing inflows, and I think you said some of the liquid strategies goes. Could you talk about the mix of fees within alternatives and kind of where the positive and negatives are shaking out? Sure. Iâll start, Marty, chime in. I mean, I would say a couple of things as we look at alternatives, again, a lot of what we saw in terms of outflows would be the liquid alternatives. So commodity ETFs in particular, currency ETFs. So, I think from that perspective that would be â those would be lower fee alternatives that were flowing out. Boiling that down to private markets that also was an outflows at about $1.6 billion, but that was largely driven by global bank loans, direct real estate, we were an outflows to the tune of about $200 million there. So thatâs really, again, realizations net of acquisitions there, negative $200 million. Continue to gather commitments and have a fair amount of dry powder and direct real estate about $7.5 billion coming into the year overall on that side. On a private credit perspective, I think itâs been a â itâs an interesting environment. It was an interesting year for private credit overall, just the floating rate nature of loans and some of the attractive fundamentals there have helped mitigate losses, but certainly as recession fears kind of persist and trying to navigate what that may or may not look like, that certainly impacts credit appetite overall. And so we continue to navigate that. I think we, coming into this year, weâre bullish on all of our private market asset classes. We feel like weâre really well positioned. We feel very good about the funds that we have launched and will be launching and that theyâre going to be well positioned for where we expect to see client demand this year. But certainly your perspective on higher yields and what the attractive entry point is going to really dictate how our flows come together as we make it quarter-to-quarter through thus. So, overall I think weâll continue to see good strong demand there. But the liquid alt and some of the movements and currencies and commodities have put overall downward pressure on the flows there. Got it. Thank you. And then I think, Marty, you mentioned for fixed income, obviously the positioning and is positive and youâre helpful for pickup and demand, but I think you need to, you said interest rate stabilizing is the kind of key factor for decision making. So, as we think about growth sales or redemption activity, do you feel like itâs more stagnant and so we kind of get more of a direction of where rates are on a global basis and then we start to see much more assets in motion? Yes, absolutely. So, look, I think thatâs true of equities also, right? Some certainty to the future is going to be a really, really important thing for how investors react this year. But for fixed income, absolutely thatâs going to be the case. Itâs on the back of a broad set of capabilities, very good performance. And Iâll just follow on to Allisonâs point in REIT, which weâve talked about over the last year. It is now being launched on a very important Wirehouse [ph], which is one of the things weâre waiting for. And weâre also in development of some follow on capabilities in our private markets that will end up in the wealth management channel. But again, that will be a multi quarter introduction. But weâre now underway. So itâs again, this wonât be immediate, but weâre now moving forward, which is a really important thing for the firm. Good morning. Thank you for taking my questions. Weâd love to start on flows. Marty, you had some commentary in the press release suggesting, you were waiting on a recovery in flows, some of the indications, maybe a week start to China, slower funding on the institutional side. So are you all generally signaling that youâre expecting flows to remain soft here, just given that uncertainty that youâve talked about based on what you can see in the activity here? Yes, look, I think thatâs a rational line would get you there, right? But as I say, weâre, from my perspective, weâre a lot closer to the end of the uncertainty than the beginning. And what we point to is just look at our relative flows, vis-à -vis our competitors how weâre positioned. Thereâs a lot of things that are going well and you donât need a lot of change and sentiment to really start to make a really meaningful impact in our flows. And so as they say, they donât ring the bell at the bottom, but weâre a lot closer to that, and I think thatâs going to be a really positive development for Invesco. Yes, Brennan, I might point to just the improvement we saw from the third quarter to the fourth quarter. Look, itâs a dangerous game to predict flows, and weâre certainly not going to try to enter that game, but as we look at the drivers coming out of the quarter and just some of the overall market sentiment right now, we saw the decay rate. Yes, the decay rate in third quarter was 2.9%. That improved to a negative 1% in the fourth quarter and some really positive drivers there that again, this is a dangerous game, but we would expect those to continue to hold up through the first quarter. So the ETF platform in particular and our strategies there 7% organic growth in the fourth quarter. Despite some of the tax loss harvesting and the bullet shares maturity, again, a lot of strength coming into the year there. Fixed income for the reasons weâve just discussed have has performed well and certainly hinges quite a bit on the rate environment. But we feel like the fundamentals are strong there. Weâre well positioned. The institutional channel does seem to be coming back underscoring Martyâs point that perhaps weâre closer to the end than is the beginning. And so, as we saw a lot of institutions sit on the sideline, and remix depend â waiting on some conviction that, that could improve here at this quarter. Active equities very difficult quarter for us in the fourth quarter. I think a lot depends on just some of the earlier conversation around developing markets and as people find the right time to come back into that asset class and that exposure just diminishment and that headwind will help us quite a bit. And then the wildcard at the moment is China. Whatâs happening there is really unique. And as theyâve changed their COVID strategy and done a 180 [ph], itâs having a real impact, but we also expect that to be relatively short term and the fundamentals are really still strong there. So, I think, we feel maybe a little bit better than we did a quarter ago. But that sure is a hard place to be at the moment because itâs been a wild ride of a year. And weâll see where things go over the next month or two. Thank you for that all that color. That is very, very helpful. Shifting gears a little and thinking about real estate and your capabilities there. Allison, I believe you made some positive commentary on how the year shook out there on the real estate front. And I think, Marty, you referenced that youâre getting close to a warehouse launch on a product. I guess, number one, on the wealth management side, have you been looking at what some other products and some of the struggles and the gates that weâve seen in some of these products on the retail side? And how are you making adjustments? How youâre thinking about structuring your own product in light of some of the lessons learned there? And then, on the institutional side, thereâs been some press around the queue building on redemptions and yet prioritization sort of given to the not addressing the queue, but rather addressing the needs of sustained investors, which makes perfect sense. Itâs just how are you managing maybe that delicate customer service dance in order to make sure relationships arenât damaged? Yes, itâs a great question and needless to say itâs been in front of everybody. Look, weâve not had that issue. Iâd also say we donât have the magnitude of size that where that has been sort of topical. So again, our client experience has been very different. But again, I recognize the relative scale that is what comes along with creating availability into these capabilities. And I think thatâs â that would be a lesson for the market. And I think if you want to get exposure to some of these capabilities in extremely challenging times, youâre going to run into some situations like that. And my personal perspective is if we do a really good job educating investors and they have the time horizons thatâs necessary for these exposures, theyâre going to do really well. So I would not make a decision not to have â to provide access to individual investors during just an extremely challenging time. So I donât know if thatâs helpful, but thatâs how I think about it. Yes. There was some press coverage around the institutional â your institutional capabilities on commercial real estate and the fact that you â thereâs a large queue rather of redemptions, but theyâre â given the illiquid nature, itâs going to take time to work through that. And thereâs prioritization given to the existing investors in the actual strategy. And so just itâs an understandable dance to try to balance, but how are you sustaining and maybe limiting damage control as far as relationships go around that inherent friction? Weâre not experiencing what youâre describing. So when there are reductions, itâs â we have very, very strong relationships with our clients and theyâre managed really quite well. So weâre not feeling the friction that youâre referring to. So⦠So given the rise that weâve seen in interest rates, I just wanted to see if you have a view on the potential reallocations in the fixed income in 2023? And also do you have a view within that on the potential mix between active and passive? And then how do you think Invesco is positioned within that to win these potential rebalancing? Itâs a great question and Iâll give you an answer. Iâm sure itâs wrong. But net-net I think getting, the rise in interest rates get into more natural interest rate levels is healthy for the marketplace. I think itâs healthy for active equities over time. And again, as I said before, once it sort of hits its stability level, I think itâs good for different types of asset classes and fixed incomes say. [Ph] I really donât know what the relative allocations are, but itâs been a long time that youâve had a market where itâs positive for stock pickers and active equity. And yes, my personal view, once you get relative outperformance, youâll start to see money go back to active equities and various elements of it. And that would probably not be a popular view. And history suggest that thatâs not been the case. But thatâs how I think about it. Thank you, Marty. And maybe just a follow-up on the other question on real estate, maybe asking a different way. So we have really great I think visibility into your liquid public funds and also INREITâs investment performance. But maybe could you talk about how some of the performance in the other products, the private products trended in 2022? Iâm especially looking for core real estate debt and also the opportunistic drawdowns? Look, I donât have a specific performance in front of me, so hard to answer the question. What I will say itâs a strong â a very, very strong team. The core capability is, itâs just a fundamental strength to the organization and the client relationship has been very, very strong over an exceeding long period of time. So again, Iâm sorry, I donât have the specific performance that youâre asking about. Hey Marty and Allison. Quick, maybe just a quick follow-up to Craigâs question around fixed income. I was hoping you guys could give some details around Invescoâs position with some of the specific products that you feel most kind of optimistic about if the recent recovery and fixed income flows from the industry continues. And how are you thinking about your ETF positioning in fixed income versus the active book in fixed income? Iâll make a couple comments. Just with our â within the ETF franchise, fixed income continues to be an opportunity for us, right? The strength has come historically from equities. We surely think we have the capabilities to grow off the ETF franchise and fixed income. So we would look at [indiscernible] going into the year. With regard to fixed income in particular, the suite of capabilities of performance is really quite strong. So itâs really going to be driven by what we see in our client demands. Thereâs been the munis, in the retail channels in the United States, muni bonds is a very attractive all the short duration elements. Bank loans continue to be very strong. So again, it depends on the market and where we are. But Allison, do you have any further insights from your perspective? No, I mean, I think, whenever it is that inflation at least â well, inflation declines and you start to see some pausing with the Fed and rate movements, I think we expect total returns to be strong overall. We would expect that to be sometime in 2023. I think Marty hit on the areas of real strength. Munis, certainly, we see that as our customers continue to focus on taxes as being an area that we expect to hear even more bullish sentiment over the course of this year. Our global liquidity is held up very nicely and we expect demand to continue there. Fixed income SMAs thatâs been a very strong area for us that continues to be a wrapper thatâs in real demand. Stable value has been a leading capability for us for a very long time. So, I think, it really does depend on your perspective on rates and credit of course. But we do expect there to be an inflection point and continued demand across a lot of our capabilities this year. I think overall net flows are still favoring ETFs over some of our active strategies, but we feel well positioned in both. Got it. Thanks for that. And then, Marty, you mentioned strong balance sheet and I think the commentary youâve made around it is sort of enabling you to operate strategically. Could you expand a little bit on that? Does that just mean sort of build liquidity and then eventually resume more active capital return program? Or do you think this environment opens up incremental M&A opportunities for Invesco? Yes. Let me make a comment then Allison can pick up. So, what weâve been using our balance sheet for right now, and weâve talked about it in different ways are really investment that are going to continue for any other company to grow in the future. So the alternative capabilities, this scenario, where weâve been using the balance sheet. Yes, weâll continue to do that. And youâve heard us talk over time. MassMutual has been an amazing partner helping us to really augment our balance sheet to a very material degree. So thatâs really been the more specific weâre talking about now in some of these foundational enterprise programs that Allison was referring to. They might not be âinterestingâ if theyâre necessary, but thatâs what creates scale within an organization. And so thatâs the other way that weâve been using very, very short term. But Allison, you want to pick up more on the other elements of the balance sheet? Yes, I mean, I think, Marty hit some of the high points. But again, we just continue to be focused on supporting our future growth and maintaining a really strong balance sheet to do that. And part of that is continuing to be really good stewards of our capital overall, being very thoughtful about the debt on the balance sheet, which has been top of mind for us and weâve been shipping away at and feel really good about the progress weâre making there, making progress there. Itâs freeing up capacity for us to again, continue to focus on our own future growth. Some of that is investing in our product launches. We are fortunate to have a really good strong strategic partner there with us. But we continue to really prioritize investing in ourselves, both in terms of our product launches, but also the technology projects and some of the foundational capabilities that we know are really going to be necessary to create the scale and this business that we expect to have over the coming years. Hopefully, thatâs helpful? Terrific. Thank you very much for taking the questions. Appreciate all the colors so far. Marty and Allison, you both mentioned sort of the longer-term outlook for China does sound very strong. Could you help unpack a little bit about where you have a queue for product launches for 2023? And if you could break down the mix between equity and fixed income and other assets in the region? Thatâd be super helpful. Sure. Well, Iâll take a stab at it. I would say in terms of product launches, overall, hard to say exactly, but Iâll tell you the demand there does favor balanced and fixed income products over equities. So it would probably skew a little bit more to the balance side than fixed income than equity. But thatâs not a perfect science, as I think about just the mix overall in China. I would say itâs skews probably 50% or so balanced and fixed income maybe as much as 60%. Balanced is a very popular asset class there. So equity is probably a little bit smaller in the overall mix there relative to what you might expect to see and a portfolio in the United States. Okay, thank you. And just to follow-up certainly hear you on sort of all the different drivers for flows. When you think about the base fee rate exiting the year entering 2023, where does that sit today and should we presume sort of a gradual decline just given the ins and outs between across geographies products and distribution channels? Yes, I mean, I would say the factors that impacted the net revenue yield and the just the overall base fee rate in the fourth quarter, we would expect a lot of those to continue into the first quarter primarily as we continue to benefit from the demand for our ETF and our passive strategy. So while that is a significant positive, and we are capturing demand where demand is right now that does put downward pressure on our average fee rate. And we would expect a lot of those trends to continue into the first quarter at developing markets in particular in global equities. And what happens there in terms of redemptions and demand overall, that will remain a headwind. If nothing else, just given the exit rate of those particular asset classes in December as we come into this year, that does put downward pressure overall because of the outflows that we experienced in the last probably three quarters there. And overall though, Iâll just say, as I do every quarter, weâre not focused on managing to a net revenue yield or an average fee rate. Weâre focused on managing the operating income and operating margin of the company overall. And so while we see that downward pressure given the mix shift in our portfolio, and that mix shift really did accelerate in 2022. We are really focused on how do we continue to operate the business to create scale and to get to scale and these passive capabilities. Weâve taken market share, weâve gained quite a bit in terms of our organic growth over the last few years, but weâre not at scale in those capabilities and getting to scale and continuing to remix our expenses and reallocate against these higher growth capabilities is our primary focus. And thatâs whatâs ultimately going to give us the opportunity to improve operating margin. Hi, good morning everyone. Most of mine have been asked, just one quick one on credit ratings. I think S&Ps on record is saying their ratings and outlook are based on the expectation that your leverage ratio with the preferred will be in the two and a half times to three times range, which you went over in 4Q. I suppose the market recovery could already have that back below three times, which could you speak to any potential risks to your capital return or new investment outlook around that issue? And based on your past experience, how much of a grace period can we expect from the ratings agencies after kind of breaching that three times bogey for one quarter? Hi, Patrick, Iâll take that. Look, we are â weâve had no conversations with S&P that would indicate we have a risk there. I think the important point is all the work we have done in continuing to manage our debt balances lower. So, while EBITDA has declined, given the market impact, one would expect that to be more temporary in nature. Given we do expect there will be an inflection, excuse me, in the market at some point. And at the same time weâve managed not only the debt on the balance sheet to the absolute lowest level in 10 years, but managed a number of contingent liabilities that wouldâve been present when they made that statement two to three years ago. Those have all been taken care of as well. So in terms of the overall liabilities, weâre in a significantly better place than we were when they made that statement a few years ago. We did receive an upgrade last year from Fitch. We do feel like we are overall in a good position as far as our credit ratings are concerned. Hey, good morning. Thanks for squeezing me again here. Just to follow-up on expenses, Allison, just coming back to the transformational project that you were mentioning earlier. I guess just how much might that lower run rate expenses as you kind of look out over the next couple of years, and as you think about expenses for this year, how are you thinking about the bookends for growth rate and expenses? So in terms of transformational projects, lowering expenses in the next couple of years, I would say they will not contribute to lowering expenses in the next couple of years. As weâve noted before, the Alpha NextGen is really our most significant investment that we will be making. We will be in the next couple of years deep into the investment period of that, and then weâll be running parallel for some period of time before we can start to streamline and decommission apps on the other side. So, we are several years away from seeing the benefit of that investment. Again, itâs the right near-term and long-term move for us as a company overall as we think about building to the scale we want to be at in the next five years, seven years, 10 years. But itâs an investment and it will take some time before we see the payback on that investment. In terms of the bookends of expenses, look the biggest driver of thatâs going to be comp and the biggest driver of thatâs going to be market related. And so as you think about the variability and our expenses and what could move, the most beyond our expectations and beyond some of the guidance I already gave it would be compensation related. The good news in that is that comes with revenue. And I think that right now as we think about what expense flex we have on the year? I want to make sure itâs clear, we are managing discretionary expenses at every level and really focused on the must haves only, and all the nice to haves are things we are foregoing. But there are a lot of must haves in this business that we think really position us well to capture demand over the next several years. And we want to stay the course on that even in some of these challenging market conditions. And weâre reallocating the discretionary expenses to some of these foundational investments that we think will serve us well and create the operating leverage for the future. Great. And just a follow-up question on the cash position, $1.2 billion, how much of that is discretionary? And how do you think about the scenario where buybacks might resume? Thank you. So the $1.2 billion, about $640 million is held for regulatory purposes, so itâs a little bit higher than the last quarter, and thatâs really FX related. So you could consider the amount above that $640 million roughly discretionary. As I think about buybacks, Iâll just underscore our capital priorities. The first is supporting our future growth, and weâve got a lot of investments we want to make in ourselves, and we think thatâs going to serve shareholders the best over the long run. We want to focus on maintaining that strong balance sheet and continue to focus on the leverage levels that we have and managing those down. And we also continue to focus on returning capital shareholders, but that weâre going to do first through dividends and steady dividend increases, and itâs really excess cash that weâll think about for buybacks. Yes, excuse me. I get off mute. I do want to follow-up just on this conversation on expenses. So thereâs some longer term investments that Allison was talking about, which weâve talked about some, and then the obvious elements around discretionary. But as a management team, we are absolutely focused on what we call, driving scale within the organization against capabilities that are in client demand. And weâre deeply into that process and weâre constantly doing it. And from that, you get the opportunity to make a decision to invest in a capability for a client, letâs say, or have it dropped at the bottom line. So thatâs another element that we have been working on very, very diligently. And itâll make us a better company, but at the same time, at some point the markets recover, youâll get further operating leverage with, from the organization. So, I think you should look at it as three different elements, and thatâs nothing new. Youâve seen us do it, time and time again. And itâs a normal practice from us and again, itâll just create better outcomes for sure, shareholders and clients. Great. Hi, good morning. I wanted to ask you a couple follow-up questions on the real estate business. So, I believe the total real estate exposure for Invesco is around $92 billion and $75 billion or so is in the direct real estate side. So within direct real estate, how much is tied to the U.S. and then how much is tied to office and retail? I would say in terms of how much is tied to the U.S., probably around two-thirds is probably roughly, Iâd have to â we can follow up with you on specifics there, but Iâd say roughly. Weâve been managing our exposure to office and retail quite a bit over the last couple of years, three years probably in particular. And really favoring asset classes like cold storage and industrial and medical office buildings and, some of the asset classes you would expect us to be in. So the story around retail has been known for quite a long time, probably five years or six years. Office has obviously been quite challenged since the advent of COVID and weâve been managing those exposure. So those are not a real concern overall. And as I think about really where our acquisitions have been focused over the last two or three years, theyâve been in these areas of real high demand. Multifamily would be another example of an asset class weâve been favoring. Okay, great. Thanks Allison. And then just specifically in terms of some of the line items here, how much does real estate contribute to performance fees? So of the $68 million, how much was from real estate, and then how much do real estate transaction fees contribute to other revenue? So on the performance fees this quarter real estate was the majority of the performance fees. If I think about prior years, you wouldâve seen more coming from IGW China overall than what we saw this year. So the two biggest drivers in any given year would be China and real estate, but in 2022 it was definitely coming more from real estate. In terms of other revenue, I would say itâs a â Iâd have to come back to you on what portion of it is. I will say the increase in other revenue in the fourth quarter was driven largely by higher real estate transaction fees. Okay. Well look thank you very much everybody appreciate the engagement, the questions and weâll be chatting next quarter. So have a good rest of the day. Thank you.
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EarningCall_1235
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Hello, and welcome to the Axalta Coating Systems' Fourth Quarter and Full-Year 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. Thank you, and good morning. This is Chris Evans, VP of Investor Relations. We appreciate your continued interest in Axalta and welcome you to our fourth quarter and full-year 2022 financial results conference call. Joining me today is Rakesh Sachdev, Non-Executive Board Chair; Chris Villavarayan, CEO and President; and Sean Lannon, CFO. Yesterday afternoon, we released our quarterly and full-year financial results, and posted a slide presentation along with commentary to the Investor Relations section of our Web site at axalta.com, which we will be referencing during this call. Our prepared remarks, the slide presentation, and our discussion today may contain forward-looking statements, reflecting the company's current view of future events and their potential effect on Axalta's operating and financial performance. These statements involve uncertainties and risks, and actual results may differ materially from those forward-looking statements. Please note that the company is under no obligation to provide updates to these forward-looking statements. Our remarks, the slide presentation, and our discussion may also contain various non-GAAP financial measures. In the Appendix to the slide presentation, we've included reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements and non-GAAP financial measures, please refer to our filings with the SEC. Thank you, Chris. And welcome, everyone, to our fourth quarter and full-year 2022 earnings call. Let me begin by expressing my appreciation to the team for delivering another strong quarter. The company showed substantial improvement in profitability, most notably in our Mobility Coatings segment, and achieved earnings near the top of our fourth quarter guidance range, setting us on a positive trajectory into 2023. Before the management team outlines the details of our quarterly results, I want to introduce and welcome Axalta's new CEO and President, Chris Villavarayan. Chris joined us on January 1, where he recently wrapped up his tenure at Meritor, a global industry leader of commercial vehicle drive trains and engineered systems. Christ spent the past 22 years supporting and ultimately playing a leading role in the remarkable transformation of the company, which delivered above-market growth, margin expansion, and substantial shareholder value creation. Chris is a seasoned global executive who has distinguished himself as a strong leader. His decades of commercial and operational experiences align well with the skill sets that the Board believes are necessary to achieve Axalta's long-term strategic ambitions. The Board has a high degree of confidence that, under Chris' direction, Axalta will be better positioned to unlock value for all stakeholders. As for myself, I've transitioned to the role of Board Chair with Chris' appointment as the CEO. It has been a fantastic few months serving at the Interim CEO, getting deeper into our businesses, helping the team focus on the immediate value levers, and doing the initial planning for our 2023 objectives. The valuable insights I have gained over the past five months will clearly help as I lead the Board and support Chris to unlock the full potential of this company. Thank you, Rakesh, and good morning, everyone. I want to start by saying it is a true privilege, and I'm absolutely honored to become the CEO and President of Axalta. My first few weeks in the role has only strengthened my belief that Axalta is a true industry leader with immense opportunities ahead. In the coming weeks and months, I look forward to meeting many of you, our employees, customers, and investors, as we accelerate our growth plans. This is an important moment for Axalta. I'm committed to delivering superior financial returns and ensuring we meet our customers' demands. Now, on to our quarterly results, with highlights on slide four. The fourth quarter was strong and the team has a lot to be proud of. We delivered adjusted EBIT of $147 million, and adjusted diluted EPS of $0.38, both at or slightly above the top end of our fourth quarter guidance range. This was driven by pricing momentum and volume growth, with notable margin and profit recovery from Mobility Coatings. Constant currency net sales growth, of 14%, was very strong, driven by double-digit pricing growth across all our four end markets, and modest volume contribution. Volume growth, of 2%, was led by market recovery in both light and commercial vehicle. Our slate of award-winning new products and customer-centric service models are driving new wins across the portfolio. Meanwhile, post-COVID normalization in our end markets create a unique opportunity for us to grow volume and outpace broader industry trends. We again delivered strong year-over-year price mix growth of approximately 12% in Q4. Price mix improved 3% sequentially, the highest realized quarter-over-quarter improvement since 2020. This is a fantastic outcome that reflects strong execution of the new actions, and highlights our prioritization of margin recovery. Pricing in the period offset substantial year-over-year variable cost inflation again this quarter, but raws remain well above historical levels. We continue to face pockets of cost pressure from inflation in labor, energy, and select specialty raws that require us to maintain our pricing momentum and prioritize better execution. I will cover this in more detail in the following slide, and highlight where I intend to focus over the coming months. Axalta's strategic priorities remain unchanged for the foreseeable future. We will strengthen our core and drive growth, while increasing our emphasis on improved near-term execution and margin recovery. This will continue along the trajectory which Rakesh was aggressively driving in the back-half of 2022. By focusing on a few key areas, we can better control our destiny, strengthen our balance sheet, and add a tremendous amount of value regardless of the external environment. First and of utmost importance is margin recovery. The teams are doing a great job here, and this quarter's results reflect our heightened focus on pricing. This is especially important as we face areas of inflation in labor and energy costs, coupled with the carryover impacts of raws and freight costs that accelerated throughout 2022 before stabilizing in the fourth quarter. Next to cost productivity, we have over $1.5 billion in fixed costs and another $2.5 billion in variable costs, including raw materials, freight, and energy. Given the large scale of spend and more than 46% of increases in variable costs over the past two years, we anticipate that we will drive cost enhancements to add considerable value to the bottom line. Another area of emphasis will be operational and supply chain excellence. I have spent most of my career in this area, ensuring safe and efficient operations for a global company. At Axalta, I see opportunity to increase capacity, deliver more reliable production, and ultimately drive near-term manufacturing efficiencies. Lastly, we're focused on driving better cash conversion, and ultimately bringing down the net leverage in this high-interest environment. This is important following a year like 2022, where working capital has been greater than at $200 million use of cash. Altogether, these near-term priorities reflect our intent to better control the controllable and yield maximum profitability in any economic environment. Let's go back to the results on slide six. I will now give you more color on our fourth quarter volume performance. Globally, volume improved 2% year-over-year driven by market recovery in Mobility Coatings and share gains across the portfolio. This is a strong result, and really speaks to Axalta's unique market positioning and resilient end markets. Volume was up in all regions except Europe which declined by low single-digit year-over-year, and was mostly driven by the mid-teen percent decline in Industrial. This was due to macroeconomic softening and the Russia-Ukraine conflict on the broader Performance Coatings segment. Macro conditions in China had mixed impacts on volumes. Auto production was again a bright spot, and Industrial benefited from significant sequential improvement as the economy reopened from lockdown periods, earlier in 2022. However, reopening and the subsequent spike in COVID cases did have an impact on traffic congestion and refinish activity. We see this as only a modest and temporary setback. Demand was very robust in Mobility Coatings, with volume improving 19% year-over-year, with positive contribution from every region. Global light vehicle and commercial vehicle production recovered from heavily constrained level in the prior year. Moving to slide seven, I will now cover the Refinish business. It was great to join many of you at our investor event in December where we highlighted the long-term attractiveness of this resilient and growing business. At the event, we also focused on our unique value proposition built around the industry's most productive waterborne paint system and our customer-centric service model. This enables us to partner with the fastest growing customers yielding market outperformance for our business and a consistent track record of strong financial returns. 2022 was another record profit year for refinish with strong volumes outpacing industry growth and successful execution of pricing actions to offset inflation. Yet, there continues to be tremendous opportunity to continue our growth momentum that I will now highlight. Industry volumes remained below 2019 level that we believe will normalize over time alongside return-to-work trend. Secular trends such growing car park, increasing miles driven, and distracted driving all together support increasing industry activity for the foreseeable future. Body shop consolidation is expected to continue and is still in the early stages serving to expand the size of the premium market segment where we have a strong selling position. Lastly, our refinish team is doing a great job indentifying adjacencies, many leveraging our recent U-POL acquisition to grow our addressable market within the auto repair and related consumer DIY markets. Let's go to slide eight, where we will now review the Industrial business. The industrial end markets continue to soften from the combination of unprecedented inflation and more recently lower demand. However, pricing remains a bright spot as industrial achieved double digit pricing gain every quarter this year and successfully offset year-over-year inflation beginning in Q2. On volumes, industrial continues to face pressure from weakening economic activity in EMEA as well as slower than expected recovery in China. More recently, higher interest rates have a negative on our construction end markets notably in North America. This has softened demand even further specifically in our coil and architectural extrusion business. However, our North American wood business remained strong with an order backlog extending into the first-half of 2023. Our EV business continues to grow with new offerings in battery components. Recently announced infrastructure and energy investment is expected to drive upside in the future of our industrial business. Moving to Mobility Coatings on slide nine, the team delivered encouraging progress towards margin recovery in the quarter. I want to recognize the efforts of the team to deliver our margin recovery goals in Q4. Yet, we still have a way to go here before achieving the levels of profitability we want, particularly given the substantial value we provide to our customers. Margin recovery continues to be our highest priority. More broadly, we view current industry forecast to be favorable following several years of constrained auto production and depleted channel inventory level. We also expect to outpace industry growth rates into 2024 from a solid book of new business wins that we have built over the past 18 months. The new contracts are at an attractive contribution margin consistent with our historical levels. We expect to accelerate the earnings recovery in the segment as new business launches throughout the coming year. Altogether, we have an increasingly better line of sight to an expected margin recovery that should be driven by industry growth, new wins, and margin improvement. Now let's move to slide 10, and I will discuss the drivers of our margin performance. Between 2021 and 2022, the inflationary impact from the variable cost was unprecedented, inflating by 46% and totaling an approximate $640 million impact to EBIT. In response, we have achieved historic pricing realization and successfully offset the inflation year-over-year impact as of yearend. Yet, as a cumulated two-year gap remains for Axalta with negative contributions from three of the four end market which continues to depress our profitability. We are fully committed to offsetting the cumulative impact of raw material, energy cost, and logistics inflation in all of our businesses. We showed good momentum in the fourth quarter as pricing more than covered the year-over-year impact from higher raw materials and logistic costs across all our four end-markets for the first time. The two-year cumulative price cost gap was cut in half from Q3 to Q4, and we were very pleased to see the positive shift in Mobility Coatings price costs during Q4. This supported a noteworthy improvement in segment margins. In the quarter, we also benefited from modest sequential cost relief in some upstream commodity categories driven by slowdowns in adjacent markets and better overall supply availability. Looking ahead, we see an opportunity for modest lower sequential unit rates to continue into 2023. However, we're cautious on the actual impacts in the first quarter, given that our inventory levels remain historically high. Inflation remains persistent in specialties like non-TiO2 pigments, energy and labor, where we do not see yet a path to relief. It is necessary for us to remain focused on price and cost actions to offset ongoing inflation and to fully recover the remaining cumulative price cost gaps. Thanks, Chris, and good morning, everyone. Net sales were $1.2 billion, an increase of 9% year-over-year for the fourth quarter while constant currency net sales increased 14% driven by pricing actions and strong market recovery in Mobility. Constant currency net sales growth included an 8% increase in Performance Coatings and an impressive 30% increase in Mobility Coatings as both light vehicle and commercial vehicle showed strong year-over-year performance. Fourth quarter volume improved 2% year-over-year as market recovery in Mobility more than offset the softer industrial environment and slower than expected recovery in China from COVID-19 lockdowns within Performance Coatings. Demand remains robust in Mobility Coatings where volumes grew 19% year-over-year due to pent-up demand and new business wins. Price mix increased 12% year-over-year and 3% sequentially, which is reflective of this being our key priority across every end market. FX translation was a headwind of 5% on net sales for the fourth quarter, driven by a weaker Euro and Chinese Renminbi. During the quarter, we've recorded a $15 million charge as part of a new cost savings initiative being implemented in early 2023. We also incurred $15 million of costs associated with the term loan refinancing, executed in December. The $30 million combined impacts of these two items are excluded from adjusted earnings. Fourth quarter adjusted EBIT was $147 million, 22% higher versus the $121 million reported in the prior-year. Axalta's adjusted EBIT margins increased by approximately 130 basis points year-over-year to 12%. This is the first increase since the current inflationary period began in early 2021 with improvement in profitability in Mobility Coatings and Performance Coatings. This is an important milestone towards our margin recovery goal. Q4 performance also included an approximate $17 million EBIT headwind associated with the impacts from the Rush-Ukraine conflict, China COVID-19 challenges and FX translation. Turning to slide 12, Performance Coatings Q4 net sales increased 2% year-over-year and 8% ex-FX driven by a 12% price mix benefit, volumes for the segment were slightly lower as refinish share gains were offset by Russ-Ukraine impacts and headwinds from a slower than expected recovery in China. Industrial volumes were lower, mostly driven by a softer EMEA and North America. Performance Coatings reported Q4 adjusted EBIT of $107 million versus a $100 million in Q4 of 2021 as a favorable year-over-year refinish contribution was partly offset by lower industrial profitability. Industrial made progress towards offsetting its cumulative price cost deficit this quarter, but this was more than offset by softer volumes. Segment adjusted EBIT margins improved by 60 basis points year-over-year to 13% in the quarter. Moving to slide 13, Mobility Coatings constant currency net sales increased 30% in the fourth quarter as volumes increased by 19%, which outpaced market build rates across light vehicle and commercial vehicle. A highlight of the quarter for Mobility was price mix growth of 12%. The team executed extremely well and remains focused on pricing discipline into 2023. Approximately $5 million of our price growth was driven by the recognition of retroactive price adjustments with several customers where the team had been in active negotiation since earlier this year. The two-year cumulative price cost gap remains a priority for Mobility, but we are encouraged by the progress to end the year. Mobility Coatings reported Q4 adjusted EBIT of $18 million versus negative $4 million in the prior-year quarter as volume and price mix growth were partially offset by raw material inflation, higher fixed costs, and the negative impacts of foreign currency translation. The sequential increase to adjusted EBIT was also noteworthy increasing from $4 million in the third quarter to $18 million in the fourth quarter, driven mostly by an inflection in the price cost environment as pricing increased by mid-single-digit percent and variable costs were largely stable throughout the quarter. Segment adjusted EBIT margins improved by 530 basis points year-over-year to 4.2% in the quarter. Moving the slide 14 for a few comments on the full-year 2022 results, 2022 proved to be a challenging year as a series of exogenous headwinds impacted the business such as unprecedented variable costs, energy and labor inflation, constrained auto production, Russia, Ukraine dynamics, and COVID lockdowns in China. These headwinds together drove adjusted EBIT 9% below 2021 levels, though we're ending 2022 on a positive trajectory, adjusted EBIT improved by 11% in second-half year-over-year, and 22% year-over-year in the fourth quarter, price mix increased 10% year-over-year in 2022 with a low single-digit percent sequential improvement every quarter. That peaked in Q4 at 3% and despite the macro and geopolitical headwinds from Russia and China, full-year volumes increased 4% led by a strong recovery in light and commercial vehicle production, and was supported by new customer wins in every end market, including notable MSO wins in refinish and a record number of new light vehicle customer wins. We also ended the year having improved our balance sheet, which I'll review in more detail in the following slide. Axalta's fourth quarter balance sheet liquidity profile remained solid. We ended the year with nearly $1.2 billion in total liquidity. Our net leverage ratio is now at 3.8 times, reflecting a significant improvement for 4.1 times at September 30th. This reflects our commitment to focusing on free cash flow in the fourth quarter to address leverage. With that said, net leverage remains elevated in part due to higher working capital balances associated with pricing and volume growth impacting accounts receivable as well as higher levels of inventory. Inventory build has been a use of more than $300 million over the last two years. Working capital balances at year-end were 11% of 2022's full-year sales, which is roughly 300 basis points above our historical levels, which will now provide a nice opportunity into 2023. On capital allocation, we paid down $47 million of gross debt in Q4 and made no additional share repurchases in the quarter. Thus, the annual total share repurchases remained unchanged at $200 million. In December, we also successfully refinanced our $2 billion term loan, which resulted in the extension of the June 2024 maturity date to December of 2029. On slide 16, we will review our Q1 guidance framework and 2023 outlook commentary. For Q1, we expect net sales growth between approximately 5% and 9% year-over-year inclusive of a 2% to 3% FX headwinds. We expect to generate adjusted EBIT of $126 million to $146 million, which we expect to correlate to adjusted EBITDA of $185 to $205 million, representing 8% year-over-year growth at the adjusted EBITDA midpoint. We expect this growth inclusive of headwinds associated with FX and the Russia-Ukraine conflict of approximately $10 million of EBITDA compared to Q1 of 2022. For adjusted diluted earnings per share, we're anticipated a range of $0.26 to $0.33 per share. This framework assumes sequential Mobility EBIT improvement from the fourth quarter, given continued outpacing of global auto builds and margin recovery. Typical seasonal refinish buying decline that is expected to result in lower sequential Performance Coatings EBIT despite a better industrial EBIT contribution from the fourth quarter and a stabilizing raw material environment, though pressure is anticipated to continue in specialty raws like non-TiO2 pigments, labor and energy costs. Altogether, we expect a first quarter low single-digit percent quarter-over-quarter of variable cost benefit, which translates into a high single-digit percent year-over-year headwinds. I will end with a few additional comments on our 2023 outlook. The macroeconomic situation remains difficult to forecast. However, we're cautiously optimistic given our specific end-market mix and the progress towards post-COVID normalization that we're expecting across most of our business portfolio. We believe that the risks of further macro headwinds to Axalta is mostly contained within pockets of our industrial end markets, with Industrial already managing through a weaker global environment. Elsewhere, we have a resilient core centered around our Refinish business which has record profit once again in 2022, and we expect that trend to continue into 2023. Plus, we expect substantial Mobility Coatings upside from industry and margin recovery. In regards to cash flow, we will be focused on returning working capital towards our historical levels as a percentage of net sales. This represents a meaningful opportunity of cash into 2023. Our capital allocation framework will continue to be guided by our focus on deleveraging and balance sheet strength. I expect the pace of share buybacks to remain somewhat muted beyond offsetting dilutions from share-based compensation as the new interest rate environment has increased the relative attractiveness of gross debt reduction. Net leverage is expected to improve meaningfully from the current levels as we grow earnings and deliver cash. Thank you, Sean. I'd like to close out by thanking our global team. I had the opportunity to spend time with our team members in some of our manufacturing facilities. We have a talented group of operators who diligently help us serve our customers every day. I'm also grateful to our business and functional teams who are driving execution and accelerating Axalta's growth plan. Thank you. And now we can go to the question-and-answer session. [Operator Instructions] Our first question today is coming from Christopher Parkinson from Mizuho. Your line is now live. Great, good morning. Chris, and understanding it's incredibly early, but just given your background and your experiences, are there any -- is there a preliminary thought process on what you can do to assist Axalta and better streamlining results in the Mobility segment, especially now that volumes and market share seem to be comfortably on the right track? Thank you. Hey, good morning, Chris. Yes, absolutely. I think if you look at my background, a lot of it on the operations side. And as I think about Axalta in the short-term, it's purely about execution. And this is where Rakesh started, as you could see in the last two quarters, and you can see the inflection from Q3 too Q4. And we certainly are going to continue to drive execution. So, as I think about operations, supply chain, procurement, what are we doing to drive continued cost improvements here, as well as the drive for continued pricing to ensure we continue to drive that price cost graph, that's certainly the focus here, and that's certainly from my background also at Meritor. Understood. And just a quick follow-up, on the Refinish side, it seems you've been also winning a decent amount of share in terms of body shop, and consolidation among some of your largest customers and [exclusive] [Ph] activities should also be a tailwind. When should we expect to see a lot of that through results in the Performance segment? Thank you. Good question. So, I think as you know, Q1 Refinish is somewhat seasonal. So, as we see that continuing through the year, certainly in Q2, you should see the benefit from that. And again, if you think about the Refinish business, whether it's '21 to '22, they've seen record growth. And as we think about '23, certainly with the lens, again what we announced at -- also at the Investor Day, what you can see is they've gained about 3,000 shops. The MSOs, as you pointed out, continue to consolidate, so certainly significant opportunity there going forward. Yes, thanks for taking my question. With regard to pricing, I guess can -- can you help us to think about how '23 looks if you didn't raise price any further in any of the channels, just what would we be seeing for a full-year price increase in 2023? And then what channels -- it does sound like there are certainly pockets where you feel you still are behind or have some inflationary pressures where you need further pricing. Can you fill in the blanks on that a little bit more and help us to understand the magnitude of -- and where you might need to see those price increases? Yes. Hey, John, it's Sean. Good morning. So, as we think, I mean the last two quarters you've seen essentially 3% sequentially from Q2 to Q3, Q3 to Q4. So, we're signaling low single digits next year, so call it $150 million of just pure pricing carryover. I think the dynamics just in a deflationary environment, it's how quickly we deflate and how it ultimately impacts some of our raw material indexing. But with that said, even with Chris' prepared remarks, the margin recovery is still not fully there. We expect to fully recover, from a total Axalta perspective, in the first-half of next year. But Mobility is still behind, as well as Industrial; Refinish has quickly caught up. But that's really the focal areas, that being the two components within Mobility and Industrial. Got it, fair enough. And then Chris, well, won't ask you too much on the operational side, obviously you have a lot to dig into. But I guess high level, if when you think about the area of leverage for Axalta and also returning of cash to shareholders, I guess can you give us kind of how you think about those topics in general, what you think might be the right leverage levels for Axalta going forward? And also, is it something where you would consider pushing the Board to maybe think about dividends versus buybacks, do you have a preference there? Just if you can give us -- just give us some of your early thoughts on how you think about that, that would be great? Sure. I think initially, as Sean pointed out in his prepared remarks, our focus is on debt repayment. So, I think we're going to continue to drive that. We're at 3.8. Again, as you folks know, we were around 4. Our objective is to get that down around that 3 mark as we were before. And so that is going to be the primary focus for us going forward, especially with the current interest rate environment that's certainly driving the focus towards debt repayment. In terms of, let's call it, return to shareholders, it's probably something we'll look at later in the year. But right now, our absolute focus is on execution and debt repayment. Got it, fair enough. And then maybe if you could just squeeze in one last one just around auto OEM. The volumes have been huge, and we were well aware of some of the big account wins that you had. Is there any initial fills -- it's not going to be like a big-box type thing, but are there any initial fills like where we should be thinking about that as we model out your performance relative to the broader global OEM market? Look, you've put out some huge numbers in the last couple of quarters. Is that an okay run rate, at least until that anniversaries or, again, was there maybe a little bit of a fill-in there that we need to consider? Yes, I wouldn't call it necessarily a fill. I would expect that we're going to continue to outpace the market in 2023, maybe not exactly by the levels you saw in Q3 and Q4. Q4, in particular, we beat in every region. And it's really a twofold reason, John. It's the market wins, but more importantly, some of the OEMs and the platforms that we're actually serving product to are actually outpacing the market. So, China is probably a really big bright spot. The market was down roughly 6% in the fourth quarter. We were well over 30%, and a big part of that is just the platforms that we're actually serving are quite frankly, just outpacing the market altogether. Just given the real-time sequence in China as it relates to the reopening, can you just give us a sense as to where volumes are by sub-segment relative to perhaps the pre-COVID levels? Yes, I mean the first quarter is typically fairly soft for us, Ghansham, with Chinese New Year and even the infection rates in the first two weeks in January. But I mean we're cautiously optimistic for '23. I think the first quarter is going to be pretty soft. Mobility has actually run pretty strong. Other than the COVID lockdowns in the second quarter, they've propped above that market, and it's run pretty well in Q3 and Q4. Refinish, with all the lockdowns, just impacted miles driven. So, that's probably the one region that just sort of further behind just given the COVID lockdowns. And Industrial, same thing, just given general slowdown in some of the European economic markets, the export market in China has impacted Industrial, and again just the COVID impacts. But again, we're cautiously optimistic we'll see slow recovery here. But we're pretty cautious on the first quarter guide as it relates to China. Okay, fair enough. And then on slide nine, you have the historical and projected builds in global light vehicles, nice little chart there. So, assuming we get to 2019 levels by, let's say, 2024, is there any reason why you would not be above the 2019 EBIT margin levels for that segment, assuming that Commercial kind of hangs in and raw material cost inflation is relatively muted relative to price discipline? Maybe I'll start off. Again, as you can see from our year guide, we're certainly going up. And we're also a little bit lower than where the external forecasters are because we're being somewhat conservative. But again, Ghansham, I think what you have to take into consideration is the inflation that we have faced in the marketplace, right? And then offsetting that margin gap on the top end between where we were at the full look with cost inflation built in. However, if you look quarter-by-quarter, even if you go into Q1, we're driving increased margins in the Mobility business, and that's the objective going forward. As you know, if you went back to, let's call it, Q1 levels, we were running at about $35 million. And this quarter, we were at $22 million, so we're -- or we're -- the Q1, we're building into '22. So, certainly we're progressing in the right direction, but still a ways to go there. Thanks, and good morning, everyone. Could I ask on the Mobility pricing in the quarter, how much of that was new bespoke pricing versus the flow-through of the indexation contracts? Yes, so fourth quarter, actually the vast majority was new pricing contract negotiations as opposed to raw material indexing. When you think about the whole year, it's probably a 50-50 split as far as the contribution between raw material indexing and just pricing negotiations. Okay, that's helpful. And Chris, maybe just preliminarily, you talked in that slide about the sort of strategic goals. When you think about operations and supply chain, is the stuff that you're envisioning, is this sort of more tactical and nimble stuff or is it more sizable restructuring kind of stuff that would have significant cash costs associated with it? Well, three weeks in, probably a little early to call, Vincent. But what I'm absolutely focused on right now is more the tactical and nimble stuff because we have to react absolutely quickly here, continuing the path that Rakesh and the team have built up, and obviously the monumental step-up they did in Q4, and we got to continue that through Q1, Q2, Q3. So, the first step is just purely focused on driving those execution aspects, whether it's utilization of our plants better, whether it's procurement, and whether it's our supply chain improvement. So, those are the drivers we're driving initially. Thanks. Good morning, everyone. In fourth quarter, sequentially, your sales were about flat, your EBIT was about flat. And yet your price-cost gap runs by $56 million sequentially. I guess the question is why didn't more of that price-cost benefit show up in EBIT, and would it show up sometime later? Hey, Alexi good morning. The big thing is refinish volumes. Q4 and Q1 are typically the soft quarters from a refinish perspective. So, coming off Q3, that's really where you see sort of some margin compression. Obviously nothing structural, just the seasonality of how Refinish works, Alexi. Okay, that's helpful. Thanks a lot. And then -- you also talked about E-coat on EV battery components, could you talk about that product, what's your content? What is the gross opportunity there? Yes. I mean -- and you're probably referencing a press release that came out few weeks ago, where we won an award. But it's really the entire infrastructure of an EV vehicle where the E-coat is going on. So, as far as our EV exposure within Energy Solutions, on that, roughly, $130 million business, it's still sitting around 30%. So, it's still pretty small, but obviously a bigger opportunity for us longer-term. Thanks very much. During your preliminary remarks, I think you said that working capital could be improved by 300 basis, you have about $5 billion in sales, so 300 basis points is $150 million. Your working capital change this year was negative 265. Why isn't the working capital opportunity larger and in general over the past 10 years, I think working capital has only been positive once for Axalta. Why is it that you tend to normally run with negative working capital year-on-year? Yes, so Jeff, we signal roughly 8% as our historical levels on a LTM basis at the end of any fiscal year. So, we're calling out the target is to get back to those historical levels. That's not necessarily going to entirely happen in 2023, but it's certainly a bigger opportunity for free cash flow generation. Within the overall working capital elements, what we're signaling is AR inventory accounts payable on accruals, I think you may be picking up prepaids, which I think you're aware we have these business incentive payments within refinish that are a typical outflow. And they range from $60 million to $70 million annually, just for perspective there, Jeff. Yes, and then your CapEx was 151. Can you remind me what's maintenance CapEx and what did you spend on that was the difference between maintenance and the 151? We don't call out specific years for maintenance CapEx, but over time it's $30 million to $50 million, Jeff, on average in a given year, I'd say 2020, 2021, we certainly underspent from a CapEx perspective, so we're expecting a little bit more of an uptick, closer to that $50 million to $60 million in 2023 within maintenance, and then we'll get back to the normal, more normal run rate in 2024. Great, thanks. Good morning. First question, just on the input side of the equation, can you just remind us how big energy and labor costs are relative to say, raw materials in your overall cost basket? Sure, so energy is right around $75 million, that's up from $33 million two years ago. So, we've essentially doubled, labor costs run about $900 million annually. Got it. Okay. And then second, just on the outlook, I think historically the first quarter has been something like 22% or 23% of where you end up normally delivering for the full-year. I appreciate the visibility is quite low, but just is that still a rough estimate as we start this year or should we expect a steeper ramp just as we start to catch up on some of those margin and cost initiatives? Yes, directionally that's a good number and what I called out earlier in the Q&A, refinish, historically range roughly 21% of the profitability in the first quarter opposite the full-year for refinish. So, that's really what's driving the overall EBITDA contribution being down in that 22% range. Yes, you guided the first quarter raws to be up high single-digit, for raw materials purchased today, what would you say they would be on a year-over-year basis and what would you estimate the monthly lag before it would flow through COGS? Yes, Steve, probably the best way to look at this is versus fourth quarter and it's down. I mean, we're seeing across almost every basket down low to mid-single-digits that we're actually procuring right now with the exception of pigments. And I bifurcate pigments, TiO2 and carbon blacks are relatively flat opposite fourth quarter, but some of the specialty pigments are actually still inflating a bit. And then energy costs are expected to be up slightly opposite fourth quarter. Yes, so we're expecting some marginal benefits in the first quarter, but again, we're sitting with essentially record high inventory levels. We expect more of that to flow through actually in the second quarter, and that's why we're a little bit more cautious on the margins in the first quarter. And can you address what led to the customer win in Mobility? Is there, I doubt that's easy to achieve with such large customers. And I guess I'm raising it as an issue with how do you get price in that business without threatening to walk away from contracts? I mean, we price for value, Steve, and there's and you saw that in the fourth quarter, some of these discussions went over two quarters for us ultimately to get to retroactive improvements. But Hadi Awada and the team that he's built over the last two years, we really started to see the progress 18 months ago. And some of these conquest wins, they take 18 months to two years to ramp-up and actually for us to get the sales. So, this has been a continuation of his team continuing to drive service, bringing good products and bringing the right team to the market. And equally important, I think we should mention that all that new business is coming in at margins that we're very proud of. Yes, good morning. In the first quarter of '23, would you expect to run your assets at a similar rate to the first quarter of '22 or higher or lower and how might that answer vary by your major businesses? I would expect them to run pretty similar. Volumes are relatively stable. Mobility is going to be slightly up versus the first quarter of 2022. Industrial volumes will be slightly down, but overall it's going to be very, a very similar buying picture. Okay. And then as a follow-up, Sean, in your prepared remarks, I think you referenced $5 million of retroactive price adjustment. Can you speak to what that is, why it occurred and whether we should expect any additional so-called retroactive adjustments in the first quarter and beyond? Yes, we're not expecting any big retrospective, but you can imagine, Kevin, some of these discussions last a multitude of months and sometimes two quarters, ultimately to get this to the finish line. And so, that's really what you're seeing the dynamic in the fourth quarter. Some of these discussions have been going on for two quarters and you're seeing the realization once we actually reached a final verdict, with the customers and actually able to invoice them. But we're not expecting big retros in the first quarter in our current guide. Maybe I could lean on you a little bit for your auto experience. The auto dealer inventories are still relatively low. Do the auto producers still have constraints keeping them from fully further restocking or are they unconstrained and you think they're just cautious about rebuilding their -- [multiple speakers] No, I believe there're still constraints and a lot of my experience was on the commercial vehicle side. And as I think about, where commercial vehicle trucks and truck production sits, there's historic backlogs on that side and if you look at some of the recent customer announcements with your earnings calls, you can see there's continued pent-up demand as we look into moving into next year. And it grows across both baskets, whether it's the Mobility side or sorry the light vehicle side or the commercial vehicle side. And you can see even with our numbers, right, so we're going from $82 million, up to $83 million to $84 million in '23, but if you look at the external forecasters there at $85 million, so we do have some op upside here, but again we are being cautious primarily, if you think about China, if you think about Europe, we want to make sure we have a fixed cost model that is slightly lower and then we are prepared for the upside here. So, and if you look overall, I think the key message is that we have, let's call it a market that we believe is going up primarily because inventories are still tight on both sides. On top of that though, as Sean mentioned on the last point, we're outpacing end market activity, whether we're driving growth in as you heard on the Mobility side, on the light vehicle side with, Hadi and the team have driven significant growth in China. And then on top of that, on the heavy side, they've also closed with Navistar here. So, anyway, great story across the board. And then, just a quick one, Sean, not that it's big, but what's driving color pigment prices up? It's very few things are actually going up right now. Thank you, good morning. Sean, first given your new contract structures in Mobility, could you remind us what happens when raws actually come down, how much do prices decline here or how much they hold? Yes. So, David, we are still behind our mobility, which we will see in the price cost slide. So, outside the indexing contracts, we are still going to be pushing price even if we do see a deflationary environment. But to your point maybe on the indexing, in general we are on six-month lag. So, again, depends on the pace of deflation. But we would expect to give back potentially something on roughly 40% of those contracts. Very good. And Chris, again welcome aboard. As you put a fresh eyes on mobility, what do you think the biggest issue was last 18 months? And were there any structural reasons why this business can't return to prior levels of earnings forgetting margins because they will go up or down based on other factors? But earnings dollars -- can we get back to prior levels? Thank you. Well, I think it's focused on execution as I think about the business. And I know that might sound pretty simplistic. But if you look at the last quarter -- two quarters and what was done, that was primarily the focus. It was focused around driving pricing. Again, I think as Sean mentioned, it's about making sure we are getting the value from our -- that we are providing for our service. And essentially in this space, I look at it as if you look at it if you look at where our customer margins are, where our margins where for the last year, we certainly can't invest. And if we are providing the value that's driving the growth, we certainly need to be pushing pricing here whether as we have discussed above and beyond where we are. And we believe we are providing that level of -- sorry, value because we certainly are continuing to grow. So, that's certainly going to be our focus as we go forward. So, one is pricing. The second part is execution. So, what does that mean? We've obviously had supply chain constraints in plants. And it's not associated with the capacities of our plants or the utilization of our plants. It's really about how we drive the supply chain from a procurement standpoint right through the facilities to get the volume out. And then we have made choices there that's obviously limited our ability to drive that gap. So, certainly those two are the focuses we are going to continue. So, simply put focus on execution. And just to layer on, I mean the clear objective is the first step is to get back to historical profitability levels. The only thing to keep in mind, global automobiles was $82 million this year. Historic levels, normal for us is $89 million - $90 million. So, the markets are still down 10%, but again, kudos to the team, we saw a nice step-up in profitability in the fourth quarter, and we are going to continue executing. Sequentially, you should see improvement going forward through 2023. Hey, guys. Nice quarter. Just one question, in terms of refinish volumes, you talked about it being seasonally weak. Or, typically seasonality first quarter versus fourth quarter. But what do you think about the second quarter? There are odds that the seasonality could be similar improvements? And maybe talk about the regions? Maybe China is not as strong sequentially. But any thoughts about what you are seeing for a typical improvement in 2Q versus 1Q in refinish? Mike, we are only guiding to the first quarter, but we fully expect there will be a nice uptick in the second quarter of 2023. We also think the cautiousness that we are seeing in China, hopefully, that will fade away pretty quickly. And we will see the benefits in the second quarter as well. As China reopens, how do you think about that benefiting your industrial demand versus auto OEM? In auto OEM, you mentioned China was a big growth driver for you. So, talk about sort of what kind of pace of improvement you expect. And on the flipside, if China does rebound then oil demand and prices could go up. And could that create some potential headwind? Thank you. Let me start off. Again, three weeks in the role. And then I'll probably hand it over to Sean, but again, obviously we are being conservative and being cautious that's our approach for China. But to your point, there is upside as you think especially since we have significant new business wins are ramping there. So, that is a bright spot for us. On the industrial side though, I would say globally we are seeing softening. And even in China, we forecasted that we are being somewhat muted. I think the bright spot for us just answering your question on the regional side. If I think about where is the opportunity for industrial, it's really North America. And we look at our building products business where we see some great growth. In the siding business also as Sean pointed out on the EV side, we are also seeing growth there. But then coming back to China and as we look at the overall basket, I would say we are being somewhat conservative as we go through it. Obviously, it's got fits and starts. We went through an experience as we started out from let's call it the COVID lockdown early in the month January, but we certainly see a lot of our facilities opening up, and it seems like the same story for rest of China. So, short-term we are being somewhat conservative. And I'll now turn it to Sean. Yes, on the mobility side that market is actually being operating really well. So, we are still pretty optimistic even in our first quarter guide on how our business continues to run outside of obviously the Chinese New Year impacts. Industrial and refinish, both of those were roughly $120 million businesses. So, there is certainly incremental improvement. But relative to total Axalta, those businesses are still pretty small. So, certainly some upside there as we think about full recovery, and just as far as China economy coming back and the impacts on sort of inflation-deflation, I guess we are somewhat neutral. We see a potential argument on both sides. But for our business, the regional arbitrage from the supply chain perspective, we expect about to be a net benefit as we think about the raw material environment. Thank you. And then, my second question is you are getting some significant volume growth in light vehicles. But you are also talking about the need to get pricing. I am just putting those two comments together, was Axalta trying to loading price or acting tough on price to gain share? And is that what we are seeing? And now, you are saying that we need to get pricing back up? Is that the right way to interpret those two points? No, absolutely not. So, the variable margins that are coming through for the new business wins are coming through at historical levels. Where we are really focused on getting price is on the legacy contracts and continuing the push from a margin perspective. Yes, hi. Thanks for squeezing me in. Just two quick follow-ups, I guess one on the new win side of it, the refinish the NFOs, the new stocking centers in Europe and the mobility side if markets broadly were flat, what do you think Axalta does at a volume level? And then just on the mobility side from an earnings perspective, you historically talked about it the recovery being 50:50, price cost, market recovery. Has that calculus changed given some of the pricing you got in fourth quarter and some of the dynamics you talked about? Thanks. Yes. So, I mean I would expect us assuming a flat market across the board that we are going to up low single digits really across all of our end markets. As far as the mobility volume, I think we said in the third quarter that it's probably has shifted more to 60:40 as far as the pricing. And it's probably now back to the 50:50 between volume and price given what we are able to do in the fourth quarter from a pricing perspective. Thank you. We have reached end of our question-and-answer session. And ladies and gentlemen, that does conclude today's teleconference webcast. You may disconnect your line at this time. And have a wonderful day. We thank you for your participation today.
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EarningCall_1236
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Good morning. My name is Margarie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Corus Entertainment Q1 2023 Analyst and Investor 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] As a reminder, this call is being recorded. I will now turn the call over to Mr. Doug Murphy, President and CEO of Corus Entertainment. Mr. Murphy, you may begin your conference. Thank you, operator, and good morning, everyone and Happy New Year. Welcome to Corus Entertainment's fiscal 2023 first quarter earnings call. I'm Doug Murphy, and joining me this morning is John Gossling, Executive Vice President and Chief Financial Officer. Before I read the cautionary statement, I'd like to remind everyone that we have slides to accompany today's call. You can find them on our website at www.corusent.com under the Investor Relations-Events and Presentations section. Now let's move to the standard cautionary statement found on Slide 2. We note that forward-looking statements may be made during this call. Actual results could differ materially from forecast, projections or conclusions in these statements. We'd like to remind those on our call today in addition to disclosing results in accordance with IFRS Corus also provides supplementary non-IFRS or non-GAAP measures as a method of evaluating the company's performance and to provide a better understanding of how management views the company's performance. Today, we will be referring to certain non-GAAP measures in our remarks. Additional information on these non-GAAP financial measures, the company's reported results and factors and assumptions related to forward-looking information can be found in Corus' first quarter 2023 report to shareholders and the 2022 annual report, which can be found on SEDAR or in the Investor Relations-Financial Reports section of our website. I'll start on Slide 3 with an update on the impact of the current macroeconomic environment on our business. I will then briefly review the progress we are making advancing our strategic plan and its priorities. I will also discuss our cost structure and go-forward actions that will address recent increases. To begin, I will reiterate my comments from last quarter, we are in an advertising recession. This is clearly visible in our revenue results for the quarter and evident across the entire media sector as reported by all of our peers recently. The decrease in advertising revenue is the logical result of companies trying to manage their profitability as they contend with inflation-induced cost increases and the impact of supply disruptions on their businesses. One of the first choices companies make is to reduce costs and cut discretionary spending such as advertising. Again, to repeat, we do not know the depth nor the duration of this economic contraction. Based on our prior experience in the early stages of a recession, the broader media industry experiences abrupt declines in advertising revenues followed by an equally quick recovery once the economy recovers. The declines in advertising revenue this quarter are ongoing evidence of the cross currents and riptides that we are experiencing in today's advertising market place. These remain mostly pandemic and supply chain related. Let me cite a few examples. With restaurants and out of home dining now fully open, consumer's love affair with food delivery to their home and related expensive service charges and delivery fees has ended. Accordingly, the direct-to-consumer food delivery category advertising spending is down. You've all seen the stories about this year's cold and flu season, not to mention the empty medication aisles and grocery stores and pharmacies, those category's advertising spending is down given depleted inventories. Supply chains issues persist in the automotive category, with many cars arriving, but they're presold. Presold inventory does not need to be advertised. Other categories with reductions in advertising spending include household goods, appliances, electronics and toys again impacted by pandemic related disruptions. Now within categories, there is also much variability as each advertiser adapts to the macroeconomic conditions in their own way based on their business strategies, adjusting their spending for their own unique challenges and opportunities. For example, there are new growth categories such as gaming, a welcomed new arrival to the advertising marketplace. Within the packaged good sector, while some clients ebb, other clients flow, investing to increase their brands, impressions and presence to take advantage of their competitors void. Our talented sales team is there to serve the needs of our advertisers, whatever they may be. Corus delivers strong, differentiated brands that can be bought across an expanding linear and digital multi-platform offering with improved targeting, automation and a suite of customizable advertising options providing a 360 degree solution that is highly attractive to advertisers and agencies alike. Visibility is still a bit limited and advertising revenue softness in television will likely persist. However, right now, we expect to see sequential improvement in the rate of decline in television advertising revenue in the quarters ahead as these cross currents and riptides do appear to be stabilizing. With this backdrop in mind, let me now take a moment to talk about our strategic plan and its priorities. Our long term strategic plan remains unchanged. We are focused on transforming how we sell media. We are putting more content in more places. We are investing in our owned content business. Recent highlights demonstrate the progress we are making advancing our strategic priorities in the face of these advertising headwinds. So let me cite these. We have improved the value proposition of STACKTV by adding our English language suite of Disney channels. We have expanded our streaming portfolio to broaden the scale of our advertising offerings with the launch Pluto TV. We launched Teletoon+, a new premium kids and family [indiscernible] streaming service available on Amazon Prime Video and Bell Fibe TV. We have expanded our authenticated content offering on the global TV app as well as on STACKTV, both now including more back seasons of big network franchises such as NCIS and FBI, full in-season stacking for Saturday night live and a winning slate of Peacock originals that include the Resort, Vampire Academy and a new season of the top audience driver Bel-Air launching in March. These purposeful moves demonstrate how we are innovating in this challenging market to grow our total video audience delivery by adding new premium digital video impressions in addition to those large audience who delivered by our traditional TV channel platforms. Further, we are growing our slate of content that we will sell into the international marketplace that diversifies our business from the Canadian economy. This successful implementation of our strategic plan is building a more resilient business for the long term. Moving to Slide four and the key financial highlights for the quarter. Our consolidated revenue of $431 million was down 7% for the quarter resulting from lower advertising revenues. Total consolidated segment profit was $132 million for the quarter with free cash flow of $21 million. These revenue declines combined with the higher amortization of program rights resulted in the leverage of 3.38 net debt to segment profit at the end of the quarter. More detail to follow on this. Over to Slide five. Canadians have more ways than ever to consume video content. Whether through their traditional set top box or two-thirds of Canadians enjoy their channel subscription or through streaming and other non-linear on-demand services. Overall multi-platform audiences in Canada are growing. Corus is well positioned to benefit from the large and expanding total video addressable market, leveraging our fan favourite linear channels to pursue opportunities in premium digital video. Equity capital markets are no longer rewarding growth at all cost direct-to-consumer streaming ventures. As a result, the entire media and entertainment industry now is acutely focused on optimizing their programming investments and audiences across both traditional linear and on-demand streaming platforms as most direct-to-consumer streaming platforms struggle to generate positive cash flow and earnings. In contrast to this, at Corus, we have taken a different approach by building a capital-light partner-led direct-to-consumer strategy. We are leveraging our asset base and existing channels platform to pursue premium digital video without making bet-the-company type investments in either the production of the content or in the technology platform stack or both. To be crystal clear, when I say leveraging our asset base, I refer to optimizing our linear channels business while simultaneously pursuing streaming opportunities in this growing digital video marketplace. Our strong, innovative and long-standing partnerships with all the US studio majors has been the key that has now unlocked these new digital on-demand premium video opportunities. Moving to Slide six; on December 01, Corus and Paramount Global celebrated the launch of Pluto TV in Canada. With over 117 channels and more than 20,000 hours of free content, this represents the most robust content offering on launch of any international markets. Our early results from Pluto TV are encouraging, with the app ranking among the top two free apps on Canada's Google Play Store, Amazon App Store and Apple TV. Our Corus channels, including content from across our family of brands as well as our 24X7 global news feeds are performing very well as expected, given their strong local appeal. We want to recognize the extraordinary efforts from the Corus team and our partners at Paramount Global in making this highly anticipated launch a reality. Over to Slide seven. We are encouraged by the early results from our three cheers for the year's marketing campaigns, celebrating the arrival of the suite of Disney channels on STACKTV. This marketing push harnesses the power of the Disney brand to drive awareness and subscriber acquisition to the platform. Although it is early days, we are seeing promising traction in our trial subscription numbers. We are confident that these powerful channel additions and other improved value proposition initiatives such as the addition of more back seasons of popular content will further the momentum of STACKTV in the quarters ahead. Moving to Slide eight. As operator of the streaming platforms look to optimize spending on production investments, they are seeking other sources of content supply, which is a perfect setup for our owned content ambitions. Our growing slate of content in production and for sale will benefit from this demand in the international marketplace. While we saw modest declines in our distribution production and other revenues in Q1, Nelvana and Corus Studios did grow. We expect strong growth in our content business in the coming quarters when compared to the same quarter last year. Over to Slide nine. It is clear that as advertising revenues decline, we are also experiencing an increase in programming costs, not an ideal combination. At Corus, we have been steadfast in our strong conviction that our US studio partners needed us as much as we needed them. This has been proven out as we have successfully renewed, extended and broadened the rights acquired through our content supply agreements well into the next regulatory regime. These investments ensure the long-term viability of our traditional channels business and now provide us with an opportunity to grow our streaming portfolio in addition to our large television audience delivery with new premium digital video impressions. These are smart programming decisions that require increased programming investments. The other increases in programming costs are required as part of our regulatory obligations. These results from the David regressive spending requirement calculated at 30% of prior year's regulated revenue along with many other restrictions that limit our ability to compete. Unfortunately, our broadcast regulator decided that some of them for last that Corus to be required to make up the approximately $50 million in Canadian production expenditures that we could not spend given the COVID-19 related production shutdowns in 2020. This unexpected decision made us spend more on Canadian programming in this challenging economic environment. Now, while we are excited about our successful programming investments with our US studios that ensure the long-term resiliency of our business, the David op strategy regulatory spending requirements is currently affecting our financial performance. The only good comment I would make is these will pass and we expect reduced Canadian programming expenditures on a run rate basis of $20 million in the years ahead. Every company in every industry these days must address the changing labor market as well as the additional costs from the post-pandemic return to normalized business operations. Companies must adjust to new workforce dynamics, whether or not that's disrupt from some early retirement or an unwavering demand for remote work flexibility requested on behalf of workers, especially younger ones. At Corus, we are making necessary investments to accommodate the needs of our people. In addition, given the investments we have made in acquiring content for our channels and on-demand streaming platforms, a companion marketing investment is required to promote these new offerings to our audience. So that's important context. The CPE cash up cost will pass. The incremental US programming investments will generate margin accretive new digital revenues. We will always invest in our people and we must market our products. Importantly, and in light of our revenue weakness, we are conducting an enterprise-wide cost review. This is looking at all expenses and operations. We will streamline our operating model and asset base over the coming quarters and identifying meaningful cost savings on a run rate basis. Thanks, Doug. Good snowy morning, everyone. I will start on Slide 10. The challenging macroeconomic environment that emerged last summer certainly persisted into the fall, impacting television advertising demand in our first quarter and contributing to lower consolidated revenue of $431 million and that's a 7% decrease from the prior year. As a reminder, in Q1 of the prior year, the pre-omicron recovery was well underway with strong consolidated revenue growth of 10% and that was bolstered by TV advertising revenue growth of 16%. Consolidated segment profit was $132 million for the quarter, reflecting the lower TV advertising revenue coupled with increased programming costs and marketing investments in STACKTV as Doug has just mentioned. Consolidated segment profit margins were 31% for the quarter. Consolidated net income attributable to shareholders for the quarter was $0.16 per share. We delivered free cash flow of $21 million in the quarter and as a reminder, last year, our free cash flow in Q1 benefited from a non-recurring $43.5 million distribution from a venture investment. Net debt to segment profit was 3.38 times at November 30, 2022, compared to 3.02 times at August 31 of last year, reflecting the impact of the lower segment profit and slightly higher debt balances. Now let's turn to our TV results for the first quarter as detailed on Slide 11. Overall TV segment revenues were $402 million for the quarter and that's down 8%. This was mainly driven by lower TV advertising revenue, which declined 11% in Q1 and that's compared to the strong growth of 16% in the prior year, as I mentioned. Subscriber revenue was consistent with last year with streaming subscriber growth from expanded distribution of streaming services acting to offset declines within the traditional distribution system. As a reminder, in Q2 of fiscal 2022, we did benefit from approximately $6 million of retroactive adjustments from the renewal of distribution agreements and that's going to set up a difficult comparable for us in the coming Q2. Distribution production and other revenue was 3% lower for the quarter and that was driven by the timing of content licensing sales and lower publishing revenues, but partially offset by the addition of aircraft pictures last February and modest increases from Nelvana and Corus studios. We do expect significant growth from our content business in the coming quarters supported by a robust international sales pipeline. We remain encouraged by our progress in creating incremental new platform revenue, increased adoption of optimized advertising and prospects for our slate of original content to position us for longer term growth opportunities. Direct cost of sales was up 8% for the quarter and is driven mainly by the 7% increase in amortization of program rights, which resulted from the investments in US through output deals and an increase in original programming deliveries. On a full year basis, we anticipate that programming costs will grow modestly with approximately one third of this driven by the CRTC's catch-up decision. TV G&A expenses were up 5% from the prior year quarter and in the current quarter, G&A mainly reflects an increase in marketing investments to promote our full programming in STACKTV, higher development costs in our content business and other costs related to growth areas. Overall TV segment profit was down significantly in the first quarter, primarily as a result of the contraction in advertising demand, higher amortization of program rights and film investments and G&A expense increases. TV segment profit margins were 33% in the current year quarter compared to 41% in the prior year comparable period. As detailed on Slide 12, despite the contraction in advertising demand, we are encouraged by the growth in our new platform and optimize advertising revenues. New platform revenue was $40 million or 10% of total TV advertising and subscriber revenues in the first quarter and that was up 13% or $4 million from the prior year quarter. The continued growth reflects the disciplined execution of our strategic plan as we deploy our expanded content rights in new places and connect with audiences in new ways to drive additional sources of revenue. As a reminder, this metric demonstrates some seasonality from quarter-to-quarter due to the higher linear advertising revenue mix in Q1 and Q3 compared to the lower demand quarters of Q2 and Q4. Optimized advertising revenue was also up significantly in Q1, representing a new milestone of 55% or $130 million of total television advertising revenue in the quarter. This is an increase of 31% or $33 million in the prior year quarter as more advertisers explore the benefits of our targeted and automated advertising solutions. Now let's turn to our radio results on Slide 13; radio is certainly benefiting from resiliency in key advertising categories including entertainment, travel, restaurant and retail, offset by continued softness in automotive. Radio segment revenue increased 2% for the quarter as a result of stronger vocal revenues, but partially offset by the impact of broader macroeconomic conditions on national sales. Radio segment profit increased 5% in the quarter, benefiting from the revenue growth and radio segment profit margin was 20% in Q1, that's consistent with last year. All right, over to Slide 14, since introducing our new capital allocation policy in September of 2018, we have demonstrated our commitment to reducing bank debt and we also trimmed out our bank debt with the issuance of two long-term high-yield notes. In just over four years, we have repaid over $500 million of bank debt, which combined with the funding of our dividend and share repurchases has contributed to a total shareholder yield of $958 million. At the end of Q1, our net debt to segment profit increased to 3.38 times compared to 3.02 times in the prior year, driven by the impact of lower advertising demand on our segment profit and lower free cash flow for the quarter. We exited the first quarter with $81 million of cash and cash equivalents and $214 million available to be drawn under our revolving credit facility. Our financial priorities remain unchanged. Importantly, we remain committed to increasing our financial flexibility over the longer term. In this low visibility environment however, we believe it is prudent to conserve cash out of an abundance of caution. As Doug noted, we have and continue to take serious cost production measures, but given continuing uncertainty in the advertising environment and the macro conditions, the company has decided to take additional prudent measures. We will not renew our share buyback program when it expires next week and consistent with this approach, the board has decided to defer its decision on the declaration of the dividend at this time. The outside date for this decision is March 15, by which point the company expects to have more clarity on advertising market conditions and Q2 results. To be clear, we are not reducing, eliminating or temporarily suspended dividend at this time. We will take this opportunity to consider the alignment of dividend declaration and payment dates. We completely understand the importance of our dividend to our shareholders and remain committed to our long term dividend philosophy. Our foremost priority is to navigate this difficult environment as we have successfully done many times before, while carefully managing our expenses and our cash. We are confident in our long-term plan to position Corus for the future by investing in the business, de-levering and providing attractive returns for our shareholders. Thank you, John. Over to Slide 15; I want to take a moment to touch on an important journey we embarked upon one year ago. For more than two decades, Corus has supported a broad range of what is now referred to as ESG initiatives. This year we are taking the next step and making a priority to embed sustainability into all areas of our organization. Our commitment to bring a more sustainable company is outlined in our inaugural 2022 sustainability report. Our ESG goals that reflect people, planet and responsibility will be an integral part of how we deliver against our strategic plan and financial priorities, build resiliency, demonstrate our ongoing efforts to make Corus a great place to work. The full report is available on www.corusent.com under the sustainability section. Moving on to Slide 16. There has been significant change at the CRTC recently. We'd like to thank the outgoing Chair, Ian Scott, for his efforts and welcomed the new Chair, Vicky Eatrides. The new chair takes the helm at perhaps the most poignant moment of change in the history of the Canadian broadcasting sector. This important sector, which brings the Canadian voice and contributes to the Canadian creative and cultural industry while providing necessary information and news across the country. Yet it continues to be completely disadvantaged by decades old laws and policy. Same time foreign players are allowed to enter the Canadian market unfettered by any obligations nor restrictions. We encourage the CRTC to move with purpose and act quickly. It is long past time for more modern equitable broadcasting regulations in this country. And now to briefly highlight today's key messages. While we are firmly of the view that we are in an advertising recession, our expectations are that we will see sequential improvement in the rate of our advertising revenue declines as we progress through the coming quarters. We are conducting an enterprise-wide cost tribute that is looking at all expenses and operations with a review to streamline our operating model. In addition to our CPE catch-up burden, that will pass and when it does, we expect to see approximately $20 million of recurring cost savings. The immediate term challenges will not deter us from our purposeful execution of the strategic plan as we grow our total video audience delivery by adding new premium digital video impressions in addition to those large audiences delivered by our traditional TV channels platform. Our owned content business will reap the rewards of our increased investments in our content slate with growth and episode deliveries expected from Nelvana Corus Studios and Aircraft Pictures in the coming quarters. It's a new year and we want to take a minute to congratulate our team for their tireless efforts to provide news and entertainment programming for Canadians each and every day. The Corus team produces and distributes great content for radio, television, our streaming portfolio and our international buyers working in ways that we never thought possible not too long ago. Our commitment to our employees, is to provide flexibility with working conditions that support the wellbeing of our people as a priority, which remains paramount to our future success. Yeah, thanks very much. A couple things. First, John, the CPE catch-up you said is about a third of the modest year-over-year increase in program costs for 2023. I'm just trying to clarify what the pacing is here for it to be a third, I would suggest a pretty big increase in what you have to catch up in this fiscal year versus fiscal 2022. I thought you already add up $15 million to $20 million of catch-up cost that was incurred last fiscal year. So maybe you need to clarify the $50 million, how it spread over these three years? Sure, we were just under $20 last -- it's a good point Vince and just to be clear, in Q1, there really wasn't a year-over-year impact on Canadian. It tends to hit us more in the back half of the year and a little bit as well. You can expect in Q2. So in big numbers, the $50 million rolls through as $20 million, $20 million, $10 million. So that's 2022, 2023 and 2024. So this year you're not going to state any. well, you said there's going to be an increase and it's really a few million dollars and it's subject to sort of what's our ability to really measure the exact delivery dates and the amortization impact of it, but yeah, it's a few million dollars increase this year is the current view of it. I'll bounce back and forth, Doug. One for you on the advertising outlook in your comments, I assume you don't have much availability in Q3 and Q4 yet. So I assume your comment that things are getting a little bit better, it means that your Q2 advertising revenue decline looks better than Q1. Normally you say you don't -- you can't make those kind of predictions because so much comes in last minute. So what's giving you that confidence? Do you actually have confirmed bookings throughout January and February that you'd be confident you will be you'll be down less than 11% this quarter? Yeah. We're feeling better about the trending of the business. We do expect the decline level to be better in this quarter than it was in last quarter and we're comping I want to -- I think December of last year, which I think is helpful. The general comments I make on that is the pandemic -- most of our advertising kind of riptides and cross-currents still looks like primarily pandemic related. So they are disruptions that our advertising category partners were having in their businesses and I cited a few. There's other is like, just pet food shortages and there's many businesses that are having trouble packaging their products. So they can't get labor and that's limiting their inventory availabilities. We did -- we asked our sales team to come back with some anecdotes. So we'd have some color for this call. So we expect those and we're seeing that in terms of the dollars that are coming on the books. We're seeing a general improvement and that's why we're saying sequential improvement in the rate of decline. The risk on the horizon I think is less the sort of adjusting pandemic outlook and it's more the macro outlook recession and that's the concern that we have and so that's why we're still cautious and it's still the visibility is somewhat limited, but we're comfortable declaring that we expect sequential improvements in the rate of decline of television advertising. And I wouldn't ask somebody else to ask about the dividend. I would leave it. The -- go back to John just on the debt covenants, do you mind reminding people given the increase in leverage that you incurred this quarter. What the covenants are on your bonds and your credit facilities? Yeah, the credit facility is the one that I'd say the most restrictive. So the leverage measurement under the bank credit facility is a little different than what we report. It doesn't include an adequate gross debt and there's some adjustments for minority interests. So I've said in the past that if you look at the reported leverage of 3.38, we would be typically for bank management purposes about a quarter to a third of a turn higher than that and the covenant I think is pretty well known as 4.25. So we still got lots of room there and obviously with the way leverage has gone pretty rapidly, we're watching that carefully. Great. And last I will bounce back to Doug and then pass the line. You mentioned -- you talked about streamlining costs, but you also said streamlining the asset base in your prepared remarks. Just wonder if you can flush out what that might mean a bit more and specifically, is there any consideration to think about radio now that we have these new sort of half-way movements in ownership rules to allow three FM stations versus two? Thanks Vince. We're looking effectively at what streamlining means for our business and that's cost and that's assets. It's clear I think to everybody that we made demonstrable strides in our video business with the significant addition of our streaming portfolio in these last number of years. We now have a path to actually increase total audience delivery and provide advertisers premium digital video impressions that they desperately seek. Agencies have been asking us to do this for years and now we're at the table and delivering that. Radio has a good business, is complementary on a local basis. Contributes lots of free cash flow. It connects us to local communities and we've synergized like crazy with television and radio teams. The slight easing of common ownership restrictions is part of the decision. It doesn't really go far enough to address the current reality of the radio marketplace, but as everybody knows my phone number and if we have an inbound to consider any asset that we think can get an good value for, we would consider a conversation. Yes, thank you. Good morning and I will take on the question on the dividend that Vince left off. So you talked about, deferring the decision to -- on the March dividend, but when you look at -- when I look at your dividend yield and I compare to other players in the marketplace, other comps, it stands out and it's quite high. Clearly currently the stock is not reflecting the dividend that you pay and investors are not willing to value the company based on the dividend. So from a cash management perspective and prudency, why not look at potentially reviewing the dividend level here, especially as visibility on advertising revenues is still slow and I have a follow up question on that, please. Maher, its John. I think in a way you've answered your question already. So look, it's always subject to the board's decision and we understand all of those factors that you just cited, but there's not going to be a decision at this point and there's not really much more we can say about it, but yes, we get where the yield is right now and we're obviously looking carefully at our results and our cash flow and our leverage. Okay, that's clear now. So, in terms of the Pluto TV, can you talk a little bit about -- I've looked -- I've been using it, it's quite -- the content is significant on it. I was just wondering how the advertising revenue model is behaving right now in terms of seeing new revenue coming in and are you seeing actually new money being spent on Pluto -- coming on Pluto TV from your advertisers? Or is there a realignment of budgets from other broadcasting operations to Pluto TV just trying to figure out if it's new money coming in or just realignment that is taking place? Good question. I think the answer Maher is a little bit of both. So first off, we're very happy with the early returns on Pluto. It's the number one or number two most downloaded app on the big -- three biggest platforms in the country. That's a great start. I'm sure you've seen the Megaphone advertising campaign that we have had in market. We'll continue to have in a market. which is certainly driving awareness, free is a good word in a tough economic environment and Canadians are rising to the fact that there's a lot of high quality gold library and catalog content there that many folks haven't seen for years and I think it's really quite impressive the uptake. So we are very happy with the early returns and we will endeavor to provide more detail as the quarters roll out, but you'll see -- you'll see that result, I think affect our new platform revenue metric in the coming quarters and that will certainly have a slope change. In terms of where the money's coming from, it was a couple of different answers to your question. We've been asked for better digital video audiences by agencies for years. The only option they had until a couple of years ago was user generated content on Youtube or on Facebook now Meta, Instagram, Pinterest and advertisers flock to that because that was the only game in town because digital provided the targeting and the automation and the benefits of user generated content was not as attractive as the as the automation and targeting. We've kind of flipped the script now. The whole world has woken up in the last 18 months to this notion of free ad supported streaming television or AVOD, generally speaking, and what I believe is happening is within the media mix -- within the digital media mix, you're going to be -- we are seeing dollar shifting out of social media into premium video. So whether or not that's our Pluto product or a Global TV app product or our STACKTV, dynamic ad insertion or it's the new Disney Plus ad layer or the Discovery Plus ad layer, I think there's going to be more of that money coming out of other platforms that are less attractive to advertisers that have higher brand environmental because we can now provide basically long form premium television content on digital platforms. So that's a big -- that's a big note. And the second comment I would make is that I do think that money that might have been earmarked for other parts of the medium mix beyond digital, now there's print, outdoor radio, television etcetera has come -- is coming into Pluto because it's the biggest game in town in fast channels in Canada and will be for the foreseeable future. Great. Thank you for this and my -- just my final question on subscription revenue, your second high -- second biggest revenue stream, it's been holding steady quite well. Can you maybe provide us maybe, just how you see that trending over the next couple of quarters year-on-year on that line please? Yeah. So Maher, I mentioned in my remarks, we did have several renewals in Q2 last year to the genome of about $6 million. So that's going to affect the comp in Q2. So don't be surprised by a slightly negative year-over-year number in Q2, but I think for the rest of the year, I think flat to -- it depends a lot on the conversion of the trial subs we're seeing right now into paying subs on stack, but I think you can assume relatively flat for the back half. Hi, good morning. Something on follow-up to Maher's last question, but I'm wondering on the subscriber line, if you could maybe give us an update on -- if there's been a change in the rate of change of the decline on the linear side because you have seen some sort of modest growth in the last year on the subscriber line and it sounds like at with the digital sort of offsetting the decline, has there been any acceleration in the decline on the linear side? No, Scott it's John. Actually the opposite, I'd say. The digital side has slowed down a little bit as the subs through the back half of last year, the growth has slowed down. So actually, on the linear side, any decline we were seeing has slowed down the last couple of quarters. And is there anything -- do you have any context as to why that might be the case from what you're hearing from any of your partners? I'll take that. I think, subscription fatigue, Scott is one. I think people are -- listen, people have tightened their belts right now. I was just reading an article this week about all the bank CEOs that are now saying that a good portion of Canadians are going to have challenges when they have to renew their mortgages and they're seeing that we have a five-year average mortgage here in Canada and if you're two or three years into your new mortgage you bought your house during the pandemic and now, oh my goodness, I got to pay a lot more in interest and I think people are really realizing that the cable channels package is enormous value. That's why it's been so successful for decades and decades and so I think that's a big part of it that the value offered from the traditional cable linear feed, but also increasing. Now this is important note. There is just as much on demand product on your package there is you're going to get on a streaming service. So if you're in a situation where you're looking to save money and you kind of -- you're paying $14.99 a month, for two or three different subscriptions, the cable package with its value proposition, I think is pretty strong. So that's I think a behavioral reality, in my opinion. Okay, thanks. That's helpful. And then I just wanted to ask on the investment that you're making in sort of the additional rights payment and the marketing there. What's the timeline that you look at to determine whether you've sort of seen the ROI that you're looking for on that because this is like you said, the timing is unfortunate with the declines in the ad market, coupled with the increased investment. So when you -- what kind of timeline do you give yourself to realize whether that investment was worth it? Yeah, I know -- so there's a couple of things on that and that's a good question. Doug, the reality is that many -- over the years I've heard countless times I can't tell you how many times. Jeez, what you guys, you're a giant Jenga stack because one of these days, all the content you get from the US suppliers is going to go on their own platforms and you have nothing to put on your air. Well, that's not -- that's frankly that's not true and I've said time and again that the US studio majors need us as much as we need them. They have a very defined strategy now. Everybody's kind of adopted to the fact that streaming is not a one trick pony. You need to invest in making more hit content. You need to protect your owned and operated linear channels business as a role to overrun that your premium global Walt Disney company Discovery Warner. You need to build your own streaming platform that's differentiated but not too differentiated from your linear offerings and then you need to have a robust content licensing business to guys like Chorus because we pay the bills. And so when we -- and we have as I said, a long standing deep relationship with our key content suppliers and so the way I think about it is, number one, ensuring the long term resiliency of our traditional linear channels business, but also broadening our ability to pursue audiences on digital platforms beyond the traditional linear service. So when I do the math in my head, in one part, it's about resiliency and sustainability of the core business or the traditional business. The other part is about investing their necessary dollars to pursue the growth opportunity and that's whatever slide that is in our deck that shows the total addressable video advertising market in Canada. It's a growing market. We are in a growing market full stop. So for me, the timeline is really dealt sort of specific and is really a partner conversation about what their objectives are. You're likely aware that when we did our big -- for example, when we did our big renewal with Discovery we are their marketing partner on Discovery Plus in Canada and that created value for them and accordingly, we were able to talk a longer term as a result. We don't provide the details on terms and as I say, no specific deal is the same, but the math is on our end, we're very specific and disciplined about ROI calculations and I can say with confidence that those investments in these new digital platforms are definitely accretive and every incremental digital dollars dropped in contribution margin. Good morning. Thanks for taking my questions. I just wanted to go back to sort of your cost reduction initiatives. Maybe you can give us a little bit of color around sort of the magnitude you are looking at. Do you think it would be likely that maybe with the Q2 call, you might be able to sort of put a dollar amount around it at that point. I just wanted some additional color on that. The specific dollar number we can talk to is once we pass the bowling ball, which is the CPE catch up spend that's a $20 million tailwind. Other than that Aravinda, I'm not going to give a target or a number other than then to say that we are always looking at our cost structure and we have an enterprise-wide challenge now to our leaders to find efficient to streamline our business to focus on the important parts of the business and we're confident that we yield substantial results in the quarters ahead. Okay. Thanks and then maybe a little bit around, so the momentum that you expect on the STACKTV front, I know there's sort of the tailwinds and headwinds. Obviously, you are continuing to add content to it, including Disney and you continue to invest in the marketing and promotions. I know you're kind of moving beyond Amazon right now to Rogers and the other distribution platforms. Any kind of indication as to the prospect of a set of an acceleration recognizing to your own comments that there is some -- there's macro headwinds as well. Yeah, thank you. A couple comments, back to Scott's question about partners and this is a good example I will just share use this story as a way to answer your question on the back end. So when we first launched our TV, that was before Disney launched Disney Plus and at the time the direction from the then CEO and now the new CEO and as it turns out, was to restrict all those rights in all foreign markets as they sussed out what they were doing with their Disney Plus direct-to-consumer streaming products. And so Disney chose not to provide us with the ability to launch the Disney channels on Stack. Three or handful of years later, when it was time for us to get back to the table and talk about our overall business relationship and they saw the runaway success of STACKTV low and behold, they wanted Disney to participate because they realized that we're reaching different audiences. We're reaching new Canadians, digital natives, etcetera and that the reaggregation of the channels business on the streaming platform was a pretty smart idea and frankly speaking, Canada first in terms of the globe and so we were able to get Disney added to the STACKTV product as of a couple of months ago. That's going to be, in our opinion, a meaningful value proposition edition and we're early on our big campaign, three chairs for the years out in the market now, but in the last three weeks and just launched, we've seen a notable kind of trend change in subscriber trials. So that's going in the right direction. We also have added a significant amount of new content on the on-demand; whether or not that's a really promising new slate of Peacock deliverables coming this year, including that season two is a big hit Bel-Air with Will Smith or a number of the CBS network shows that we now have modern library stacks with that NCIS, FBI. You can go back to season one and watch them all at least last three or four years I should say modern library not total library that's re-adding to the value proposition and we do believe that the growth within Amazon Prime video will increase. We have had a significant series of massive high top level meetings with the Amazon Brass to talk about how to grow that business in Canada. They're very, very excited about our business partnership and as you know, we're launching in new platforms as well and we'll continue to do that. The other thing that I wanted to make mention of is, in addition to just the subscriber growth, kudos to our advanced advertising team, the dynamic ad insertion revenue uptake on Amazon's STACKTV has been especially noticeable for us. It's been that -- we don't -- I'm not going to give you a number, but it's been a real source of mass of growth in digital and the advertisers uptake is very promising. So that's been a business. It took us a little while to get turned on. We had to -- we had to work with Amazon on their tech roadmap to enable that ability to give DAI to our advertisers, but now that we've launched it, we're seeing great uptake. So there's both the subscription growth, which we expect and there's also the incremental growth on those audiences that watch on demand. More than half of total hours viewed remain on the live stream, which I think is a testament to the resiliency of the channels experience, but now we're able to monetize much more efficiently the on-demand inventory. So that's new inventory, new impressions and thus new revenues. So a couple of comments there are for Stack for you. Thanks a lot. Good morning. I want to go back to the dividend question and just highlight maybe a few things and then probe you a little bit further. If I look out, for example, to let's say F'24, presumably as you were alluding to Doug, things will get a bit easier, if not frankly better. So EBITDA resuscitates your can-con catch up gets halved to the $10 million mark and then of course, given the revenue pressure in TV this year, your can-con burden in '24 goes down. So taking all of that into consideration, I would assume that leverage, gets reduced, gets below three times probably next year, not sure if it gets automatically to your target of 2.5, but certainly much lower than the current level. So notwithstanding the notion that no one knows what landing we might have and the extent, magnitude and duration of any recession, what am I missing here in terms of I know it's a board decision on the dividend, not entirely surprised by the deferred declaration of the March dividend, but nonetheless, is there a missing piece of the puzzle here to get you guys particularly worried? Is there an imperilling somehow of the return to EBITDA and free cash flow profile, because I'm saying all of this and that's even before we see any cost cutting benefits accrue to you guys? A couple of things there and thanks for the question. First of all, there's a little bit of housekeeping here. Our current dividend schedule does create a two-month gap between the declaration of the payment of our dividends and that's something we probably should address, a number of years ago. We didn't. So that's I think an opportunity. And the second thing is and again, as I cited earlier, we believe that we're going to see sequential improvement in advertising at least of the riptides and cross currents that have resulted from the kind of ending God-willing of the pandemic. We're not factoring in any macro recession at this point in time and so I'm interested in seeing this quarter's earnings coming out from the Canadian companies and the banks in particular and so it's really out of abundance of caution at this point in time that we want to track our company's results and also carefully stay attuned to the realities of the Canadian economy. It seems to be holding up relatively well with a great job spent recently, but I've got a number of concerns out there as I mentioned earlier on the housing market and household spending and we are as you've seen in the pandemic-related effect on our advertising revenues, we're the first to feel the pinch. So in the event, there is a recession in Canada, we'll be the first to feel that pinch too. So we're just being out of abundance of caution, we're just taking this opportunity to watch the business carefully and be smart stewards of capital. No, fair enough. Thanks for that, Doug. One more question. Just the context of all the messaging out there in regards to peak content, at least the production out there having sort of probably hit that peak maybe at some point last year, can you talk at all to implications in regards to output from Nelvana and the core studios as well as any context around usual or above average US series cancellations in terms of false schedule moving into eventually winter spreads? Yeah, there's no, there's nothing out of the ordinary now in terms of the US network schedules delivery. So there's nothing there that would cause us concern. The peak content note is the correct one and I alluded to that in my comments, the days of runaway spending, long duration growth stories are not being valued by equity markets anymore this as well as anybody else on the call and everybody's trying to sort out how to make their streaming business as profitable and the fact of the matter is everybody loses the money out there and these are all the big majors, Netflix being the exception. So in our in our instance, as I said, we've been smart about how we've so chosen to participate in the streaming marketplace through a capital light partner-led strategy, which will continue to pursue and I'm sure we'll find other avenues towards that total addressable video audience market in Canada, but at this point in time, our content supply is very, very good luck and for a number of years or the note well into the next regulatory regime, no disruptions insight. So we're feeling good about that. Yeah, thanks very much. Adam just took one of my two questions. So the other one here, I guess, starting with you Doug, on the ad cycle, I think most analysts on this call have been through a bunch of ad cycles here in Canada, but you're closer to this than we are and the color you gave just in terms of anecdotes was extremely helpful. So I appreciate that. When you think of the macro recessionary impacts, I guess the two questions I'd love to get your thought on to the extent you have a view is when you look at these categories going into recession, the baseline going into recessions is obviously arguably very different than what it has been in prior cycles just given what the pandemic has done. Did you think that leads to either better or worse kind of outcomes here in a recession? And then the second one would be, this time around you've got a pretty good kind of digital presence. Your premium inventory is growing there and I think to Maher's question on just some of that migration that you're seeing underneath the hood, getting the digital side of things here holds up relatively better to what we've historically seen on the traditional and linear side? Thank you. Good question. Yeah, that's a -- I'm trying to find a way into your answer and the first question is like, what does a recession look in the midst of the kind of pandemic recovery on a category by category basis. So a couple of thoughts, ultimately, the automotive supply chain issue is going to be resolved and so then I read somewhere that the average age of the NATO is still at record highs in North America and so you expect to see advertising come back from that category and that's an important category. Notwithstanding all of the travel situations over Christmas and lost baggage, etcetera, you would think that the demand would begin to subside to some degree. Maybe it's now there because of those issues and you get more of marketing from airlines and accommodations in travel advisory direct-to-consumer players with which has been pandemic related. If there's a recession, obviously food at home, beverage at home would be a priority over dining out and put away from home and those categories might respond accordingly. So I don't -- I really can't give you a defined answer other than to say, these categories move around a lot and inside the categories and move around a lot and what we try to do is to inoculate the economic realities with providing advertising solutions that are so effective that we get more share of dollars on our platforms and that's I think a key piece of trying to recession proof our business -- will never recession proof it, but in concept, what we're trying to do now is provide a cross-platform solution so that when you buy your common audience segment or your custom audience segment with Cores, you're buying on digital and you're buying on linear. And so you're getting your audience delivery on both platforms and that's the end state for us is to be able to provide a cross-platform audience delivery solution and increasingly, we're getting closer and closer to that both on account of our investments in cinch and common segments and automation and data science and all that sort of stuff, but also because we're rapidly replacing whatever modest declines we're having in television audience is linear -- on the linear side. We're replacing and then that sum on the digital video impression side. So we think of it more of that way Drew is it's really about continuing to provide a very attractive environment for advertisers so that whatever the economic macro backdrop is that we're giving them what they're looking for targeting automation, a premium video environment and results. Great, thank you, operator, and thank you, everybody for your time this morning. Happy New Year once again. As ever, we're available for follow-up conversations and questions if any. In the meantime, drive carefully out there. It's still snowing and have a great weekend. Take care.
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EarningCall_1237
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Ladies and gentlemen, good day, and thank you for standing by. Welcome to TAL Education Group Third Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a Q&A session. Please be informed, today's conference is being recorded. I would now like to hand the conference over to Mr. Jackson Ding, Investor Relations Director. Thank you. Please, go ahead, sir. Thank you, operator. Thank you all for joining us today with TAL Education Group's third quarter fiscal year 2023 earnings conference call. The earnings release was distributed earlier today and you may find a copy on the company's IR website or through the newswires. During this call you will hear from Mr. Alex Peng, President and Chief Financial Officer; and myself Investor Relations Director. Following the prepared remarks Mr. Peng and I will be available to answer your questions. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in public filings with the SEC. For more information about these risks and uncertainties, please refer to our filings with the SEC. Also, our earnings release and this call include discussions of certain non-GAAP financial measures. Please refer to our earnings release which contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures. Thanks, Jackson. I appreciate you all for joining us on today's call, especially as we are approaching the Chinese New Years' holidays. I'd like to really take this opportunity to wish you and your families a very happy Chinese New Year. One of the traditions of Chinese New Year is to recap the past and plan for the future. On this call, I'd also like to share with you our performance in the last quarter, as well as our expectations for the quarters to come. During this fiscal Q3, we continue to enhance our offerings while developing our go-to-market capabilities. We recorded US$232.7 million and RMB 1,658.5 million in net revenues for the quarter. The net revenues decreased by 16% and 21% in RMB and USD terms compared to Q2 respectively. Historically, our fiscal Q2 tend to benefit from seasonality effects in terms of revenue. So if we look at a quarter that's more comparable to Q3, for example, Q1, the net revenues increased 4% in US dollar terms and 14% in RMB terms. We expect to continue our development in the next quarter. In terms of profitability for the fiscal quarter ended on November 30, 2022, we recorded US$4.5 million and US$23.2 million in non-GAAP operating loss and non-GAAP net loss attributable to TAL respectively. You may have noticed that our operating income decreased by $47.6 million quarter-over-quarter. The decrease in operating income was primarily driven by the reduction in revenue due to seasonality, as well as our investment into new initiatives. So with that overview, I'd like to give Jackson the floor to share more color on the operational developments and the financial performance of our core business lines. Afterwards, I will update our business strategy for you and then we'll open the call for questions. Thank you, Alex. I'm pleased to share more details on the progress we made in our three main business lines this quarter. Before we start, please note that the financial data is based on our unaudited results for the quarter. I'll start with our learning services and other business. Learning services and other continues to be our largest revenue stream and is accounted for slightly more than two-third of our total revenues for the quarter. Within learning services, we continue to fine-tune our enrichment learning programs and as a result saw an increase in average retention rate for two consecutive quarters. We believe a healthy retention rate is key to the long-term sustainable growth of our enrichment learning programs. We'll continue to monitor our learner retention and optimize our offerings to drive healthy retention level. In terms of learner enrollment, we recorded a quarter-over-quarter decrease in average learner enrollment from Q2 primarily due to seasonal fluctuation. However, if we compare the enrollment of Q3 to that of Q1, we recorded growth in learning enrollment between these two periods. Further some recently rolled out enrichment programs such as rhetorics and international chess demonstrated initial customer reception in this past quarter. Like I mentioned in our prior conversations, our enrichment programs are designed to facilitate learners all around development. This is a concept that requires some time for the market to digest and accept. Aside from operating metrics, we're also closely monitoring customer feedback on our enrichment programs. We're encouraged about our customers' feedback and appreciate their trust and support. We'll continue to fine-tune our enrichment offerings to deliver value to our customers. In this past quarter, we also witnessed recovery in our offline learning centers. In fact, revenue generated from offline enrichment programs increased in Q3 when compared with Q2. Despite that typically and historically Q3 has been a down quarter from Q2. We increased our offline learning centers by single-digit in this past quarter. This is the second consecutive quarter where the number of our learning centers grew slightly. In this [indiscernible] age where OMO learning experience continues to proliferate, we see online and offline presence both as important components in our learning services business. Our online presence reaches customers despite their geographic locations, while our offline presence provides us the opportunity to interact with our customers face-to-face. We continue to optimize our learning center network and will gradually and cautiously increase the number of our learning centers in the next few quarters to come. While our domestic learning services business continues on its development path Think Academy, our overseas learning services business maintains its momentum with online operations covering a global market and offsite operations in countries such as US and Singapore. Think Academy again booked a year-over-year triple-digit growth in this quarter. We see significant market potential for Think Academy and will continue to drive the growth of this business. Moving on to our content solutions business, which accounted for roughly 20% of total net revenue compared to slightly more than 15% a quarter ago. Revenue from content solutions grew quarter-over-quarter driven by growth from multiple product lines. I talked about small books in the last couple of quarters, the products where we embed videos into print books to supplement learning experience of all users. In this quarter, we're glad to see that a significant portion of the users who purchased and activated the online features of the smart books are learners who historically never enrolled in our learning program to the best of our knowledge. We see this as a positive sign in that our content products are reaching new customers and increasing our total addressable market. Within content solutions, we also made progress on the exploration of smart learning devices. We tend to think of smart learning devices as comprehensive content solutions that combine our exclusive learning content and personalized learning experience supported by AI technology. We'll continue to enrich our products based on our insights into users' learning habits and their learning demand. In addition to product development, we also continue to build our go-to-market capabilities for our content solutions business. In an industry where offline distribution channel typically constitutes a large portion of the total volume, the majority of our content solutions are sold through online channels, such as e-commerce and live streaming. We're embracing these new distribution channels and we'll continue to build our capabilities within these channels. Finally, let's look at our learning technology solutions business. Total revenue for our learning technology solutions business accounted for more than 10% of our total net revenues in Q3. In this past quarter, we updated our products and further developed our selling and marketing efforts. For learning technology solutions, we sell to both private and public sectors. I talked about the private sector before and will shed more light on our effort in the public sector today. In this past quarter, we released a new sub-brand called Meixiao Smart Education, which targets the market for schools. Our solution for schools primarily includes smart homework, smart lesson preparation, integrated teaching platform and small after-school care. This business is still in its early stage and we'll provide more details as the business matures. After updating the above business progress now let me take you through the key financial results for the quarter. Our net revenues totaled US$272.7 million, representing a 77.2% decrease from US$1.02 billion in the same period last year. The decline in revenue was a result of the succession of our K through ninth Academic Services in the mainland of China. Cost of revenue decreased by 80.2% to US$103 million from US$519.5 million in the third quarter of fiscal year 2022. Non-GAAP cost of revenues, which excluded share-based compensation decreased by 80.9% to US$99.4 million, from US$519.2 million in the third quarter of fiscal year 2022. Gross profit declined by 74.1% to US$129.7 million, from US$501.4 million in the same period last year, while our gross margin increased from 49.1% to 55.8%. Selling and marketing expenses decreased by 74.3% to $70.4 million from $273.6 million in the same period last year. Non-GAAP selling and marketing expenses which excluded share-based compensations decreased by 75.3% year-over-year to $63.8 million from $208 million -- $258.6 million in the same period last year. The year-over-year decrease was primarily the result of a reduced number of selling and marketing activities. General and administrative expenses decreased by 69.0% from $93.0 million -- from $300 million in the third quarter of last fiscal year. Non-GAAP general and administrative expenses which excluded share-based compensations decreased year-over-year by 72.7% to $74.8 million from $274.4 million in the same period last year. Loss from operations was $32.9 million compared to loss from operations of $108.4 million in the third quarter of fiscal year 2022. Non-GAAP loss from operations which excluded share-based compensations was $4.5 million compared to non-GAAP loss of operations of $67.6 million in the same period last year. Net loss attributable to TAL was $51.6 million in this quarter compared with net loss attributable to TAL of $99.4 million in the same period last year. Non-GAAP net income attributable to TAL which excluded -- excuse me. Great. So, I think I got cut off when I said non-GAAP net loss attributable to TAL which excluded share-based compensations -- was $23.2 million compared with non-GAAP net loss attributable to TAL of $58.6 million in the same period of last year. Turning to the balance sheet. As of November 30th, 2022, the company had $1.86 billion in cash and cash equivalents, $1.18 billion of short-term investments, and $447.4 million in current and non-current restricted cash. The company's deferred revenue balance was $270.8 million by the end of the third quarter. Now, I'll hand the call back to Mr. Alex Peng to briefly update you on our business strategy outlook. Alex please go ahead. Thanks Jackson. I think Jackson has just given everybody a pretty detailed picture and lots of numbers. So, what I'll try is to maybe take a step back and paint the big picture. As we continue to transform our business into a smart learning solutions provider, we remain committed to executing our company's long-term growth strategies with each of our four business blocks. Although the revenue of this quarter was affected by exchange rate fluctuation and seasonality, our new business has maintained the momentum of continuous development. We expect our main businesses to continue to develop in the next few quarters. The first, our learning services and other business. We will continue to strengthen the quality of the products and services, while also gradually roll out more programs and increase our physical footprint. We are a believer of the enrichment learning and all-around development. As the market for enrichment learning evolves, we plan to leverage our â in learning in our operational knowhow to further serve our customers. For our content solutions business, we're really encouraged by the progress, but we also do understand that we have a long way to go, before we become competitive in this relatively new market lots. We intend to increase our TAM through serving our customers with quality content in various form factors. In the next few quarters, we'll roll out new product SKUs, while investing in our go-to-market capabilities, especially in our OMO channels. Turning to learning technology solutions. We are committed to enhancing our services for clients in both private and public sectors, with quality content innovative devices, and advanced technologies. Our goal is to work with our clients to deliver a better learning experience to end customers. About the outlook for Q4 we expect our development to continue in the fourth quarter. We do not expect to break even in the next quarter as we continue to invest in certain new initiatives. We believe the transformation into a smart learning solutions provider is a long journey and are currently focused on creating value for our customers through our offerings. And as I come to the end of my remarks, I'd like just to say, we're just a few days away from Chinese New Year. And there's another name for Chinese New Year, which is Spring Festival. Spring is the season of renewal and growth. I think on the previous call with you all, I reflected on the fact that we changed our mission statements, and how critical it is for us to adopt a growth mindset going forward. So as we head into the spring season, it is with that growth mindset that we'll embrace the future. Thank you. [Operator Instructions] Our first question comes from the line of Lucy Yu from Bank of America. Please go ahead. Your line is open. Thank you. Thank you, Alex. Thank you, Jackson for sharing the results details. I have a question on margins. So, can you shed a bit more color on the margins for this quarter, and also expectation of the main business operating margins going forward? Thank you. Lucy, thanks for the question. This is Jackson. I'll take this one. Before I spend more about the numbers, I would just say, as we transform our business and how we think about profitability, we probably focus more on creating more value for customers and have structurally healthy business model as opposed to focusing on near-term operating profitability as well. But let me break this down for you a bit. When I look at the three main business lines, for learning services and other, in this past quarter, we had a positive operating margin. For learning technology solutions, we are also operating profit and had double-digit operating margin. For content solutions, if we look at the more mature SKUs, they're profitable on a contribution margin basis. But some of the newer SKUs are still in investment phase. You also asked about margin outlook in the future. I would say, as we look in the long run, when we think about learning services and other, we tend to think operating margin will have some fairly small room for margin improvement as the business goes up and the improvement will be quite gradual. And for content solutions, we'll carefully manage our operating profitability, as we manage the balance between mature and new SKUs. Lucy, I hope that answers your question. Thank you. We will take our next question. Our next question comes from the line of Liping Zhao from CICC. Please go ahead. Your line is open. Good evening, Alex and Jackson. Thanks for taking my question. Iterating to your introduction report, the content solutions business is still in the investment period. Can you share the main direction of investments? And could you also share your thoughts about, how the company becomes an industry in here, sir? Thank you. Thanks, Liping. Let me unpack that question. So, in terms of the direction for investment, it will probably be in a few areas. The first one, we mentioned I think on a couple of previous calls, our aim is really to build world-class content. Much of it is going to be built in-house. And we're going to also increase our cooperation with our partners to bring those content into market. So, as I think about that more topics -- more topic areas for print and smart books and continue to enhance the digital features of those contents, more core factors for hardware, those are all going to be the investment areas on the content side. Secondly, I think we're going to continue to enhance our channel capabilities. I think, we talked about this just now, that much of our content products are sold on online channels. These channels are developing rapidly and should be able to build a competitive channel presence. We need to continue to invest into our capabilities and we're also going to be into â invest into an omnichannel approach so that our customers will have a seamless experience across all these touch points. Lastly, I'm also going to mention infrastructure, especially on the supply chain side. As we go into these various form factors, we obviously are getting deeper into various kind of supply chain for physical movement [ph] and these are all deep expertise areas for us to build up our experience and capabilities, wanting to continue to enhance our product, quality and experience and also to ensure we have a competitive cost structure. So I think if you look at the investment, that's what we are going to be looking at the three main areas. In terms of the strategy in introduction â I think I mentioned this on a few calls over the past quarters, I think we are continuing to â led to building that world-class content. We continue to infuse more technology such as an AI into our product. And we also ensure there's an integrated experience for our customers across all these form factors. So Liping I hope that answers your question. Thank you. We will take our next question. Our next question comes from the line of Felix Liu from UBS. Please go ahead. Your line is open. Good evening. Thank you, Alex. Thank you, Jackson for taking my question. My question is on the COVID outbreak that happened in China recently. How does that impact our business in the February quarter? And given offline activities have largely resumed in many cities in China now, how should we think about the online and offline strategy from here? And would you expect a reacceleration of our offline expansion? Thank you. Felix, thanks for the question. Regarding the first part of your question, the impact of the epidemic, I would say historically we carefully manage that impact through offering an online option to students who enrolled in our offline classes, when the epidemic caused inconvenience. In the last â and looking forward and obviously, as the impact of COVID starts to diminish in China, we'll offer a balance and hybrid online and offline learning experience to our learners. We do see both online and offline offerings as important components in the learning experience we provide to our learners and they each have their own merit. The second part of the question asked a bit about offline expansion plan and future outlook. I would just say with regard to our offline learning centers, for the last two consecutive quarters we increased the number of our learning centers by both single-digit increase in the last two quarters and we currently have somewhere between a 100 and 200 learning centers. In the next few quarters to come, we'll continue to slowly but gradually increase the number of our learning centers. Felix, I hope that answers your question. Thank you. We will take our next question. Our next question comes from the line of DS Kim from JPMorgan. Please go ahead. Your line is open. Hi, Alex. Hi, Jackson. Happy New Year. I was actually going to ask about profitability but both of you have already provided a great insight, so thanks for that. May I then follow-up with quick housekeeping questions, perhaps three if I may ask. First one is, what was this $32 million other expenses this quarter in the below OP line? Just curious any details there? And can you remind us on the nature of the restricted cash on our balance sheet, which was quite sizable, I think at a $450 million total including non-current? I remember this was somewhat related to some financial products, wealth management products and whatnot but just wanted some clarification or elaboration would be really appreciated. Thank you very much. Got it. Yes, this is Jackson. Thanks for the question. I heard -- the second part of the question is loud and clear with regard to restricted cash. And just to confirm that the first part of your question was related to other -- that $32 million of other expense? Got it. Yes. So that $32 million of other expense obviously is not related to any operating activities and that is a combination of multiple factors including: one, exchange rate fluctuation and two, some of the equities we hold and booked according to fair value. And the second part of your question with regard to restricted cash, again, it's a combination of multiple factors including: one, some of the payment we collect from learning from for our learning programs are restricted; and two, some of the wealth management product depending on the nature of the underlying instruments are restricted as well. Thank you so much for the clarification. Yes. Thank you sir, and congrats on the decent and strong restructuring and a greater performance. Thank you again. Great. Again, thank you everybody for joining us today. A Happy Chinese New Year and we'll see you next quarter. Bye-bye.
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EarningCall_1238
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Good day, everyone, and welcome to Eagle Materials Third Quarter of Fiscal 2023 Earnings Conference Call. This call is being recorded. [Operator Instructions]. At this time, I would like to turn the call over to Eagle's President and Chief Executive Officer, Mr. Michael Haack. Mr. Haack, please go ahead sir. Thank you, Drew. Good morning. Welcome to Eagle Materials conference call for our third quarter for fiscal 2023. This is Michael Haack. Joining me today are Craig Kesler, our Chief Financial Officer; and Bob Stewart, Executive Vice President of Strategy, Corporate Development, and Communications. We are glad you could be with us today. There will be a slide presentation made in connection with this call. To access it, please go to eaglematerials.com and click on the link to the webcast. While you're accessing the slides, please note that the first slide covers our cautionary disclosure regarding forward-looking statements made during this call. These statements are subject to risks and uncertainties that could cause the results to differ from those discussed during the call. For further information, please refer to this disclosure, which is also included at the end of our press release. I want to start my comments today by stating that this was a tremendous quarter for Eagle Materials financially, operationally, and strategically. Financially, we achieved record revenues, up 10% year-on-year, exceptional margins of 31%, EPS growth up 26%, which reflects the strength of our businesses and our continued pricing opportunities in every segment. This EPS growth also reflects our exceptional cash flows in excess of our operating growth and improvement needs. This enabled us to repurchase over $100 million in company shares this quarter, bringing our total cash return to shareholders over the last three years to nearly $1 billion. Operationally, we achieved the best safety performance in company history in terms of both recordable injury rate and lost time injury rate. This achievement is one that I'm most proud of, as the result stems from years of focus from every employee at Eagle to ensure that we have a culture of protecting each other and caring for our fellow employees. We have consistently been well below industry averages on this metric, but this year we truly separated ourselves from our peers. I am proud of the Eagle team, the progress we have made, and want to personally thank everyone for their focus to achieve this result. We are also making progress across the board on our company's strategic priorities. One I would highlight today, that I have also talked about in the past is an important environmental and operational priority for us, our rollout of Portland Limestone Cement or PLC. This priority enables us to make our scarce clinker go further in cement production and it reduces our carbon intensity. Adaption and adoption are not immediate because there are operational investments and State DoT approval is needed. Two quarters ago, I shared that almost 15% of our cement sales were PLC. I'm happy to state that approximately 30% of our construction-grade cement sold this quarter was PLC. This progress has given us confidence that we can make a full conversion to PLC for all construction grades by 2025. Very shortly, we'll be more formally updating our progress, goals, and long-term aspirations on this and other matters in our forthcoming updated environmental and social disclosure report. Now let me turn to the coming year. I enter the year very optimistic about the prospects for Eagle Materials, notwithstanding some of the obvious uncertainties about the calendar 2023 macro backdrop. Current business conditions are exceptional and provide a foundation for this year. I can say that our record results this quarter would have been even better if we did not see exceptionally wet weather, particularly in December across the entire heartland network. As a reminder, wet weather does not imply demand destruction, it just means interruption and delay. Notwithstanding these temporary conditions, cement demand is strong, leaving us in a relatively sold out position with virtually no opportunity to build an inventory position. On the light side of the business, our Wallboard operations remain busy. Current home construction activity remains robust. The number of multifamily units under construction, for example, is at the highest level since 1973. Of course, the key question today on many of our minds is around what the uncertainty and housing activity ahead will mean. Let me offer the following perspectives on these uncertainties. First, as I have stated before, geography matters. Our enviable U.S. heartland system that we have built will serve us well in the coming years. Specifically, for cement, it is hard to see a scenario where U.S. cement demand would decline for us over the midterm. This stems from the fact that State and Federal allocations to fund infrastructure are well underway and give better visibility into the next three-year demand picture. There are a few cement substitutes existing today or on the horizon that would fundamentally change this picture over this time frame. U.S. cement manufacturers will work to make their precious clinker go further and to be put to the highest and best use. These efforts will not add up to enough additional supply to alter the supply-demand fundamentals in front of us in the midterm. At the U.S. cement supply, I see very little that would materially change the supply tension in relation to demand for the U.S. heartland. Barriers to capacity addition are very high for the U.S. cement industry, both in terms of permitting and construction cost. Even if this were not the case, no new builds or plant expansions could change this picture over the midterm time frame, even if the project did not commenced tomorrow. High cost imports will increasingly be required to meet U.S. demand as they have in the past. Again, for a well-positioned heartland producer, imports to one degree or another will support pricing in the U.S. heartland as transportation is very expensive and is expected to remain so. Now let's turn the discussion to the uncertainties for the other half of our business, specifically Gypsum Wallboard. Gypsum Wallboard is used in single and multifamily residential construction, repair and remodeling, and commercial construction. But most significant among these is residential construction. Mortgage rates are key in modulating demand. It is welcome to see that we are off the mortgage rate highs that we saw last quarter. I think Fed Chairman, Powell, may have expressed the uncertainty right now the best when he said and I quote, "I don't think anyone knows whether we're going to have a recession or not. And if we do, whether it's going to be deep one or not." Many economic scenarios imply a sizable and sustained gap between supply and demand for housing over the midterm, mainly driven by household growth and demolition of older housing stock. The outlook for repair and remodel demand seems especially well supported with record homeowner equity by the average age of the U.S. housing stock and by the number of single-family homes entering their prime remodeling years. With higher interest rates, homeowners may be inclined to stay put and improve their homes. The bottom line for light side demand is that there is cause for optimism for the midterm and the long-term as it relates to housing construction activity. It is the near-term where we see some obvious uncertainty around home buyer demand and homebuilder activity. If we turn to the Gypsum Wallboard supply side, we see limits to manufacturing supply response broadly in the industry due to raw material supply limitations. As we have emphasized before, we are insulated from the negative implications of this broad and important trend, we are, in fact, beneficiaries of it. As we own many decades of natural gypsum and our one plant that uses synthetic gypsum has a secure and very long-term supply agreement. There is another aspect of the industry supply situation that is important to understand and history is instructive here. In 1998 through 2000 and in 2005 through 2006 time frames, we saw increasing pricing for Gypsum Wallboard. In both cases, shortly thereafter, we saw significant price deflation. In 2021 through 2022, we have again seen pricing progress and it raises the question among the servers about what is ahead for Wallboard pricing at this time. In those prior periods, increasing demand was also met with significant industry capacity expansion, which culminated gypsum as the market demand began raining. In the case of post 2005 and 2006, we in fact entered the longest and deepest housing construction recession in U.S. history as massive capacity was being added to take advantage of synthetic gypsum, which was believed at the time would be plentiful and cheap. This assumption about synthetic gypsum proved to be wrong for several reasons. One reason is the retirement of coal-fired power plant, which is continuing. And the other reason is the greater use among power plants of lower-cost natural gas, which does not need to be scrubbed, hence, does not produce synthetic gypsum. In recent years, we have not seen material capacity expansion. In fact, we have observed significant capacity constraints, stemming from the ability to secure enough raw materials economically for a new plant or to expand the production of existing plants. This is a key factor shaping the outlook that I think is unappreciated today. I should also add that for our Wallboard businesses, we will benefit from some tailwinds we have not seen for a while. Notably, in the lower cost of natural gas and OCC inputs, both of which should provide some margin support. Regardless of what 2023 brings, I have confidence that Eagle Materials is positioned well to succeed. I believe this for the following reasons. First, we know how to navigate uncertainty. We have proved this by being one of the very few in our space that has navigated the longest and deepest construction recession in U.S. history and remain profitable every year. This is largely attributable to our low-cost producer positions which are highly sustainable and from a competitive standpoint are arguably widening. Our pretax margins are in the vicinity of 25% for the enterprise and the gap with the competition is widening. Second, our businesses are strong cash flow generators. Our strategic decision-making is heavily focused on making the best use of this cash. The third reason for my confidence, we are good capital allocators. We are highly committed to growth believing growth in the core that meets our strategic and financial return criteria. We have tripled the size of the heavy side of our business in recent years and as I commented earlier, returned nearly $1 billion to shareholders through share repurchases and dividends over the last three years. Our return on equity stands in the vicinity of 30% today and remains industry-leading. With that, let me turn it over to Craig for a financial review of our quarter. Great. Thank you, Michael. Third quarter revenue was a record $511 million, an increase of 10% from the prior year. Excluding the acquired business in Northern Colorado, revenue was up 8%. The increase reflects higher cement and Wallboard sales prices as well as increased Wallboard sales volume. The strong fundamentals in both Cement and Wallboard contributed to record EPS during the quarter. Diluted earnings per share was $3.20, a 26% increase from the prior year. This increase also reflects our reduced share count resulting from our share repurchase program. Fully diluted shares were down 10% from the prior year and down nearly 30% from the peak in 2015. Turning now to segment performance. In our heavy materials sector, which includes our Cement and Concrete and Aggregates segments, revenue increased 3%, reflecting higher cement sales prices and revenue from the acquired business in Northern Colorado, partially offset by lower cement sales volume resulting from difficult weather conditions and much lower inventory levels during this quarter. Cement prices increased 13% and sales volume were also down 13%. Operating earnings declined 11%, reflecting lower sales volume and higher costs, partially offset by higher cement prices. Moving to the Light Materials sector on the next slide, revenue in our Light Materials sector increased 23%, driven by higher Wallboard sales prices and sales volume. Operating earnings in the sector increased 51% to $95 million as higher net sales prices helped to offset higher input prices. Looking now at our cash flow, which remains strong and as Michael highlighted in his remarks, we continue to generate very strong cash flow and allocate capital in a disciplined way. During the quarter, operating cash flow improved 7% to $180 million and capital spending decreased from $28 million to $18 million. We also repurchased approximately 824,000 shares of our common stock for $103 million and paid our quarterly dividend, returning a total of $113 million to shareholders during the quarter. Year-to-date, we have repurchased approximately 2.5 million shares or 6.5% of our outstanding. We currently have 8.3 million shares remaining under our current repurchase authorization. Finally, a look at our capital structure. At December 31, 2022, our net debt-to-cap ratio was 47% and our net debt-to-EBITDA leverage ratio remains at 1.4 times. We ended the quarter with $61 million of cash on hand. Total committed liquidity at the end of the quarter was approximately $675 million, and we have no meaningful near-term debt maturities, providing us with substantial financial flexibility. Thank you for attending today's call. Drew, we'll now move to the question-and-answer session. Hey, good morning and nice work in the quarter, especially given these weather headwinds. And on that, first on -- for Cement, I guess, the volume there in the quarter, weather was obviously an issue, and I think it was pretty well expected. But Craig, you mentioned lower inventory as well. Can you help us understand maybe the -- how much that really impact and how much impacted the quarter, how much was weather, and then will these lean inventory levels continue to impact your year-over-year volume going forward or with the lower volume in the quarter, were you able to build some inventory and maybe help mitigate the impact there as we move into the spring? Yes, good question, Trey. Yes, in terms of this quarter, I think it's a pretty unique comparison, both in terms of weather patterns and inventory levels of where we were a year ago versus this year. If you recall, last winter really was late to start and allowed us to really sell through the entire month of December. And then this year, the weather pattern is a little different in December. And we just didn't have near the inventory levels. So I think just a unique comparison year-over-year for this quarter. I think we get back more into our typical cadence where volume growth is tough to come by as we are and remain sold out, but I don't think you'll continue to see this type of variance in the sales volume as the inventory issue is kind of just a one quarter thing. Got it. Okay. That's super helpful. Thank you for that. And then kind of still sticking with Cement. So you guys have January price increases that have been in place now here in your Cement market, I guess, for a few weeks now. Is there any early read on maybe even directionally on how those increases are going thus far? Yes. Trey, this is Michael. When you look at the supply-demand dynamics, we have implemented double-digit price increases across our network. We're still working through with some customers, but with the supply-demand dynamics, that's what we're expecting. Hey, thanks. Good morning. Great quarter as well. Hey Craig, the earnings contribution from the joint venture was pretty strong, I guess, really snapped back despite the headwind on volume. Is there anything in particular to point to there? Yes. I think, look, as we said in the last couple of quarters, we had some operational issues there that we believe we had turned the quarter on. And when these businesses and the operations start to become more consistent, you see a turnaround pretty quick in terms of profitability. So that the operation has seemed to make that term. Okay, great. And then I guess, back to Trey's question, realizing the supply/demand dynamics, I'm just curious, I mean is this harsher winter sort of impede your ability to realize these sort of new year price increases in Cement in the short-term, I mean, how do you think about that? No. When we look at it, we went into the winter time frame and the fall time frame at very low inventory levels. And so the weather really, as I said in my comments, just really delays the use of that product with it. So we don't see any impact going forward for that winter weather issue with it. Supply and demand fundamentals will drive the business. Okay. And then just one on Wallboard. Michael, I appreciate your -- sort of your comments around advantaged cost structure, those sorts of things, all very valid. Have you seen any disruption either lean of competing assets within your footprint, those that just can't be as cost competitive in this environment, just wondering if you've seen any sort of changes in competitive dynamics around your markets you play in, in the Wallboard business? No, when you look at how Eagle is structured, we're not dependent on any third parties for our raw material supply. We're located in the Sun Belt regions. I love where we're located. I love how we control our own cost structure with it. We don't have any plant that is disadvantaged in any way to compete in these markets. Good morning. On Cement, it sounds like the demand outlook is pretty positive despite past issues. And I'm just wondering, understanding you don't always know your cement is going. Are you starting to see IIJA spending flow through and volumes? And are you seeing that maybe replace weaker residential activity or just wondering sort of the end markets and that infrastructure impact? Yes, Anthony, good question. Look, the infrastructure spending is supported in a couple of different ways. There's no doubt state spending has taken the bulk of the financing effort over the last several years, and that has continued to remain very robust in our markets. To your point, you have federal spending that is on top of that going forward. It's hard to parse out exactly what's funding an individual project sometimes. But anecdotally, you are starting to hear that those monies are starting to impact planning and individual projects. So that side of the business continues to do very, very well. I'll point out, we also continue to see recovery and strength in the private nonresidential construction activity, especially in our markets around some of these very, very large projects that are just starting to get underway. Okay, that's very helpful. And then just a quick one on the Wallboard Paperboard side. I mean, the decline in OCC late last year was pretty dramatic, and I'm just wondering what you thought maybe drove that and the sustainability of that? And if you can just kind of remind us maybe the margin benefit that you could accrue from there and what the sort of lag is there? Yes. So as you saw this quarter, the lag is pretty quick within the paper business itself. So that contributed to a large majority of the improvement and the profitability in the paper business. It then does take a quarter or two lag into the Wallboard business. But what has been a headwind in what I'm going to say, calendar 2022, fiscal 2023, has certainly turned around from OCC prices as we look forward into calendar 2023 and our fiscal 2024. A lot of international reasons why OCC prices go up and down relates to generation and overseas purchases. But the spike that we saw a year ago, probably wasn't sustainable, and these are a little bit more normal levels. I'm wondering if you could just talk about Cement margins when your footprint was smaller. Some 20 years ago, you folks were able to get that business up to 30% margins. And I'm wondering what the price increases that you have in place now, do you think you could approach that level of margin in this cycle? Yes, Jerry. Look, I would say the acquisitions that we've made over the last decade or so and the improvements that we've continued to make in the network, whether that's from a distribution perspective or just operating efficiencies, I think we actually have a lower cost system today than where we were in prior cycles, in many different ways, again, logistically and operationally. And at the end of the day, that's what we can focus on, and that's how we can improve margins. And Craig, maybe just to cap in the pencil a little bit there. You spoke about the pricing actions you've taken, can you talk about just the level of inflation that you're expecting in Cement, just to put into context for us the level of margin expansion that's feasible in calendar 2023? Yes. As we've been saying in the last couple of quarters, we do continue to see some inflation pressures still around cement energy prices and Cement that's generally solid fuels and electricity. So we expect that to continue into fiscal 2024. Now the pricing that we have in place should more than offset that like we have done here in fiscal 2023. But I think we'll continue to see some inflation around energy and cement. Okay, super. And then around the volume cadence, to your point on whether your volumes were maybe five points lower sequentially than normal seasonality. As we look at the current run rate and running that through with normal seasonality in March and June, it does look like the business still has shipments that are down in the high single-digit range year-over-year. And I just want to make sure there aren't any inventory moving pieces, etcetera that might skew where that cadence is shaking out just based on normal seasonality off of the past six months of performance? Jerry, with one exception there, we've talked a lot about this Portland Cement product that we've begun producing and selling out of our facilities. I think you'll continue to see that ramp up over this coming year, which should give us some incremental volume out of facilities. So you're right, generally, the growth in sales volumes will be tough to come by, given that we're continuing to be in sold-out conditions, but we do have one lever to pull around PLC that might be able to offset some of that. Hey good morning everybody. Thank you guys for the question. This past year, a lot of cement markets were on allocation. I mean, do you guys think we're going to see a similar sort of dynamic in calendar 2023, and I know you mentioned being sold out but just curious kind of what you're seeing high level there? Yes, it's a great question and how the supply and demand is currently right now, I think we're going to be going into this next year, very similar to last year, where we will be -- our key is to keep our plants running and get as much out of each plant as we can because the demand is there. So there will probably be some allocations later in the year as long as this demand profile maintains, which we think is going to maintain this year. And could you talk a little bit about what's happening or what you're seeing in the M&A marketplace right now and maybe kind of the bias of pursuing some -- an acquisition versus buying back your shares here at these levels? Yes. So we look at everything as we say. We are also very disciplined in what we will buy, how it fits into our network. You could see during the past quarters where we have done transactions, where we've extended our distribution footprint, it's -- right now, we would look at anything that comes to the market. It's just when businesses are in sold-out positions, there's not as much on the market. So you can see where we pivoted to the logistics side, like I said, with the Nashville acquisition. We bought aggregates positions in the Denver market. Those are things we look at continuously, and we will continue to look at anything that comes to the market that makes sense for Eagle. It just has to meet our strategic criteria. Hey, good morning guys. Hey Craig, I wanted to follow up on something, I think you said it about non-res and particularly like large projects, large non-res projects. Are you seeing that in specific regions or are you seeing that everywhere? Yes, pretty broad-based, Adam. Whether it's the semiconductor facilities, the battery facilities, it's those types of very large on-shoring of manufacturing that we've seen in our markets. And again, pretty broad-based. Okay. And then Michael, you made some comments about the lack of new capacity entering the Wallboard market going into this a little bit of a soft patch. Are you -- what's the implication of that, do you actually see pricing even if volumes decline a little bit do you see pricing kind of staying flattish? When you look at everything, it's all on the supply and demand criteria with it. And when you -- one of the inputs into that is how much board is going into the market. So I know there's been debates both with analysts and us when we look at different markets on what the capacity of the Wallboard industry is today with it. And we just don't see -- in previous years, we've seen or previous cycles, I should say, not years, we have seen where there's been capacity expansion added, and we are not seeing that capacity expansion added. We also have a Wallboard industry that's much different today than it was in the past with a lot of consolidation that happened since the last cycle with it. So I do see a different animal this time than in previous cycles. And then lastly, your Wallboard cost per unit went down a little bit sequentially in Q3. Do you think that trend can continue with gas prices coming down? Yes, very driven [ph], Adam. Yes. On a sequential basis, we did see energy prices come down, and that was a good sign. Natural gas has certainly been under pressure here over the last couple of months and more importantly here in the last few weeks. So -- and look, I'll also tell you at a freight level, we saw freight tick down just slightly. That doesn't happen very often. So yes, we saw again some of those would have been headwinds this year starting to turn around. Hey guys. Well, Michael, it's great to hear that in the medium term, you don't expect volumes to be down in Cement. Any color on how to think about Wallboard in the near term, call it, calendar year 2023, just given the tougher housing backdrop? At least what we're hearing is maybe backlogs will carry the industry through the early parts of the calendar year. But any color here on how you're thinking about the shape of the year in terms of Wallboard demand? Yes, Phil, it's a great question. When I look at it in my comments, I'll point to some things in the comment is we're monitoring the near term very closely. As said, we have a great foundation going into this year with it. Demand has been consistently strong with it. However, we do monitor as you guys do, housing starts, everything else with it. Our concern more is around the near term than the midterm or the long term. But right now, demand is strong, and we're going to be positioning the company that if that does change, we could react quickly to that. But right now, we are producing what we can produce for the near-term demand, and then we'll see where the market takes us. And on that note, Michael, you guys have some of the lowest cost Wallboard facilities out there. If you guys had a pivot on the cost side, what are some of the things you can do just given your low cost profile already? Yes. So how we run all of our facilities, we monitor each of the facilities. We know which ones -- which market it is with it. We've been very flexible. With Wallboard it's not a very cost-intensive input business. We've been able to modulate with the demand just by ship structures and everything to be able to satisfy that and not add significant cost to the operation with it. So we watch that closely for each of the markets, each of our plants serve and then we modulate as needed. But right now, where I won't leave you is demand has been strong. So we're prepared for those if those happen, but we haven't implemented those. Got you. And just one last quick one for me. So Craig, on the energy front, help us think through the step-up, I guess, for calendar 2023. Because you're hedged a bit on that gas and then solid fuel prices, I think, for Cement. I think the - you have the ability to kind of hold on to prices for a full year, but I think it starts resetting fairly soon. So just give us a little color on how you're set up currently? Yes. So for fiscal 2024 on the cement side for solid fuels, most of our prices are effectively locked in for the year, albeit at higher prices than where we were this past year. And we have a good hedge position within -- for natural gas, again, which is more within the paper and Wallboard segments. And -- but we're not overly hedged. So we are enjoying some of these lower prices and expect to continue to enjoy them at these lower levels. Hey, a couple of questions on the Wallboard side, but I got to go back to the Wallboard margins. Can you just help us maybe parse a little more specifically the impact of OCC on that 400 basis points, maybe what percentage of your costs are paper and wallboard and given that OCC prices remain pretty low, and I know there's a lag, could we see even more help as we kind of move into fiscal Q4? Yes. So in terms of the lower OCC prices, they really didn't have much of an impact on the Wallboard business. As I said, it manifests itself first within the paper business as they're purchasing on a daily basis. The shift to the pricing to the ultimate Wallboard business happens over a one to two quarter lag. So that margin improvement that we saw this quarter didn't really have much to do with OCC. That is still yet to come for the Wallboard business. Okay. That's super helpful. And I don't want to be super near-term focused, and I think there's some questions out there that I want to talk about Wallboard volume. But just any color on how January is tracking, I mean are volumes still positive, it just seems like if you use normal seasonality, Wallboard volumes could be down year-over-year in Q4, just any color there? Yes. Look, I think as we said, I think Michael's comments are orders and shipments have remained steady during the quarter and even here into a little bit of early January. So as Michael has been saying, we haven't seen any change in that. Okay. And just my last one here, just a big picture question. It kind of comes again back to this idea around Wallboard margins more in the intermediate term. But doesn't the outlook look pretty good there, I mean, one, you've still got the OCC benefit kind of on the come, they're saying what looks to be kind of lower for longer. Two, freight rates have peaked in the near term. In my view, they're going to be deflationary in 2023. Three, diesel and gas prices are both fading. And four, I think labor starts to disinflate as the year goes on. I mean doesn't that lend itself to durability around margins at a minimum or an ability to, I guess, at a minimum, at least absorb any pricing weakness that may be on the horizon in Wallboard? Yes. Look, Tyler, I think you pointed out some very good positive trends for the industry and for us. I would add to that, just again, for our unique position and the surety around supply of gypsum that we have. So, many of these things that you were mentioning were macro more general ideas. But as it relates to Eagle and the other, there's that surety of supply at a reasonable cost for us. So yes, we think our business, our Wallboard business is very well positioned. Thank you. Most of my questions have been asked, but one quick one on Wallboard. What are you hearing from your distributor customers on how they feel about their inventory positions heading into this season, any kind of indication, light, heavy, just directional commentary would be great? Keith, at the end of the day, there's really not a lot of inventory in the channel. Wallboard is a perishable product so it degrades if it's kept outside. So you're talking about weeks. So -- and it's always hard at this time of year. You exited the holidays and you're into January where you can have weather disruption. So I don't know if that's much of an issue. Okay. And secondly, on Cement and particularly in the JV, the amount of tons has come down the last couple of years. I know you've got the issues we discussed earlier in the last couple of quarters. But longer term, is there any reason it wouldn't get back to the kind of tons we saw a couple of years ago, particularly given the tight market in Texas, you've been discussing? Well, yes, I -- Keith, we need to look at that in two different lenses on that. For our manufacturing tons, we've been sold out consistently. And we've talked about some of the operational problems we've had that we think are behind us. So the operational side and the manufacturing tons would be there. We also had a larger side that was a procured material that we are moving, that side has dried up. So the growth tonnage on the procured side where we were buying and reselling will be more consistent with where it's been over this past year. This concludes our question-and-answer session. I would like to turn the conference back over to Michael Haack for any closing remarks. Thank you, Drew. We appreciate everybody calling in today, and we'll look forward to talking to you at our next call.
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EarningCall_1239
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Welcome to the S&T Bancorp's Fourth Quarter Earnings Conference Call. After management's remarks, there will be a question-and-answer session. Now, I would turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead. Thank you, and good afternoon, everyone. And thank you for participating in today's conference call. You can follow along with the slide portion of the presentation by clicking on the page advance button at the bottom of your screen. Before beginning the presentation, I want to take time to refer you to our statement about forward-looking statements and risk factors, which is on Page 2. This statement provides the cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in this presentation. A copy of the fourth quarter 2022 earnings release as well as this earnings supplement slide deck can be obtained by clicking on the earnings materials button in the lower right button of your screen. This should open up a panel on the right where you can download these items. You can also obtain a copy of these materials by visiting our Investor Relations Web site at stbancorp. With me today are Chris McComish, S&T's CEO; and Dave Antolik, S&T's President. Good afternoon, everybody. And Mark, thanks for the introduction. Welcome everyone to the call. I certainly appreciate the analysts being here with us this afternoon and we certainly -- we absolutely look forward to your questions. I also want to take a moment to thank our employees, shareholders and others listening in on the call, your commitment and engagement is what drives these financial results and these results are yours and you should be very proud. 2022 was an historic year for S&T and in many ways was an inflection point for the company, both strategically and historically. We started the year by celebrating our 120th anniversary, which provided a great opportunity to not only celebrate our past but to think strategically about our future. During the year, we made significant enhancements and additions to our leadership team, all focused on building for the future while ensuring we delivered performance today. Our leadership team took this opportunity to also engage with all of our teammates to define our purpose for the next 120 years, all around building a future that's people focused, a people forward future. This purpose supported our values and provided the roadmap and blueprint for our growth and our impact and differentiation as we move forward in the market. While building for tomorrow, we certainly stayed focused on today as evidenced not only by the numbers we'll talk about in a few minutes but also by the achievement we had in the marketplace around things critically important to us around employee engagement and customer experience. We have multiple instances of market leading recognition from third parties and we are quite proud of these results also. We define them as our trophies and there's many of them. And we look forward to continuing success there as it's so foundational for everything that we're trying to do financially. In addition, we delivered a 13% shareholder return on our stock, which significantly outpaced our peer median. This return was aided over the past year by three separate dividend increases, equaling more than 10% growth in our dividend to the current $0.32 level that we announced yesterday. Now let me turn to Page 3 and give you -- talk a little bit about the quarter as well as the year, and then I'm going to turn it over to Dave to talk about the balance sheet. But as you can see on Page 3, we had record earnings of $1.03, that's an 8% increase link quarter, it drove -- was driven by a 29 basis point increase in our NIM, achieving 4.33%, obviously, aided by the higher interest rates as well as our -- the asset sensitive nature of our balance sheet. The return metrics were extremely strong with the $20.36 ROTE and a PPNR of $2.36, numbers that we feel very good about. What's not on here we will talk about later is also an efficiency ratio of 49% for the quarter. This efficiency ratio is important to us. While you'll see some expense growth, that expense growth is all around investing for the future and having a starting point at an efficiency ratio like that gives us the flexibility needed to make the investments and move our company forward. Moving to Page 4. Again, a record year $3.46 earnings per share and $136 million of net income, approximately $25 million more than a year ago at this time. Again, very solid return metrics aided, obviously, and driven by NIM expansion, while at the same time continuing to see improved credit costs. We'll talk about those in a few minutes. Again, it was -- been a heck of a year from a performance standpoint. We feel very good about the opportunities as we head into 2023, not only on the strength of our financial performance, but as I said, the engagement level of our team, the clarity of how we're moving forward together and the opportunities in the marketplace. Well, thank you, Chris, and good afternoon, everyone. And thank you again for your support of our company and interest in our company. If I can direct you to Slide 5, which depicts balance sheet changes for the quarter. Total portfolio loans increased by $87 million or 4.9% annually, driven primarily by consumer activity. We continue to book residential mortgage production to our balance sheet versus selling, which has supported the majority of this growth. We also continue to experience growth in our home equity balances. In the home equity space, we have seen consistent growth through the year to continue into Q4. This includes increases in the number of customer commitments, total commitments and outstandings. We've seen very consistent utilization from this customer base at 47%. And growing the home equity customer segment is incredibly important to us as it represents the manifestation of our focus on customer relationship banking and is clearly focused on growing the value of our deposit franchise. Moving forward, our pipelines indicate the ability to maintain home equity growth and some moderate pressure on our residential mortgage activity. Turning to the commercial book. Total balances increased slightly in our C&I and commercial real estate construction categories. We've seen commercial revolving utilization rates stabilize at 46%. Calling activities in both CRE and C&I spaces have increased during Q4, and we anticipate growth to remain stable for the first half of '23 in the low to mid single digit area. Our commercial banking efforts are focused on growing with and supporting our existing customer base and continuing to improve and develop more consistent asset quality results, particularly given the current economic pressures that exist. Deposits for the quarter were down $191 million as we continue to experience runoff due primarily to competitive rate environment. We are focused on building upon our strong legacy as a consumer relationship driven bank, and recently, we hired a consumer deposit product manager to help lead our strategy and go to market efforts. Turning to Page 6. We are very happy with the progress being made in reducing our NPLs, both in Q4 and for the full year. The graph at the bottom of the page illustrates the outcomes of our efforts in support of our desire to reduce problem assets. We're also very pleased that much of this reduction came via the execution of individual customer exit strategies and not as a result of excessive charges. We continue to closely monitor all of our portfolios for potential economic impact that could result in future credit losses and added to the qualitative segment of our reserve during the quarter. We feel that our level of reserve supports our business strategy and positions us well to manage through any potential downturn. Well, thanks, Dave. Slide 7 shows that net interest income increased by $5.3 million or 6.3% compared to the third quarter. The net interest margin rate in the fourth quarter was 4.33%, that's up 29 basis points from the third quarter and is up 130 basis points ex PPP compared to the fourth quarter of '21 before this rate cycle began. Loan yields improved this quarter by 69 basis points and the cost of total deposits, including DDA, increased by 33 basis points to 60 basis points. Interest bearing deposits increased by 50 basis points compared to the last quarter. We have seen increased interest in short term CPEs, especially in the one to two year area. Half of our loan portfolio is [either] short term rates, which continues to be a big driver of the net interest income and net interest margin improvement. As part of our ALCO strategy to protect the net interest income and margin in a declining rate environment, we have hedged that floating rate loan concentration to approximately 42% which receive fixed swaps. We continue to evaluate the right level of hedging and -- which will depend on the rate environment and our deposit pricing experience. Our funding base is very different now than it was during the last rates up cycle, with a much better mix, including over $1 billion more in DDA, a money market product that no longer reprices immediately with Fed rate changes and lower wholesale borrowing levels. We do expect that net interest margin improvement to moderate in the first half of '23 as deposit betas catch up and the Fed increase has slowed down. And then with the Fed pause, we would expect some NIM compression in the back half of '23. However, based on the better funding mix I described earlier, we expect to see lower through the cycle deposit betas compared to the prior and most importantly, for us, better net interest margin betas. On Slide 8, noninterest income increased by about $883,000 in the fourth quarter compared to the third. The largest item is a gain on the sale of an OREO property for $2 million, which shows up in the other line. We also had an OREO gain in the third quarter of about $0.6 million as we have had some success in resolving some credit issues. So net, that accounts for most of the favorable variance in fees. Mortgage banking was essentially flat compared to the third quarter. As Dave mentioned, almost all of our production went to the portfolio and contributed to the loan growth we had in that category. Our quarterly fee outlook is approximately $14 million. On Page 9, expenses were up $1.7 million compared to the third quarter. Salary and benefits increased primarily due to higher incentives of about $1 million related to our performance. Also within salaries and benefits, pension expense was higher by $0.6 million due to settlement accounting from lump sum payments for some retirees. Improved revenue drove the efficiency ratio to below 50%. Our quarterly expense expectations going into '23 are in the $52 million to $53 million range as we invest in people and infrastructure. Page 10 shows our capital levels, which are strong and well positioned for the environment. We extended our buyback authorization through March of 2024 and that had $29.8 million remaining. We'll continue to look for opportunities depending on economic conditions, our financial performance and the price of our stock. With the smaller securities portfolio as a percent of assets, strong earnings and a more efficient balance sheet, we have seen stability in our TCE ratio over the course of the year despite AOCI adjustments. Thanks very much. At this time, I'd like to turn the call over to the operator to provide instructions for asking questions. Just wanted to start, just a clarification on the NIM path and then deposit beta assumptions you mentioned, still expecting lower than prior cycle. I think, last quarter, you talked about a mid to high 20s. Is that still the thought there? And then another just clarification on the noninterest expense and income guidance, the $14 million and then the $52 million to $53 million. Is that to be taken as kind of first quarter guidance to build off of, or is that more of a range that you're looking at for the year? So not too much growth throughout the year essentially. Okay, terrific. And then I guess, just if we could dig into the -- sorry, to bounce around here, but back on the margin. If you could -- if you have any more color on kind of how you think that the margin might play in terms of when it would peak. I know you mentioned pressure in the back half, but if you're thinking peak in the first or the second quarter and where that level may be and then kind of the degree of compression you're looking at in your budget? And these are -- a lot of assumptions, a lot of modeling going on. But in our sense, given the expectations from the Fed of maybe one, maybe two more smaller increases in the first quarter to maybe early second quarter, we would look for maybe just a slight expansion of the margin in the first half of the year sort of leveling off, likely peak margin in the second quarter. And then with the Fed maybe being on the sidelines, we expect continued -- some continued pressure offset some by a better replacement rate on loan maturities. And also on the liability side, some of the growth there that might offset some of our higher cost borrowings. But we'd expect maybe in the 5 basis point per quarter range of compression, if all assumptions sort of happen as we would expect. So maybe a little bit lower than we are here at the fourth quarter level or 33% by the fourth quarter of 2023? Chris, I wanted to start, you know really productive year kind of about the help for you guys, and that's got a lot done. Curious what's the agenda look like for '23 here? I mean, obviously, the macro backdrop is uncertain, but we always charge on anyway. Curious where you guys are focused and just what we should be mindful of as the year progresses just from a strategic standpoint? Thanks a lot for asking that question. I can talk for a long time about it because it's the work that we've been doing as a team as I try to allude to. So as I said we really took advantage of this past year of all centered around this 120th year celebration and there's distinctive and unique things about this company and it's what engaged me and excited me to come here 18 months ago. And it all starts with this employee engagement and customer experience, engagement and reputation of the company in the marketplace. And that's a great place to grow from. And so we spent a lot of time dialing back, understanding where did all that come from and where is it, it's highly focused on our people and our people relationships and the fact that this whole idea that we have around being people forward. The industry changes, what we do, how we deliver for customer changes, customers change, right, digitally and so forth, but there's a relationship aspect and there's an emotional tie that people have to their bank. And so we've been able to kind of extract that and simplify it for all of us to say who are we, how are we going to win and differentiate in the marketplace, and then what is winning -- how do we define winning. And we reinvigorated. You may say it's all the rate environment, but I'll tell you we were talking about this a year ago before rates started increasing, and that is the whole health of our deposit franchise and the focus of that deposit franchise on customer relationships. So we've built out -- we've started with building teams and building talent. We've hired a Head of Commercial Deposits that came out of a very significant national bank that's running that business for us. We've recently hired a Head of our Consumer Deposit business that also came out of a very large bank, all very interested in being part of this company and what we have to to deliver going forward. So a lot of work around the people and understanding where the opportunities are within our customer base as well as our prospects. We're working on product capability. So from a treasury management standpoint, our digital banking offerings, all of those things, understanding the importance of ensuring that we have the product to deliver to our customers. And then we're doing things that are important like ensuring incentive plans are aligned around things that are important like that deposit franchise. And why isn't it important because that's how our customer defines who their bank is, is where that deposit business is. And so we're highly focused on it. I would say the intensity of that focus is different than it had been here at S&T. We've historically been an asset growth oriented company, and we're never going to stop making loans, and loan growth is important to us. But we know the health of that deposit franchise gives us every opportunity to put capital in the market and deploy it that way. You've seen the improvement in credit quality and that's an intense focus around the things that Dave talked about, making clear on what we think where we want to play, how we want to win and then attacking things strategically that way. The [433] net interest margin is something that we're really proud of, but to give it back -- with inferior credit quality does not represent moving forward. And so we're very focused there. Obviously, the efficiency ratio and the way we drive profitability at this company is something that I'm really proud of, I inherited and we're going to continue to stay in that range, but we also know that we need to invest well. But all of that, Mike, is underpinned by the engagement level and the talent level of our team. And so those four big pillars are the things where we're focused, and we're spending a lot of time individually with our 1,100 employees talking about those things. And then just a couple of financial questions, follow-up for me. Mark, on the efficiency ratio being sub-50%, I actually asked this to another one of my banks this morning. I mean is that -- it feels like as we invest in technology and trying to get more efficient here and branches become less necessary that that's almost becoming kind of table stakes. So I'm curious how you're thinking about it. So just feel kind of arbitrarily low just given the NIM where it is kind of structurally to your peak highs, or are you guys hopeful that this range of efficiency is suitable for you guys as we move forward? I mean, we think it is sustainable. Part of that, though, is we're much more focused on maintaining the margin stability, and that's going to be the key to maintaining that that type of efficiency ratio. So basically not much growth from where you were on a core basis this quarter. And so I'm curious what -- can you break that down another layer? I mean, is that assuming pretty stable mortgage environment, pretty stable wealth investment environment because of market volatility and just anything where you maybe could be too conservative in that bucket as you think to next year? I mean the one thing that could potentially change is on the mortgage side, if we were to see the kind of pricing, and just the way Fannie's pricing relative to what we think is a fair value for their mortgage production that we could see some additional sales in the secondary market on the mortgage side. Right now, that $14 million assumes a pretty low level of sales. So we're kind of assuming that, that market looks the same. So that could change that number, but it would have an impact on the potential on the balance sheet growth as well, especially kind of in the first half. Wealth does not assume a big increase in the stock market, which would help us out as well. If AUM sort of naturally grew just because the market is up, that would be beneficial for us as well. We do see some pressure that we need to overcome on the overdraft side, as we look at that product and how it's positioned for the year. So those are the things that I can think of that would⦠And then I would say on the commercial side, the treasury management business, I mean it's a growth focus for us, and we're going to be intensely focused on that as we move forward. The counter, the offset to that is the earnings credit rate in environment. And then as the earnings credit rates increase through the year, there's an offset some of that on your service charge. So we're trying to measure it in absolute terms of growth and not so much look at the net relative to the earnings credit. Just kind of Mike, on a year-over-year basis, we had about $3 million worth of OREO gains in this year. We don't expect that to repeat itself next year. The one area where we do have opportunities within our business banking segment, where we have not actively sold treasury products. We have a dedicated group who's focusing on mining that customer segment in order to drive product into that customer and provide a service that they desperately need. So design the product, supporting it with the people and we believe is going to drive some better treasury management results. I was hoping to hone in on the noninterest bearing deposit line item. Look, your deposit beta cycle to date and your ability to hold the mix shift of deposits together has been far better than I would have thought at this point in the cycle and just given some of the results in the fourth quarter. Maybe give us a better sense for what's within that noninterest bearing deposit bucket. How much of it is retail versus business, how have account growth -- how has account growth gone versus kind of balanced growth? And just give us some flavor for how structurally that might be maintained or some outlook as to where it might drift down to? Well, the consumer business split is about -- it's about 60-40, and that's in the business side is where we've seen a lot of the growth over the past several years. So in essence, we're sort of doubling down on that business side. We think that's where a lot of the opportunity is. When we look at some other banks that have similar loan mixes to us, heavily on the commercial side, they have even greater, a greater mix towards the commercial side. So we think there's some opportunity. And as Dave talked about and Chris talked about focusing on the treasury management, both from the -- for the commercial book but also for the small business. We think even though there might be some kind of runoff of existing customers that there's a lot of opportunity with customers that we have their loan but we have not proactively and effectively gotten their deposit relationships. And we think there's a lot of upside there. And do you have the the cost of all-in deposits at quarter end just for frame of reference, what we're dealing with going into the first quarter? At quarter end, I don't have. For the full quarter, it was 60 basis points all in. I don't have the right in front of me for the quarter end. The other thing on the consumer side, remember, we're very much a mass market consumer bank. So we don't have -- if you look at kind of average mix, it's kind of in the median of what you would see, which, therefore, doesn't create huge gains or significant declines kind of through the cycle, and that represents some stability. Last one is just thoughts around the projected outlook and then the $10 billion threshold, timing on crossing $10 billion, potential expenses from crossing and then the updated loss driven amount? I'll let Mark speak to the timing. But this is something I've been focused on over the last 18 months that I've been here, and if you look at the talent level that we've elevated in the organization and talent we've brought in is all in preparation for that. So we -- and so there's a fair amount of this expense or from a people standpoint is embedded in our run rate today because we're building for the future, and we're setting ourselves up for that process and recognizing even when and if we -- when we go over $10 billion, there's still some evolutionary time to work through there. So it's everything from spending time in seminars, talking to peers that have gone through it, working with accountants and advisers and others as well as talent in the industry that have been through this sort of work. So it's important to us but it's really -- whether it's $10 billion or $15 billion, it's all about building a foundation for growth and ensuring that we're not only generating the growth from a top line standpoint, but we're doing things in a compliant way in line with the regulations. And then from a timing perspective, we're just right around $9 billion now based on sort of mid single digit or a little bit higher loan growth. We're probably a couple of years away from sort of an organic cross on the $10 billion. And then when it comes to the [Durbin], we look at it -- once a while, the last time we looked at it, I looked at it, it's about half of our debit card, which is about -- ends up being about $7 million on a full year basis. Operator, we did have one question in the queue, it was regarding outlook for loan growth for 2023. And the simple answer is, mid single digit loan growth. If you look at kind of what I described in my prepared comments regarding consumer activity, as I said, we continue to expect that to perform as it has. And on the commercial side, kind of back half of the year, focused growth, and we do understand, and as Mark and Chris described, we expect the NIM expansion to temper and stop at some point. So we do understand that growth, in terms of revenue, will have to be driven by some asset growth. And we're building the teams out. We have the infrastructure in place to do that, and we're very comfortable executing on that strategy. Could you give me a little bit of color as to -- maybe break down on a monthly basis, how the loan yields were looking for the fourth quarter? And then what's current production, what kind of yields are you seeing in current production and what kind of yields are rolling off? So in total for Q4, our kind of start -- our new loan yields were around [6.25] range and that compared to the kind of roll off, both payments and payoffs of about [5.60]. So we had about a 60, 65 basis points improvement based on that. They were, I mean, in line. We didn't see heavy path by any stretch. So they were kind of more normal of what we'd expect both on the consumer and the commercial side. Well, as I said, my job from the day I got here is to prepare for growth and build a foundation for growth. And we control -- we have a lot more control over the organic growth than we do to the inorganic growth. But we believe and our financial results would tell us that we should be a participant in future consolidations. When, where and if and how that happens is that's -- it will happen in the future, but it's certainly something, again, that we're very focused on from a preparation standpoint. So as the foundation is laid, I mean, what kind of -- in terms of parameters, what size of institution are you guys most interested in? Some of it is whether it's size or make up is probably a better answer. We talk about the health of the deposit franchise and the importance for that being a foundation for our growth. The geographies that we're in and the adjacent markets culturally are very attractive to us. We don't see ourselves doing something kind of in that billion dollar and below range, that makes a lot of work for not a lot of gain. But that being said, it's almost is -- you're really well aware, is very event driven. So it's about building relationships and understanding that there is the right strategic and cultural fit, while at the same time, the financial opportunity is there for growth. I mean our expectations for growth are pretty modest on the deposit side. I think we're going to be focusing a lot on mix and developing the relationships that Dave and Chris were talking about. So we would expect, especially on the business side, a decent improvement in the DDA quality. We might not see the largest increase in the balances but the quality of that DDA should be better, but a lot of shifting. We would expect to see some higher CD balances by the end of the year, but some of that's going to come just from migration from other areas of the bank. So net-net, we're not looking for huge deposit increases. We'd consider that successful given the rate pressure that we expect. We're very focused on -- as we talk about the quality of the franchise and the mix and tying it back to customer relationships. Can you add a little bit more color around how you're thinking about protecting the margin? You said you brought down the floating rate to like 42% in general. Like where could that go, is it kind of opportunistic and what level are you trying to protect? So we're trying -- when we look at the protection, there's kind of 2 pieces of that. One is on the -- just on rates down protection should the Fed reverse course. So that's primarily the hedging that we've done is more meant to protect that. So we have certain internal parameters that we look at to just shop type analysis and ramp type analysis and we're trying to limit that net income decline to a percentage we can live with. And so that that additional hedging, combined with the structure of the deposit book and the borrowings that we have, factors in that. So the fact that we're actually borrowing a little bit now on the short end works in some ways is some additional rates down protection. So if rates move down actually on the Fed side, we would expect to see a little bit larger -- or certainly larger compression than if rates don't go. So we limit -- we're trying to limit that. On the maintenance side, it's more about this back to this deposit franchise and trying to maintain higher quality so that, at the end of the day, we have customers that are rate -- a little bit less rate sensitive that aren't as demanding for the top of the market rates and our hot money. So that is something that we'll continue to work on over the course of the year. So that hopefully, we can tell you at the end of the year that our deposit franchise is of higher quality and that will help support reducing the amount of margin compression that we would see. Okay. Well, thanks to all of the analysts on the call and your engagement and your questions. We greatly appreciate your interest in the company, and you help make us better and we thank you for that. So we're off into the new year. And again, we're very proud of '22 and we're moving forward into '23. So thanks. Look forward to talking to you again soon.
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EarningCall_1240
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I'm Josephine Edwall, Senior Vice President, Communications. And here us with you today, we have Magnus Groth, our President and CEO. And he will join us from our office in Ismaning, Germany. And in Stockholm, our Executive Vice President and CFO, Fredrik Rystedt, will also join. And in the end, as usual, we will have a Q&A session. Thank you, Josephine, and good morning, everyone, to this Q4 full year report, but also with a focus on the fourth quarter, of course. And to summarize the fourth quarter, we saw record high sales and -- both in growth and sales in total. Our adjusted EBITDA was in line with 2021 despite significant cost inflation. Of course, the massive price increases that we put through played an important role here, but also efficiency improvements and higher volumes. So, we were able to combine throughout the year, price increases with the continued volume growth. We did three acquisitions during the year. So, I'll talk a little bit more about them. And a very high pace of innovation, higher than in the years before. E-commerce grew with 20% to 15% of sales. So, the financials for the full year, net sales increased with nearly 30% and the sales -- organic sales growth, including M&A, was 17.7%, of which acquisitions amounted to 2%. Adjusted EBITA, as I mentioned, almost in line with the year before, thanks to the top-line growth in combination with efficiency improvements. Adjusted EBITA margin, 8.4%, and ROCE at 9.7%. With all of this combined, the Board suggests to the Annual Shareholders' Meeting an increase in the dividend from SEK7 per share to SEK7.25, which means that we continue on a nice gradual increase here in the dividends, provided an increase, if that is approved by the Annual Shareholders' Meeting, by 4% compared to the year before. I mentioned three acquisitions, Legacy Converting, which strengthens our offering in North America in wiping and cleaning, and Knix and Modibodi that we've spoken about before that saw significant growth here in the fourth quarter, giving us a leading position in leakproof apparel in the world. Very exciting, very sustainable, very much in line with what our consumers and customers are looking for. I mentioned that our pace of innovation was higher than in previous years. We have launched over 30 new products and some of them you can see here behind me, which is 20%, 30% more than the year before. So, in spite of the difficult and challenging market conditions, this is important to us, and we can continue to invest here. E-commerce, SEK23 billion of e-commerce sales, a growth with 20%, and this is in a year when many e-commerce and -- sites or e-commerce businesses have been struggling coming out of the pandemic. So, we still grow slightly faster in e-commerce than we do as a whole. And you can see the split here and what we expect going forward is that direct-to-consumer, which is currently 2% of sales, will be higher -- gradually a higher share going forward with the acquisitions of Knix and Modibodi, but also with other initiatives that we are doing in the company. Something that's really, really key to us is to remain in the lead in sustainability, and we saw a lot of progress also in 2022. We were able to continue our path to achieving a reduction of our Scope 1 and 2 emissions to 2030 by 35%. We're now at minus 18%. And today, I only present Scope 1 and 2. Scope 3, we're still waiting for those numbers. It takes some more time, but we expect to see good progress in that area as well. And then, you can see a list of awards and recognitions there from very reputable institutions. So, this is something that's so appreciated by our customers, our consumers, our employees and other stakeholders. Moving over then to the fourth quarter of this year, which might be the part that's of most interest. Again, very strong sales growth, net sales 28%, and the sales growth in the quarter organically with acquisitions of 16%, and an adjusted EBITA that grew over the same quarter of last year with 33%. And you might wonder, of course, how can this be when the margin is only up 30 basis points from 9% to 9.3%. But this is, of course, due to the huge growth in top-line. So overall, if margin is increasing slightly, which we're very happy about, we're even more happy about the fact that overall, the EBITA profit is growing by 33%. And adjusted ROCE improves with 130 basis points and earnings per share by 20%. So, a very strong development in the fourth quarter. The adjusted EBITA bridge where we saw a support from gross profit margin of 70 basis points in Q4, and this was in spite of headwinds from raw materials, energy and distributions of 950 basis points. So, we are now through our price increases and other initiatives over compensating for that for the first time. So, we are really moving here. A&P in line with EBITA growth, which means that A&P is increasing, but not as a percentage of sales. While SG&A, which is lower as a percentage of sales for the year increased in the fourth quarter. And this is a combination of salary inflation, higher payout on incentive programs in 2022, travel costs. So, it's more of normalization effects than -- but also some salary inflation rather than that we're taking on actively more cost, which we are not. So, that's the overall bridge. And another way of looking and presenting that was much discussed in the last quarter is this input cost increases versus implemented price increases. And after the third quarter, we presented that we were catching up with the cost inflation in energy, raw materials and distribution, and we were less than two quarters behind. So, I'm really happy to announce that we have now caught up with these costs after having a sequential price increase from Q3 to Q4 of 6%. So, as you can see, a really steep uptick there in the curve when it comes to price increases. Now, looking forward, even though we see stabilizing input costs in these areas, we expect to continue to have inflation, salary inflation and an inflation environment in maintenance, in our SG&A costs, sales administration, which is particularly when it comes to salesforce, important for Health & Medical. And this is something that we will have to continue to compensate with price increases. So, price increases is still high on the agenda even though we have caught up in this area. So, with that, I will hand over to you, Fredrik, to talk about our three business areas, which have all of them grown through the year. So, over to you, Fredrik. And I will start with Health & Medical. And we achieved a good growth, organic sales growth in Q4 with 4.6%. And all of our business areas are affected by lower activity in Russia, including Health & Medical. And as you know, we are in the process of exiting our Russian business. If you exclude that for Health & Medical, organic growth amounted to approximately 5.1%. And this is mainly driven by pricing. You all know that pricing in comparison to our other business areas is a bit of a slower process, reimbursement systems, tender business and [Inco] (ph) are the main explanations to that. But despite that Q4 of '22 in comparison to Q4 of '21, we increased prices with over 7% and sequentially, just from Q3 with 1.7%. So, really, really good progress there on the pricing side. You can see that volume was slightly negative, and this is predominantly driven by the fact that we abandoned a few loss-making or non-profitable contracts in Incontinence Health Care. So, cost inflation continued to be very severe. And if you look at the margin impact, just in comparison to the same quarter of '21, the margin impact was 6.6 percentage points, 660 basis points. The main drivers there being superabsorbent and fluff and actually negative currency transaction impact. Now, we expect, as we go forward, that input cost for Health & Medical will largely stabilize. But -- and I think you mentioned that previously, Magnus, if you look at indirect cost inflation is quite significant. And not least for Medical, this is a major factor. So of course, we will need to continue to increase prices as we progress in coming quarters, of course, to compensate for that, but also to restore the margins of the business area. Now, just a final couple of comments on the acquisitions that we've made. So Hydrofera, Aquacast and the sports tapes business with several brand names, they all have been well integrated now into the rest of our business, strengthening our offering, all performing very well. And just take that as an example of Hydrofera in Q4 with a growth of 11.4%. So, really a good progress on the acquisitions. Now, turning to Consumer Goods, really excellent growth, as you can see, nearly 16% here organic. And of course, the same as for Health & Medical has also been impacted by the -- or the lower activity in Russia. And here also the exit of the baby diaper business in Colombia. And if we kind of adjust for those two, growth was actually roughly about 17.5%. So, really strong. And same here, the main driver was actually pricing. So, we achieved a kind of year-on-year in Q4 of roughly about 20% and sequentially a bit over 6%. So, very, very strong progress. And we had that pricing increase in all our categories and all our geographies. And of course, as we have seen also before, here, consumer tissue was the main driver. You can see here that volume actually was down, and this is new, because we have seen volumes previously in -- during 2022 actually being positive. Here are the main drivers, and if you disregard here Russia and baby, approximately 3% down in volume, the main drivers being consumer tissue and baby. And if you take consumer tissue as a start, then, of course, this was impacted by the very significant price increase. But actually, to an extent also that price negotiations were ongoing during the fourth quarter impacting that. It's our actual belief here that -- it's absolutely our belief that as competitors catch up in the balance between input cost and pricing, volumes will pick up in the coming quarters. And of course, when it comes to baby, the impact was there beyond LATAM, also the fact that we also, in this area, left an unprofitable retailer contract. So, this was the main explanation. So, if you look at the input cost, starting with energy, it was actually much lower in the quarter than we anticipated, and this had to do with a couple of different things. So, first of all, generally, pricing levels in the spot part of our energy consumption was lower. And secondly, we had subsidies in the European system and also a couple of one-offs. So, in terms of the energy price, it was much lower. But you can still see that the input cost was -- the impact from that was very severe with 1,130 basis points, so really very significant. And as -- exactly the same as for Health & Medical, we see inflation in indirect costs. So, basically, in coming quarters, we'll see input costs to actually stabilize with the exception of one thing, and that is the energy that will significantly increase. A couple of reasons for it. The prices in our hedging contract will be significantly higher. And the one-offs and the subsidies that I mentioned earlier will not be there in Q1. So, we will see that increasing. And the same goes for indirect costs that will increase. So, overall, of course, we will continue to work extensively with price management. And then, finally, a couple of comments on the acquisitions of Modibodi. It's early days there, but it's a good progress and progressing in line with our plans. And as an example, Knix had a growth in the fourth quarter of 28%. So, we were really happy with that. And it was specifically in the United States, that was the main driver. So, very much in line with our hopes for the company, so performing well. Turning to Professional Hygiene. We've been really pleased with the performance of Professional Hygiene throughout year, and Q4 was really no exception. So, if you exclude Russia here, the organic growth was pretty close to 20%. And PH, or Professional Hygiene, is the area where prices have increased the most. So, Q4 versus Q4 of '21 was increasing with about 30 -- 23%. And sequentially, we increased prices with approximately 8.5% between Q3 and Q4. Now, volumes were negatively impacted, as you can see here. And the price increases played a part of that. I mentioned Russia earlier. And we also had a quite challenging market in the -- in Asia, and you can actually see this very clearly from this slide, when you compare the organic sales growth in mature versus emerging market. Now, also and pretty much the same story in terms of Professional Hygiene, input cost inflation was very severe and input cost increased or had a margin impact of roughly about 690 basis points. So, very, very severe. But as you see, and this was also the same for Consumer Goods, that overall EBITA is much higher. And here, we also see -- and it was slightly so also in Consumer Goods, but here, a very, very significant margin improvement. So, we are quite happy with the performance, as you can see here from Professional Hygiene. Now, the cost outlook remains pretty similar to the other. Energy will increase significantly in direct costs. So, although margins have picked up here, it is definitely our view that prices need to stay and potentially even increase further. Now, just as a final comment also in this area, we made an acquisition at the early part of 2022, with Legacy Converting, really strengthening our offering in the wiping segment in North America. And also, Legacy has performed well in the fourth quarter with strengthening margin and growth, good growth. And if you look at the total wiping and cleaning business in Q4, it actually increased with a bit over 12%. So, good progress in general for Professional Hygiene. So, after having listening -- listen to that, it's quite clear what our priorities are for the year ahead. Price management will remain very, very important for us and a strong focus, but also our longer-term efforts to innovate, to strengthen our brands and to launch products and solutions that our consumers and customers appreciate. We also will have a strong focus on cost efficiency to manage also the increases that Fredrik referred to in indirect costs. So that's an important focus for the year. And of course, as always, working with the overall mix to grow faster in the high-margin businesses and continuing our very important sustainability journey. So, very clear priorities for this year, and we're already one month into it and working hard in all these areas. So, thank you, Magnus. Thank you, Fredrik. And let's invite our audience for a Q&A session. Operator, can you please help us open up the lines? Hi, there. Good morning, everyone. My first question is on other costs, which stepped up sequentially again by around another SEK900 million. What is driving that other than the more negative cost savings? Could we assume that there's some reallocation of energy cost to surcharges within other costs versus underlying cost allocation? And then, my second question is on the volume drop off in Professional Hygiene, in part driven by the sequential step-up in pricing. Was the volume reaction more than anticipated? And are you seeing greater elasticity in Europe as we're hearing from some other companies? Or perhaps is there an element of forward buying by distributors ahead of anticipated or planned price increases? Thanks very much. Yes. Basically -- thanks, Victoria, for your question. I'll give a brief answer, and we can provide more details should you want that. But if you take the overall cost increase, it's mainly related to distribution cost overall being higher. It's also actually inflation in our product or our COGS relating to inflation in salaries, and the rest is largely actually due to SG&A. And if you look at that SG&A, it's driven by many factors of salary inflation. We actually have a bit of higher bonuses this year in general inflation. So, it is a cost increase that we see that's generally driven of the market conditions, and to some degree, as I mentioned also, bonuses. Okay. So, regarding the second question about Professional Hygiene, we have a very, very strong performance in Europe and an improving performance in the U.S. and quite weak development in Asia in the quarter, as you could also see from the much lower sales in emerging new markets. Nothing specific, no news about any prebuying in anticipation of higher prices or anything like that. I think it's just one of those variations in general. I feel very confident about our Professional Hygiene business that it will continue to develop really, really well as it did in the fourth quarter and throughout the year actually. Hi. Good morning. Thanks for taking my questions. My first one is on price increases, you mentioned the need to take incremental price increases again in '23, Fredrik. Are you able to give a magnitude of sequential increase you're looking for in Q1 like you did with respect to Q4, with the Q3 results last year? My second question is on energy costs. And obviously, it's not an insignificant number for Essity. You are normally, I believe, on average, 70% hedged entering the year. I just wanted to clarify, is that still the case for '23, i.e., the variable impact depending on where energy prices go from here is going to be on the 30% unhedged? And then, if I could sneak a third one in. Could you talk a little bit about your private label consumer tissue business in Europe? And give some details on the organic growth and margin there relative to your overall consumer tissue business? I'm sort of -- I guess I'm asking, is the business gaining volume share as consumers are trading down? And how does that impact the margin? Thank you. Yes. I didn't actually get your second question there, but I'll start with the first one. I think it was regarding generally energy cost. And yes, they will be significantly higher. So, I think, I mentioned that already that if we look at input cost, they will be largely stable with the exception of energy, but the energy will increase significantly. So, it's not really spot rate related. We don't know the spot rates, of course. The part that is unhedged. And that's roughly -- the unhedged portion is roughly about 30% you can say for electricity and for gas. It's actually you can say more for electricity, but if you include the regulated market, it's roughly to that extent. So, we are not speculating on the spot price. We hope it will stay low. But we can see that for the 70% that we have hedged in gas and electricity, prices are significantly higher. And then, I mentioned that we had subsidies and one-offs. And you can -- we are not for commercial reasons exposing that number. We cannot do that. But you can get to kind of a lead if you look at the Q3 energy cost versus Q4, it's about SEK500 million or so lower in Q4 versus Q3. And of course, that was much better than we expected. Although prices were super high in Q3, it was still much better than we expected. And this is, of course, the subsidies and the one-offs that I was referring to, and they will not be there in Q1. So, in reality, we will see Q1 being much higher in terms of energy costs and, I also mentioned, indirect. Maybe I could answer the question -- first question you had about price increases if we're giving any indication regarding the first quarter. And we're not. As you remember, Charles, we expected price increases going into Q4 from Q3 to be on a similar level of about 3.5% as we saw from Q2 to Q3, and then it turned out to be much higher. Of course, there will be a positive rollover effect, but -- so we will see price increases also in Q1, but we're not providing a number there. And then, when it comes to private label, yes, we are seeing some downtrading still very much in the U.K. and, to some extent, in Latin America, but also in some other markets, and that is benefiting our private label division. It's interesting to see that even though we have raised prices more towards the retailers on the private label products than on our branded products just to a large extent, for cost reasons, so the cost impact on the private label products is much higher. The retailers have not raised prices on private label as much as unbranded. So that's a specific situation. But that's what we're seeing, downtrading that we are picking up by having a tiered, good, better, best assortment with our brands, but also by having a strong position in private label. Hi, guys. Good morning. Thank you for the questions. A couple, one for Magnus and one for Fredrik, if that's okay. Magnus, can I -- I want to discuss the environment in China in as much detail as you can. Vinda, I think, reported a loss in Q4 after already seeing a sequential slowdown in Q3. And if I remember the discussion we had at Q3, I think the focus was going to turn on recovering profitability potentially at the expense of losing the Number One position. Could you discuss the operating environment in China, the pricing landscape, the excess supply potentially in the market that is impacting pricing ability there? And then, secondly, housekeeping for Fredrik. Could you help us with the likely net interest cost for 2023, particularly as it stepped up in Q4? And if you can explain why the cash flow interest charge is much lower than the P&L, that would be good, as well as touching upon CapEx expected for 2023 as well as the tax rate? Thank you. Okay. Thanks, Faham. So, I will talk to China as much as I feel -- I can as a Board member. Of course, Vinda is a listed separate company where Essity is the majority shareholder. Q4 was challenging because of partly the reopening of the markets with the high infection rates that had an impact on -- throughout the supply chains in our plants and also in our ability to supply products. So, there were a number of specific issues for the fourth quarter. But having said that, Vinda did raise prices, not sufficiently. There is price competition, especially then on the basic grades, less so in the premium grades where Vinda is moving. And especially in the fourth quarter, it was a challenging environment because of an anticipation of lower pulp prices coming in 2023. So, it made it more difficult to raise prices. Vinda has launched a number of new products in the premium part of consumer tissue to move away from areas that are and have been commoditized for a long time. And where there is an oversupply, the flat products and more into products like the 4D-Deco, the Embossed 4-layer products and, of course, the Tempo assortment. And this shift towards more premium products is successful and is ongoing, and we'll see more of that next year. And Vinda has continued a clear focus to raise prices going forward. So, that strategy hasn't changed. I think that's as much as I can say about China and Vinda's performance and plans for now Faham. And I hand over to Fredrik for the housekeeping questions. Housekeeping? Thank you, Faham. I will try and do a bit of that. So, I think your first question related to the net interest cost and it's difficulty to give a forecast there and the reason is quite simply that we got a lot of floating. So, if you take according -- very much in line with our policy. But if you look at the proportions of fixed of our debt is roughly about 30%. And if you take floating, of course, obviously, then 70%. The average maturity, if you look at interest rate fixing is about 14 months or in that order of magnitude. So, clearly, when you look at that, you can see that we are quite dependent when it comes to the finance net of the floating rate. And just to give you a bit of a proportion, if you take Q4 here, we had an average interest of 3.1%. And if you look at the corresponding period in 2021, we had 1.3%. So, it's been a very significant increase of the floating rates. Of course, we have the flexibility to go into more long term. We can do that. But of course, it will be much, much higher. As we kind of work our debt down a bit, then that's a positive impact. But of course, it's not expected to be lower than what you've seen here in Q4. And so, when you come to CapEx, we're quite close to our estimate in 2022, as you have seen. It's always difficult to judge exactly with timing. When it comes to 2023, roughly about SEK8 billion or in that order of magnitude. I think the final housekeeping question you had Faham was the tax rate. And here, it's always difficult to give an exact forecast of the reported rate, because that's impacted by all sorts of different movements back and forth. But structurally, if we just take our structural rate, is roughly between 24% and 25% is in that order of magnitude. That will vary a bit depending on country mix, et cetera, but roughly 24%, 25%. So that is what you should expect for 2023. Yes, good morning, and thank you for taking my questions. The first one is on plans for 2023. I understood your comment during the call regarding the priority being the recovery of input costs and essentially margins. But we heard from one of your competitors yesterday signaling that they intend to raise A&P or advertising costs specifically by about 100 basis points for this year to invest behind innovation and growth in the brands. So, I was just wondering if you can sort of share what your intentions are in terms of planned investment levels this year versus last year, whether you also intend to invest a little bit more than you did last year? And then, my second question is on the cost saving program, which had a pretty significant step-up in the fourth quarter. I think it was just over SEK1 billion. So, if you can just give some color on how you managed to unlock those savings so late in the year and how that should impact the next couple of quarters? And then, my last question, if I could, is whether you can provide any sort of indicative inflation guidance for the all-in cost -- COGS, I should say, for 2023, given that you've got flat pulp, but still rising energy, still some inflation on labor charges? Should we expect mid-single-digit, high single-digit, low single-digit COGS inflation for 2023? So, any guidance there would be great. Thank you. Okay. I can start with the A&P. Yes, we are planning on higher A&P levels. We're not giving the detailed guidance on the number of basis points, but we are planning to do more A&P this year, because we have a lot to talk about, and we're coming out from a very, very challenging year. So, expect a step-up in overall A&P investments for 2023. Yes. Let me start with the last question first. So, I can't really give you more guidance than I already did, Fulvio, because in essence, we can only kind of look at one quarter ahead. And as I have already mentioned there, we see stable -- largely, I should say, stable, the cost on input factors with the exception of energy, which will increase a lot. And of course, longer than a quarter is quite cumbersome. We can make all sorts of assumptions. But in the end, it's about adapting to the surrounding world with being agile in terms of pricing, et cetera. So, we can't give you much more guidance. When it comes to the cost savings, I'm a bit unsure there what you actually mean, Fulvio, because, in fact, it's a bit tricky when you look at cost savings. We constantly save costs and become more efficient in general and Q4 was no exception. But if you look at the way we look at productivity, you will remember that we look at our cost saving or cost picture in terms of total productivity. So, we look at it on a net basis, all the positive savings that we do and of course, also the negative impact, which comes exactly -- well, as an example, with inflation in maintenance or productivity loss from other factors in the surrounding world. It was actually quite negative for us, the total productivity in Q4. So, there was no savings. So, I'm a bit unsure what you're referring to. Underneath the surface, the savings continued to be good in terms of material rationalization, in terms of yield improvement, in terms of how we become more efficient in the plants. But on a net basis, with all the kind of negatives that was -- that were existing in Q4, it was in total negative. So, I can't really answer your question there, Fulvio. Thank you. Good morning, everyone. My first question, in fact, is coming back on the cost inflation. So, you said that you expect stable input. I'm a bit surprised about this. So, excluding energy costs, what are your expectations for a different input cost and especially on top, the U.S. dollar has weakened. So, could you explain why we're not seeing lower input costs there? The second one is on -- and then, as well, can you -- on SG&A, I understand there is inflation in salary. What kind of inflation shall we be talking about? Are we -- is it a mid-single-digit rate that we should factor in? And my second question is on pricing negotiation. I mean, first of all, why was it that you were able to get a better pricing in Q4? But importantly, you just had a pricing negotiation in the autumn. Are you able to right now go back to the table with the retailer for further pricing? Or are we expecting that further price increases to be later in the year? And what do we expect in terms of [indiscernible] the discussion to be tougher. You were mentioning cost -- sorry, delisting. Are we expecting some of that to persist in the first quarter? Thank you. So, starting with the last question regarding the pricing environment, that has been very challenging all along, I would say. And in spite of this, we have been successful also protecting volumes and our Number One and Number Two positions. So, that will continue. And the discussions and negotiations with some extent, negative impact on volumes that we had in the fourth quarter, we will see the positive impact now in the first quarter. So, we will have more pricing going forward. And then, when it comes specifically to Health & Medical, that's just an ongoing process, because it takes longer, as we always say. So that will continue throughout the year. And then, as Fredrik mentioned earlier, we believe that some of our competitors need to catch up and that this will provide a favorable pricing environment also going forward. And then, exactly how that comes into the different quarters this year, I can't really say. So that's -- about the third question, price continued -- price increases, Fredrik, do you want to talk about cost inflation and⦠Yes, I can give that a shot, Celine. So, if we look at the different areas, starting with Health & Medical, we expect about stable input costs there. So, basically, higher cost when it comes to superabsorbent, bit lower cost when you look at nonwoven as an example, and roughly about similar for fluff as a -- sorry, a bit higher for fluff. So, overall, you can say roughly stable as far as we can see at this point of time. When you take Consumer Goods, a bit more uncertain there. We expect -- and I'm talking sequentially now because if you compare the kind of Q1 a year ago, then of course, it will be a lot higher. But if you look at it sequentially, we expect slightly -- with the delays we have, slightly lower pulp costs. That's at least our hope and perhaps somewhat better currency conversion there, but it's a bit uncertain. So, largely stable, perhaps a bit down when it comes to Consumer Goods. And when it comes to finally Professional Hygiene, stable raw materials, so basically for the same reason. So, it's difficult to give -- this is our best estimate at this time, of course, that can change. When it comes to SG&A, that's a tricky question, I think, because it's a very varying situation in different countries. But generally, as you -- and of course, we just don't know that quite yet simply because there are all sorts of salary negotiations and other indirect cost negotiations ongoing. So, it's a bit difficult to actually forecast. But of course, I think it's quite clear that pretty much every company is facing significantly higher cost as we go along as inflation is high. Whether it's exactly single mid-digits or a bit higher than that, very difficult to say. Yes, thank you. Thanks for taking two questions. Firstly, about the -- your comments as we now move from raw material cost inflation to indirect cost inflation. So, can you discuss a little bit about the challenges in price management, i.e., raising prices between different divisions? I understand that it may be the easiest in Health & Medical because that's where the SG&A and salesforce is a bigger cost item rather than input costs. But maybe more specifically, how much more difficult will it be in consumer tissue and in Professional Hygiene to raise prices on this indirect cost inflation? That's my first question. Yes. First of all, in general, we would like to talk about prices and price increases in relation to the value that we provide, of course, to consumers and to the retailers in building profitable shelves and also then digital shelves for them and making them competitive compared to their competitors and not just base it on cost, which -- but of course, that's easily what happens when you have the input cost explosion that we had last year. This year, I think it will be more about value and -- the value that we provide, which has been clearly visible with a relatively good service levels in most areas to competitors and our strong brands and strong innovation and so on. So, we're not always linking the need for price increases, of course, to the incoming costs. Maybe I misheard when it came to Health & Medical, but this is the area where it takes the longest and actually it's most difficult to raise prices because of many contracts being -- having a three-year duration, but also because of the reimbursement schemes where countries need to change and increase the reimbursements. So that takes longer. Momentum is picking up for Health & Medical, that's very good. So, it is a challenge, and it will take the coming year for them to catch up on margins and this goes then not only for the raw material, but also for the larger SG&A portion that they have compared to the other two business areas, as you mentioned. But this is something that they are working with very, very actively every day. So that's regarding pricing. Let's see going forward here. We have learned now to raise prices and work with price management every quarter instead of maybe once per year in Professional Hygiene and Consumer Goods. So, I believe there is a good basis now for continuously discussing what needs to be done on pricing so that everybody is happy with their margins and their overall profit levels. No, not yet. It's still coming. Just maybe a quick follow-up on this. Have you agreed on any one-year contract outside the Health & Medical for 2023? And could that be the reason... Right. Fair enough. And then, the second question that I had was that the -- as Fredrik was commenting, you had negative overall savings in 2022 due to the very broad-based cost inflation, and now you're saying that SG&A, salary inflation, those are still heading higher. So, do you see any potential in sort of structural reduction in those items, i.e., to put it bluntly, headcount reduction in -- or maybe⦠I mean, it's nothing new. Over the last couple of quarters, we've been saying that inflation is coming and we'll cover those costs as well through price increases and efficiency improvements. So, it's nothing that comes as a surprise. It's more visible in the Q4 numbers. But remember that some of those increase you saw there are kind of a little bit of one-time impacts that we now have incentive payouts that we haven't had for the last two years. We have a return of travel costs, for instance. But also, of course, more real underlying longer-term inflation. So, this is something we have been anticipating and we are working very hard not only with pricing, but also with cost efficiency throughout the company. So sure, it's something that we're talking about and working with every day. And maybe just to complement, perhaps even repeating what you just said, Magnus, there, but a few factors that has been -- or have been really impacting 2022, in general. So, the productivity, in much as we kind of have seen tight labor markets in the United States, especially in the early part of the year, the productivity and -- after post-COVID so to speak, we also had lots of new employees in our factories, particularly in the United States with lower productivity number as a consequence. So, of course, that is not expected to be worsened on the contrary, probably improved. If you also make another kind of -- and you said it one-off, we have been facing a lot of surcharges also ourselves, energy surcharges that have come into on top. And this is also something that we, as in our way of looking at this actually include as a negative saving. Those are more market movements because all the competitors are faced with those. But of course, we don't expect them to increase. So that negative will not be increasing, so to speak. I think, there is another factor also mentioned before, and that is that we have practically more or less zero bonuses in 2021, that was adding to the picture quite a lot, much more bonuses in 2022, and we don't expect that to be kind of a drag on. We hope bonuses will be there, of course, but not increasing as we saw in 2022. And then, finally, what you don't see because of the net accounting that we do or the way we show this, is that underneath the surface, you see a lot of savings. So, all the ongoing projects are still generating sufficient or healthy savings, and we will continue that high pace also in '23. So, it will hopefully look better. But of course, obviously, there's going to be inflation, a lot of it also in '23. Yes, good morning. Thanks for taking the questions. I have two questions. The first one is with regards to your expected volume trends during 2023, can you share anything with regards to when you expect things to improve a bit the quarter-after-quarter in -- is that already in Q1, for example? Is the China outlook is better? And related to that, the innovation agenda you have for 2023? Then, the second question is on Latin America. Last year or 2020, you did a significant transaction, but the picture is a bit clouded beneath you exiting some baby business in Colombia. What has been the momentum in the LATAM business in the second half of the year? And what's the outlook for '23 for that part of the world? Thank you. Okay. So, starting with the volume development, very difficult to say. But of course, as I mentioned, our categories are typically very, very stable. These are products and categories that consumers need every day of the year. And compared to all other FMCGs, including our competitors, we had a much better volume development during last year than all others, and we only had a dip in the fourth quarter. So, I think that was a quite strong performance. Having said that, I would expect volumes to kind of normalize and to see some volume growth in the year ahead, of course, because it's -- even if we enter into a recession in some markets, that shouldn't have -- and historically, that hasn't had a big impact on volumes in our categories. And China, I think there will be some instability here in the first or second quarter as China comes out of COVID. And what that means? I don't know. We'll just have to see, I think. Latin America has been a huge success story over the year, and they just continue to raise prices, grow volumes, strong market share performance, really firing on all cylinders. So, really happy about Latin America and the performance there. We knew that the baby business that we had in Colombia through Ecuador was underperforming. And what we decided was to step out of the diaper part of the business, but we still have a substantial wipers -- baby wipers business that's growing in a very healthy way. So, overall, strong performance in Latin America and an area where we will focus and really invest going forward. Yes, thanks a lot for taking my questions. May I just follow up on what we talked about previously on the call on other costs, which have continued to increase across all three divisions, but especially in Consumer Goods. Could you just maybe talk a bit about what you expect in the first quarter? Are we seeing any easing? Or are we expecting the same kind of cost or even higher costs on that other line for the group as a whole and maybe in particular on the Consumer Goods side? Yes. I can give that a shot, Linus. It's a tough question to answer. If you look at -- just starting with the math a bit or the numbers we had in Q4, roughly about SEK2 billion higher cost in comparison to Q1 of '21. So, it's quite significant. And as I already mentioned, about -- more than SEK400 million was related to distribution, about SEK900 million or so was -- or a bit more was related to SG&A. And then, finally, the rest was what we discussed earlier when you come to kind of production cost productivity. And I mentioned there as an example, maintenance and energy surcharges. If I try and speculate a bit -- and of course, part of that A&P, as I mentioned, the bonus increase that we saw here that was quite significant actually in Q4. Generally, we don't expect a lowering of the other cost line because of the kind of ongoing inflationary tendencies. We hope that we'll be able to have less impact from the COGS part, as I mentioned, as we improve -- continue to improve productivity and savings. When it comes to SG&A, I don't think it will be -- it will continue to remain high, actually. So, overall, we don't expect any kind of big decrease, Linus. The surrounding world doesn't seem to be behaving in that fashion for the time being. But of course, we remain very, very eager to maintain a good cost structure, and we are doing just about everything to safeguard that, that happens. That's clear. Many thanks for that clarification. And then, on the other other line, the one kind of the fourth division of yours, and you've had a big IT project ongoing. What's the update on that? And what's the other cost expected for full year 2023, please? Okay. I can start with the IT project, which is our upgrade to SAP S/4HANA, where we launched successfully the pilot in May of this year in the Nordics and the Baltic countries. So, a good testing ground, seven countries, all our different businesses and also plants in several countries. And after expected teething problems, we are now designing the global rollout template and this is incurring some costs according to plans. And then, by the end of this year, beginning of next year, we expect to start the rollout in waves. And of course, our expectation is and what we're seeing now from the new ways of working in the Nordics and in the Baltics is that this is a huge opportunity for efficiency improvements and automation once we have this in a big part of the group. In the short-term, there are some additional costs by running the old and the new systems in parallel. But we can see from the performance in the Nordics and Baltics that this will really help us once we start rolling out on the bigger markets that we're expecting to do next year. And I guess, maybe I can answer the other question you had there, Linus, and that was the other other sounds a bit odd, but it's group common cost, you can say. Among other, there we include this project, the EWoW project as we call it. And in 2022, we have SEK1.1 billion. We expect SEK1.2 billion roughly. So, you can deduct from that, that's typically salaries and a bit more spending on IT, et cetera. So roughly about SEK1.2 billion cost for 2023. Great. And then, just one final comment on -- you talked about the downtrading. What was the mix impact in the fourth quarter? And do you have any guidance for the first quarter, please? I believe, if I remember now correctly, we had positive mix throughout the year in all three business areas. So, really happy about that continued development. We have that now for several years and in more or less all our categories. So, we're still having a positive mix component. And as we have stated, we don't believe that downtrading should have such a big negative impact and that it will also be temporary, because our categories are not such a big part of disposable income in general. So -- but again, we are well set to manage any downtrading with broad offerings also catering to those customers to consumers, and that's also part of our innovation efforts for this year to launch more attractive assortments also in the good and better parts of the business. No. I think just to emphasize exactly what you said, mix is, of course, impacted by the downtrading, but overall positive. So, very good performance. May I squeeze in one last question? It would be on the net interest cost. It was SEK570 million in the quarter. Is that a good proxy for the coming quarters? Hi, there. Thanks for the follow up. Just wanted to clarify when you say raw material levels sequentially similar in the first quarter, do you still mean an impact of 100% on profit and not lower? And then, raw material deflation should start in the second half of the year as it stands right now. Is that how you see it? And then, just on energy costs, should we think about it bouncing back to over 30% impact on profit in the first quarter as subsidies and another one-off disappear? Thanks very much. Yes. Just not -- thanks for your questions, Victoria. I'm not 100% sure I understand, but let me just try and see -- try to answer, and please help me if I'm not answering. But what I was referring to before was the sequential, so stable in comparison to what we experienced in Q4 when it comes to price levels. So that was what I was referring to. If you take Q1 of '23 versus Q1 of '22, it will be significantly higher for all three business areas. So, that's what I meant. And when it comes to energy, we haven't given a forecast there. But as I mentioned previously, you saw that quite significant decline between Q3 and Q4 of 2022. So, roughly about SEK500 million, and they were mainly, you can say, related to one-offs. Not only, there is also better spot prices, but a big part was actually related to one-offs and the subsidies, and they are not expected to be there in Q1. So, hence, we'll see much higher energy costs. Thanks for taking my questions. I have three. First, on pricing in consumer tissue. You've mentioned competitors need to catch up on pricing, which would be favorable for your ability to raise prices. But also, you have some competitors which have had to stop production because of energy cost now coming back, which will put additional pressure on volumes and pricing. Can you give more color on the supply of consumer tissue in Q4? And how do these two factors balance out in your ability to further raise prices? Yes. So that's correct that especially in the third quarter, we saw some competitors who were actually stopping production because of the high energy costs, and they are back producing. Supply-demand balance in Europe is quite good actually. So, we don't expect that to have a big negative impact on our pricing opportunities in going forward. So, from a balance point of view, we've had a fantastic momentum throughout last year, and we aim -- of course, it's always very challenging, but there's no real change in the market environment looking forward. Okay, thank you. Then on your cost savings, as looking to the next two quarters, if you can give some, should we expect your cost savings initiatives to be offset by inflation, meaning that you will continue to have negative savings? Yes, I can -- we don't give actually a forecast. I can't give you that overview. As I previously mentioned there, we have a high activity when it comes to cost savings underneath, but whether that will be kind of on a net basis, positive or not, I can't really say. We don't give that forecast. If I could step in here, it's -- we're running over quite a lot, and I know I have some interviews coming up. So maybe we can take one last question. And then, unfortunately, it's great to have this discussion. But then, unfortunately, I think we have to close the conference. Like with all, both acquisitions and divestments or exits, it's nothing that we really can give any indications on beforehand, and there's nothing substantial that we're planning for in that area. Yes. Hello. Good morning. So, just one quick one on gross margin. A competitor of yours reported figures yesterday and said that at current input costs, they expect a year-on-year improvement in gross margin every quarter in '23. How do you reflect on this? And is that -- this is the case for you as well? Thank you. We don't give those types of forecasts. So, I can't really say anything more about that. We don't give the full year guidance and not on that detailed level. Okay. But just some comments on kind of how you think about the margin -- kind of the gross margin component? Gross margin is, of course, one of our key metrics and something that's also very visible in our incentive schemes. So, it's something we're working with very actively, and it's the improved gross margins that gives us the ability to continue to invest in the brands and in growing market share and improving net margins. So, it's a key component for us and a high priority always to work on improving gross margins in every way we can. Okay. So that was the final question, and you know where to find Johan Karlsson and Sandra Aberg for follow-up questions from the IR team. So, with this, we conclude today's conference. We wish you all a good day.
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EarningCall_1241
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Greetings and welcome to the Five Point Holdings LLC Fourth Quarter and Year-End 2022 Conference Call. As a reminder, this call is being recorded. Today's conference may include forward-looking statements regarding Five Point's business, financial condition, operations, cash flow, strategy and prospects. Forward-looking statements represent Five Point's estimates on the date of this conference call and are not intended to give any assurance as to the actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could affect future results and may cause Five Point's actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors included those described in today's press release and Five Point's SEC filings, including those in the Risk Factors section of Five Point's most recent annual report on Form 10-K filed with the SEC. Please note that Five Point assumes no obligation to update any forward-looking statements. Thank you, Joe. Good afternoon, everyone, and thank you for joining our call. I have with me today Leo Kij, our Interim Chief Financial Officer; Mike Alvarado, our Chief Legal Officer; and Kim Tobler, our Vice President Treasurer and Tax. Stuart Miller, our Executive Chairman is joining us remotely. I'm pleased to update you today on the progress of the Company through the fourth quarter and for the full year of 2022. I will also update you on our team's focus as we move through the current real estate market down cycle and our strategies for 2023. Next, Leo will give an overview of the company's financial performance and condition. We'll then open the line for questions to our management team. It is notable for the first time we're reporting our earnings within three weeks of the close of our quarter. We are in control of our business. As I wrap up my first year as CEO of Five Point, I'd like to recognize the extraordinary efforts of our team and to say I'm very proud of them. 2022 was a year of organizational transition, operating through the impacts resulting from the Federal Reserve's aggressive increase in interest rates. Through it all, the team has remained focused on our operational priorities. Turning to our financial results, consolidated net income in our fourth quarter was $22.5 million, and our SG&A was $13.1 million, a $4.5 million reduction in SG&A compared to Q4 2021. Consolidated SG&A for the year was $54.6 million a 29% reduction from 2021. We ended the year with cash and cash equivalents of $131.8 million. Two key successes contributed our fourth quarter positive results. The first was our execution on our commercial land sales strategy where the Great Park Venture closed on a very strong sale of approximately 42 acres of commercial land for $240 million or $5.7 million per acre. As a result of this sale and the strong cash position of the Great Park Venture, we received distributions and incentive compensation payments from the Great Park Venture of approximately $67 million. Our second key success during the quarter was renewal of our development management agreement with Great Park Venture which is now extended through the end of 2024. This extension reflects a strong value add that our management team brings to the partnership. As we start the New Year and being well aware that increased interest rates have changed the market dynamics, we will be focused on three main priorities: generating revenue, managing our capital spend and managing SG&A. Execution on these priorities should generate net positive cash flow for 2023 and provide the liquidity to allow us to capitalize on the opportunities that we expect to be available when the market stabilizes. With the establishment of our commercial land business, we now have two potential source of meaningful revenue, residential and commercial. During 2023, we anticipate that the Fed interest rate tightening cycle will end and the housing market will adjust the new interest rate environment, expanding buyer demand as the year progresses. Although we see 2023 as a transition year in residential, the one reality that cannot be denied is that in our California markets, housing is still in short supply and there is still demand for well-located homes in master planned communities. We will remain patient and manage our business to realities of the current market. To that end, we'll be looking to work with the builders to sell land at prices that reflect the balance between current market conditions and a scarcity of entitlement inventory in our markets. Following the successful commercial land sale at the Great Park last quarter, we remain optimistic in moving forward our unique commercial land offerings at the Great Park and Valencia, both of which are positioned with land constrained positioned with and land constrained markets. Additionally, we continue to have historic low vacancy rates in the industrial market, coupled with continued rent growth which we expect will continue to drive demand in this preferred asset class. With over half of land in our initial commercial offering that Great Park already sold, and continued interest in negotiations on remaining sites remain confident in the continued demand in the commercial markets for not only industrial uses, but for other uses as well. In many instances, we have the only entitled and ready developed commercial and industrial land of its kind in the market. Our desirable communities, our unique assets are complemented by a balance sheet that enables us to maximize value with patient offerings. At quarter end, our balance sheet reflected a $131.8 million of cash on hand and $0 drawn on $125 million revolver giving us available liquidity of $256.8 million and a debt to capitalization ratio of 25.1%. We also have no principal debt repayment obligations on our senior notes in 2023 or 2024. I'll now provide some updates on each of our communities. The open builder neighborhoods at the Great Park continue to sell homes, but at reduced absorption rates compared to last year. As has been the pattern in prior new home sales slowdowns, coastal California holds up better than in the markets and that is what we're seeing at our communities. During the fourth quarter, builders in our Great Park community sold 113 homes, up from 82 homes in Q3 and for the year sold 326 homes. Solis Park, which had its first model complex home in July of 2022, currently has 636 homes remaining sold at the original 849 even though these numbers are small by historic standards, based on the current pace of home sales, and typical time period for builders move from land acquisition to omni model homes, we believe that there will be a need for the builders again buying land again in 2023 to position themselves for new home sales in 2024. Our next residential community in Great Park District 5-South which is community of 719 homes and 11 neighborhoods, will be our focus in 2023. We previously brought this community market right before the Federal Reserve began its aggressive rate increases and after initial strong interest, new builders paused their land purchases. We've done new conversations with the builders and would anticipate moving forward on some of the sites this year. On top of the ongoing residential opportunities at Great Park, we're actively engaged in selling the balance of our initial commercial land offering. Our commercial parcels offer to the South County market something that's not been available for years, large parcels of entitled land of flexible zoning that allows a multitude of uses, including life sciences, R&D, office and industrial among others. In Valencia, new home sales by builders totaled 49 homes during the fourth quarter, down from 166 homes in the third quarter reflecting the limited available inventory. For the year, builders sold a total of 594 homes with 11 of 18 programs now sold out and currently only 323 remaining homes available from our initial 1,268 home offerings. Builders continue to work on their models for next year at Valencia, which encompasses 18 neighborhoods and 598 homes. These neighborhoods are expected to open in the second and third quarters this year, creating additional inventory to drive builder sales. While we did not close any home sites in 2022, we're still engaging with the builders like and currently looking at opportunities to add single family floor rent and multifamily floor rent products to our mix of offerings. In particular, multifamily is a strong real estate segment that could provide housing options for residents and land revenues for us even during this time when this [per sale] residential market is under pressure. Finally, we also have commercial opportunities in Valencia and we plan to bring -- sign 35-acre sites at market in the first quarter of 2023. San Francisco remains a priority for Five Point and for the city and county of San Francisco. It is irreplaceable land along San Francisco Bay with a broad mix of approved development opportunities. As we start the New Year, we have initiated the process to obtain approvable plan that rebalances the current development entitlements to facilitate Candlestick moving forward ahead of Hunters' Point Shipyard while still maintaining the overall community development mix. Concurrently, we're working with the city to update the existing tax increment financing timelines to account for the navy delays at Hunters Point. 2023 will be a pivotal year for San Francisco as we work through these issues and set the groundwork for the standalone development of Candlestick as the first phase of the larger mixed use community. In an effort to provide some context to the coming year, I feel it would be helpful to provide some sense of how we see this next year progressing. Clearly, there remains much uncertainty amid these challenging market conditions. Therefore, my comments will be more general in nature. First, I'd like to reiterate that the positive finish to 2022 gives us confidence in our commercial land strategy. We expect to have commercial land sales at Great Park and Valencia during 2023. Further, as we reengage with our guest builders over the next few months, we expect to be able to find mutually beneficial ways to structure and price our valuable residential land. At this time, we don't feel it will be prudent to provide estimates of the number of commercial acres or potential home site sales. We expect as majority of 2023 land sales will occur in the third and fourth quarters. Generally for the first half of 2023, we expect to generate cash from all sources of between $80 million and $100 million offset by total capital expenditures of $45 million to $55 million, debt service payments and other accruals of approximately $45 million and other expenses of $10 million for a cumulative expenditures of between $95 million and $110 million and by anticipated SG&A expenses of between $12 million and $13 million per quarter or approximately $25 million for the first half of the year. We will continue to look for additional savings opportunities in our SG&A. While our cash flow for the first half of the year is expected to be mildly negative, we continue to make constructive progress to a cash flow positive model, which we believe will be obtained by the second half of the year and into the future. In summary, our last half of 2022 was challenging for the entire industry and we are well aware of the headwinds we are still facing. We are cautiously optimistic about the opportunities available to us in 2023 and we're confident in our ability to capitalize on them. With a focus on accountability, we're looking to drive bottom line performance, create positive cash flow and fortify our balance sheet while building shareholder value. We will continue to monitor the impact of rising interest rates and inflation on buyer demand for housing and we'll adjust our plans proactively to preserve and maximize the value of our master plan communities. Despite the recent challenges created by market conditions, we have positive momentum and are feeling ever more optimistic about our future. A summary of our financial results was included in the earnings release issued earlier today in which we reported consolidated net income of $22.5 million for the quarter. We recognized $17 million in revenue that was mostly generated by our Valencia and management company segments. Selling, general and administrative expenses were $13.1 million which represents a reduction of 25.5% compared to the same quarter last year. The decrease reflects our reduction in headcount as previously reported during our first quarter earnings call. Equity and earnings from our unconsolidated entities was $26.2 million and was primarily a result of recognizing our share of the net income generated from the commercial land sale at the Great Park Venture that Dan described earlier. Turning to the balance sheet and liquidity, our net increased inventory for the quarter was $9.6 million. This increase includes accrued capitalized interest on our senior notes of $12.3 million and a decrease of $27.7 million for reimbursement from the Communities Facilities District or CFT for certain public infrastructure costs that have been incurred as part of the development process at our Valencia segment. This is the first CFT reimbursement we have received since we started the current development in Valencia. As a community grows, and the qualifying costs are incurred, we expect to receive more reimbursement. We paid semiannual interest of $24.6 million on our senior notes and we paid $4.1 million including $700,000 of interest against our related party EB-5 reimbursement obligation. Distributions and incentive compensation of $66.9 million was received from our interest in the Great Park Venture and we also received a distribution from our interest in the Gateway Venture of $8.6 million. As recently reported on an 8-K filing, our development management agreement with the Great Park Venture was renewed through 12/31/2024. The compensation payable to our management company during the renewal term remains unchanged and includes a monthly base -- which includes a monthly base fee payment and incentive compensation payments equal to 9% of any distributions made by the Great Park Venture to holders of percent interest. Total liquidity was $256.8 million at quarter end. This is comprised of $131.8 million of cash and cash equivalents and $125 million of available borrowing capacity under our revolving credit facility. No borrowings or letters of credit were outstanding as of December 31. Our debt-to-total capitalization ratio was stable at 25.1% and our net debt to capitalization ratio after taking into account our cash balance was 20.9%. The company has four reporting segments Valencia, San Francisco, Great Park and Commercial. Segment results for the fourth quarter are as follows. The Valencia segment recognized a $509,000 loss for the quarter. There were no land sale closings in Valencia. However, the segment did report revenue of $3.8 million. Most of this revenue related to changes in estimates of variable consideration from the amounts previously recorded on prior land sales including profit participation that we collect from our homebuilders. Segment revenue was offset by selling, general and administrative costs of $3.1 million that were mostly comprised of employee compensation, as well as selling and marketing costs in support of our active development areas. The San Francisco segment recognized a $1.2 million loss for the quarter. This loss is comprised of general and administrative costs incurred to support the segment's continued focus on reassessing the development plan and the approval process for our San Francisco assets. Our Great Park segment reported net income of $93.7 million for the quarter, which is comprised of $5.1 million and net income generated by our management company and net income of $88.6 million from the venture's operations. As it relates to the management company, Five Point recognized $13 million in management fee revenue during the quarter, $3 million of which was from monthly base fee payments and $10 million of which was from non-cash revenue recognized for changes in estimated incentive compensation payments expected when the venture makes future distributions. Offsetting these revenues were expenses of $7.9 million comprised of $2.2 million for the cost of providing management services primarily the project team compensation, as well as $5.7 million of amortization expense associated with our development management intangible asset. The venture's operations recognized revenue of $244.4 million during the quarter. This is mostly comprised of the sale of approximately 42 acres of commercial land for a purchase price of $240 million. Offsetting these revenues were cost of land sales of $140.6 million, SG&A of $2.5 million and related party management fee expense of $14.7 million. Management fee expense is comprised of $3 million of monthly base fee payments and $11.7 million increase in accrued incentive compensation resulting from a change in estimate of aggregate payments probable of being made as the venture makes future distributions. We own 37.5% interest of the Great Park Venture and 100% of the management company. Although the Great Park segment reports to full results of the Great Park Venture, our investment is reported under the equity method of accounting and therefore the assets, liabilities, results of operations and cash flows of the venture are not consolidated within our financial statements. The company's equity and earnings from the Great Park Venture after adjusting for investment basis difference of $7.2 million is $26.1 million for the quarter. The Great Park Venture is a self-funding operation with no debt and had a cash balance of $149 million at the end of the quarter. Moving to our Commercial segment, we had a net loss of $192,000 for the quarter. This included a $300,000 loss from the operations of the Gateway Commercial Venture and $100,000 in income from the services provided by our management company. The venture is a self-funding operation and had a cash balance of $5 million at the end of the quarter. We own 75% of the Gateway Commercial Venture and 100% of the management company. Our investment in the venture is reported under the equity method of accounting and therefore the assets, liabilities cash flows and results of operations of the venture are not consolidated in our financial statements. Five Point's equity and loss for the quarter from the Gateway Commercial Venture was $224,000. Hi, guys. Good afternoon. How are you, Dan? Good to hear you. Thanks for all the information. Very helpful, especially kind of the cash flow buildup for 2023. I think that's hopefully helpful for people. I know it's more information than you've provided in the past. So appreciate that. I guess before we drill into some of the details on that, just in terms of the builder appetite for land. Clearly, the fourth quarter was a pretty challenging environment and I think last quarter you had kind of signaled maybe you would get some residential lot sales in the quarter and obviously that didn't happen. But it seems like the news flow is getting a little bit better here over the last handful of weeks. Builder sentiment improving, rates continuing to move lower, kind of the normal seasonal uptick is starting to kick in here ahead of the selling season. So I'm curious if you've had any more recent conversations with builders since the New Year? Has there been any indication that the builders are looking to maybe dabble back into the land market after kind of moving into the sidelines in the back half of last year or do you feel like they're still in wait-and-see mode kind of trying to figure out how the selling season unfolds? Alan, that's a real good question. And the answer is that we actually all of the builders that were engaged prior and we call D5 South, we've already had conversations with them this month. A number of them are sharpening pencils and starting underwriting again. We actually have one sale that we were in negotiations last year that actually is still in process, it's kind of kicked over this year that we're still actively trying to wrap up the final pieces of that. But the - what isn't doesn't jump out of these numbers, especially if you think about Great Park in particular. We had 18 sales last week at Great Park. The available inventory at Solis that's all was left in the Great Park. It will be sold out by year end. So all the builders we're talking to are all thinking about their 2024 having a product available in 2024. And as you know, it's not too early to start working on that. So, long answer to your question, but we have four or five builders actively re-underwriting right now. And so we expect to do well there. Alan, I'd just say, the signs are positive. I mean, so I would say the early signs very positive. But obviously, we're going to wait-and-see hopefully next quarter and tell you more, but early signs are positive. Great. I do have a couple of quick housekeeping questions, I'll just ask quickly, hopefully we can check through them. Number one, I might have missed it. Did you give the cash balance number in Great Park at year end? I think that's the number you've provided in the past? And should we think about the cadence of the distributions kind of like the last few years? I think it's been more in the back half of the year or maybe after a lot of land sale. So should we think about that similarly in 2023 if you have a land sale in the back half of this year that should coincide with another distribution? Alan I don't have to - yes I mean, certainly as we have the year-end land sales, we would anticipate additional distributions. But it is necessarily all tied to that because the partnership is very conservative and made a conscious decision at the end of the year to hold on to additional cash as they see how this year sorts out. So I think we were - are not necessarily tied to land sales as much as we're tied just like everyone else, a little bit of clarity on how the market is moving forward. Got it, that makes sense. Another question here so you mentioned the plan for San Francisco sounds like looking to move forward with Candlestick there. Just thinking through the cash flow, I'm assuming once you guys get that plan approved or we get to move forward with it, there's going to be some development expenses that need to occur obviously before you book any revenue. Is that contemplated at all on your 2023 expectation for cash flow to have any development expenses there? And if not, what do you expect those expenses to look like once they do begin to kick in? Well, the first part of your question, we are not expecting any of those expenses in 2023. And you know the - what it's going to take to kind of kick that off obviously, we'll have a lot more clarity as we get closer to that point in time, but getting to the first commercial pad because of Candlesticks relationship to the 101, if you remember, it used to be an active ballpark, people could get off 101 and go there. It's actually compared to a lot of projects not that extraordinary. It's real money. I don't want to mislead you at all. But I - to try to estimate what that would be right this moment, just be a little bit early, but the first pad is very accessible from the 101 Freeway. Got it, okay. That's helpful. And then final question, I think you said in that cash buildup that you expect about $80 million to $90 million coming in the door in the first half of the year. Can you kind of just break that up a little bit? Is that - are those commercial land sales, is it apartment sales, residential distribution to any additional guidance you can give on that? Yes, it's a combination and really - I'll start at the bottom, actually we finished. I mean, we are expecting an interim distribution in the first half of the year based on our view of the market. So it's really a combination, it's combination of operating revenue, CFT reimbursements and recoveries, sales that we are currently working on and then obviously the distributions I just mentioned. And so within that basket of opportunities, we see - we have visibility $80 million to $100 million in the first half of the year kind of in that basket and how it finally settles out, I can't tell you right this second. But we're feeling very good about that kind of basket of opportunities. Perfect, all right. Well, thank you for taking all of my questions here. I appreciate the time and best luck with everything. Great, I was just wondering if you could talk a little bit more about the management agreement and what material changes there besides the economic side? And can you talk a little bit about why there's change control added to that? Thanks. So from the economic side of it, it really is when we did the one year extension last year, we kind of changed the economics from a standpoint of kind of reimbursement cost to kind of just a set monthly management fee. And so that part has remained exactly the same. That's just rollover exactly as it is. And we added basically two years and there's been no change to our preferred return earning in connection with that. So that it's really the big - the one change was really that adding those - actually just adding the time. On your question about the change in control, our partners in that are obviously very senior folks and we have spent a year and I've spent my year working with them and really working on that relationship and they actually really like the management team in place today. And so one of the things that they've kind of said is, hey, we really like how everything is working today and we want to be sure that if you Dan or Mike or Stewart aren't engaged that we have an opportunity to speak into that because we've got a very good operating relationship today - going together. So it's really kind of more around kind of that keyman question. And the change in control is - and that's going to also - it's also a continuity issue for them. They really want continuity because of what we've been able to achieve the past year. That makes a lot of sense. Really appreciate all that color. And can you talk a little bit about extra access to liquidity if you guys have a more prolonged slowdown and maybe if rates don't really move and building kind of freezes up for a little bit longer? Well, obviously, we have the $125 million line that has zero drawn on it. As we kind of project out the market where we're going, we don't have the thoughts that additional liquidity will be needed. And certainly, if the market doesn't recover we will be reducing costs materially. Right now, we've got capital for revenue communities later this year and into 2024, there is some capital, although we're being very careful about it that needs to be spent. If we really believe there wasn't an opportunity to generate revenue, we would stop all of that, which would clearly help liquidity. Hi. I just wanted to start by saying this through it, I started my career in IR at Lennar and I learned so much there and you really have the hardest working in world class treasury and accounting teams. So now on to Dan, can we expect that you guys might build more homes through a fee build program. This was a very successful program when you guys did it. And it would emphasize to your guest builders that there -- that you guys are working with scarce resources that if they don't prioritize, you will. Robert, help me on what is your last comment? I'm not quite followed. If we don't prioritize they will, what are you thinking there? Like you guys had a fee build program where you guys were able to recognize good profits on and so you guys could go ahead and do that again if your guest builders don't purchase the land from you. Okay. All right. Thank you. I understand. That's a good question. It is certainly, I take nothing off the table. And in my career, I have done fee builder extensively use it at a different life to come out of '08, '09. And so it's a model I'm extremely familiar with. We haven't seen the need right now based on the conversations we're having with builders, but it's certainly something that I'm familiar with and it's something that we could definitely move to quite easily that's really where the market moves us. Okay, great. Next question on the related party tax liability. S&P is including this debt in their calculations. Can you speak to any potential overhang here? Yes. I think -- yes, I'm sorry, we have [indiscernible] can I think can probably address that question by the time, but you want to repeat the question to make sure that we answer it correctly? Yes. S&P is treating this as debt now on their calculations, they're saying they don't know if you'll recognize the tax savings and you'll still have a liability associated with it. So just like how should we think about this. Yes Robert, we've actually had conversations with the rating agencies about that and clarified that the TRA is a projected obligation based on our ability to use it. And our expectation today is that those payments would occur after the bonds expire. So it doesn't affect the collect - and our ability to pay the bonds and I want to reiterate the obligation only arises if we benefit from saving taxes. So to-date, the partners, the prior partners have been paying taxes that we would have otherwise paid, but because of the way the calculation is made, we haven't yet benefited. So just if that - did that help you? Absolutely, I just got one more, which is can we talk about the stages of completion of the various home sites that you own? It seems like a lot of them were slated to close this year, they should all be close to completion or ready to be sold. So if we had how many were completely finished or how many were close to being finished, like work in process, we could kind of know the liquidity of the lots whether they could go to land banks or spec builders should custom builders have dropped out. So that's my last question? Thank you. So Robert, let me first talk about Great Park. We had D5 South moving right along last year and once again being prudent when the sales weren't materializing, we've got the black top down and we've got all the wet sand and we [stopped that dry]. So we can complete those lots quite easily. So we're kind of in - we're kind of in a good place there and it will be the next place that we - next community we open in Great Park and it's in, as you say, it's in very good shape to move forward - about a lot of additional capital but just to remind everyone all that is self-funded through the partnership. And we've got substantial liquidity to do what we need to do on those, but that's actually in very good shape. And then when you get to Valencia. Valencia we have actually some sites that are - I kind of call them really more of infill sites that were in the early parts of the Mission Village, which is what we kind of call the first area there. They're actually ready to go. They're [mass grading] all of them structures in them and everything is stubbed. And then we have some other areas that we need to go back that are still mass grading streets cut. The storm drains are in but we're going to need to go back in and pay them out and put in wets and dries. But once again, we're - the next areas we go into there, that's kind of where we're at. The mass grading, let's say, streets are gutted. Storm drains are in. So we're in pretty good shape there also, but it will take a little more capital there as we move forward. Thank you. Ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the call back to Dan Hedigan for closing remarks. Thank you. On behalf of our management team, we thank you for joining us on today's call and we look forward to speaking with you next quarter. Thanks everyone.
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EarningCall_1242
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Hello everyone and welcome to the First Interstate BancSystem, Inc. Fourth Quarter Earnings Call. My name is Nadia, and I will be coordinating the call today. [Operator instructions] Thanks, Nadia. Good morning. Thank you for joining us for our fourth quarter earnings conference call. As we begin, please note that the information provided during this call will contain forward-looking statements. Actual results or outcomes may differ materially from those expressed by those statements. I'd like to direct all listeners to read the cautionary note regarding forward-looking statements contained in our most recent annual report on Form 10-K filed with the SEC and in our earnings release, as well as the risk factors identified in the annual report and our most recent periodic reports filed with the SEC. Relevant factors that could cause actual results to differ materially from any forward-looking statements are included in the earnings release and in our SEC filings. The company does not undertake to update any of the forward-looking statements made today. A copy of our earnings release, which contains non-GAAP financial measures, is available on our website at fibk.com. Information regarding our use of the non-GAAP financial measures may be found in the body of the earnings release, and a reconciliation to their mostly directly comparable GAAP financial measures is included at the end of the earnings release for your reference. Joining us from management this morning are Kevin Riley, our Chief Executive Officer; and Marcy Mutch, our Chief Financial Officer; along with other members of our management team. Thanks, Lisa. Good morning, and thanks again to all of you for joining us on our call today. Again this quarter, along with our earnings release, we have published in an updated investor presentation that has additional disclosures that we believe would be helpful. The presentation can be accessed on our Investor Relations website and if you have not downloaded a copy yet, I encourage you to do so. I'm going to start off today by providing an overview of the major highlights of the quarter and then I'll turn the call over to Marcy to provide more details on our financials. Our fourth quarter performance capped off a very strong year for the company as we executed well on the integration of our merger with Great Western, realizing cost synergies we projected for the transaction while continuing to generate solid organic loan growth throughout our footprint. Specific to the fourth quarter, it was a bit noisy with a handful of clean-up items that should set the stage for strong 2023. While these items had a $0.07 impact on earnings per share in the quarter, we continued to execute well and saw continued positive trends in our loan growth, core margin expansion and asset quality. As a result, excluding selected items which we will walk you through, the company generated $0.89 of earnings per share. It is worth noting that this quarter included a $0.07 less contribution from purchase account accretion because of fewer early payoffs. We also added to our already robust allowance for credit losses despite continued improvement in asset quality and only two basis points of net charge offs in a quarter. As you can see on Slide 10 of the investor deck, our ACL coverage ratio has expanded meaningfully over the last two quarters. With this strong financial performance and a shift -- positive shift in AOCI, we saw a 2.3% increase in our book value per share and a 4% increase in our tangible book value per share from the end of the prior quarter. The banking environment continues to be favorable for us in the fourth quarter, which we were able to take advantage given our strong capital and liquidity position. Many banks seemingly to pull back on loan production due to capital and funding rates, we were pleased with our ability to win deals. In our larger footprint and increasing production from our newer markets, we saw plenty of high quality lending opportunities. As a result, while maintaining our conservative underwriting criteria, we were able to generate our highest level of loan growth of the year with total loans increasing at an annual rate of 11.1%. Going forward, we will be selected in our growth opportunities as the environment remains uncertain and funding is less bountiful. As such, we are truly planning for a slower pace of growth in 2023 than we experienced in the second half of 2022. The largest area growth during the quarter came in our commercial real estate, much of which was the result of construction loans moving into this portfolio. The majority of these projects were multi-family properties, which given the high constraint in many of our markets and the significant demand of affordable housing are strong low leverage credits that we are adding to the balance sheet. Overall, the average rate on our new loan production in the fourth quarter was between 5.5% and 6%, which was up considerably from the prior quarter and progressively increased as the quarter went on. However, the average rate on loans funding on the balance sheet was lower as prior construction commitments made earlier in the year funded this quarter. This trend will impact us for the next several months with projects and process. On the deposit side, we indicated on our last earnings call that we expected balance to be relatively flat in the fourth quarter and they were earlier in the quarter. The outflow in the fourth quarter was concentrated in the month of December. While it appears the outflows were largely seasonal in nature, there is an element of depositors putting some of their excess liquidity to work. Going forward, while our base case for 2023 suggests flat deposit balances year-over-year, we do expect normal seasonal declines in the first quarter. We also anticipate a mix shift out of non-interest bearing and lower cost balances into our index money market and CD specials. You should expect to see deposit betas increase accordingly, but remain relatively benign over the full cycle when compared to prior cycles. In term of -- in term of time deposits as a third quarter, we continue to selectively utilize our ability to offer higher rates to add and to retain profitable long-term relationships. While this has placed some upward pressure on our deposit costs, to this point, the expansion and earning asset yields has outpaced those increases and our adjusted net interest margin expanded by another two basis points this quarter. While this margin expansion trend will be harder to sustain going forward due the balance sheet mix, we do anticipate to see good year-over-year net interest income growth in 2023. Despite the more challenging economic conditions, our asset quality trends were favorable again this quarter with total amount performing assets decline by 24% and net charge-offs of just two basis points. Criticized loan balances were modestly higher. However, there was nothing unusual about the inflows we experienced here. As you know, credit was the biggest question mark heading into the acquisition, and our board recognized that well. During the fourth quarter, we exceeded targets of -- targeted reductions of non-performing assets and criticized loans set by our board. This resulted in a $4.2 million incentive compensation adjustment, you see referenced in our material. Over the -- over the portfolio -- overall, the portfolio continues to perform extremely well and we are pleased with the significant improvements we have made since closing in the Great Western acquisition. And with that, I'll turn the call over to Marcy's for some additional details around the fourth quarter results. Go ahead, Marcy. Thanks Kevin, and good morning, everyone. Just to make sure we're providing clarity, I'll start by summarizing the notable items that impacted our financial results in the fourth quarter. We had $3.9 million in merger related expense, $4.2 million of additional incentive compensation related to asset quality improvement, which Kevin mentioned, a $1.3 million additional litigation accrual, which has now been settled and a $400,000 reduction to the fair value of loans held for sale. In aggregate, these items had a $0.07 per share impact on our fourth quarter financial results. Additionally, the purchase planning accretion declined by $9.3 million from the prior quarter or $0.07 per share due to lower levels of early payoffs. Now, I'll move into the rest of our financial results, which unless otherwise noted, will be in comparison with the third quarter of 2022. Our fully tax equivalent net interest income decreased by $8.2 million, which was entirely due to a lower impact from purchase account accretion as I just noted. Excluding purchase accounting impacts, net interest income increased by $1.4 million. Our reported net interest margin decreased 10 basis points from the prior quarter to 3.61%. Again, excluding purchase accounting accretion, our adjusted net interest margin increased by two basis points to 3.49% from the prior quarter, driven by a favorable shift in our earning asset mix and an increase yields on loans, investments and cash. This offset the 36 basis point increase we saw in our cost of funds. As you have likely already noted with strong loan growth and deposit outflows, we increased our use of short term borrowings in the quarter, which ended a little over $2.3 billion. As noted on Page 14 of the investor debt, cash flows off the securities portfolio should mostly fund loan growth from here, but the higher balances of wholesale funds to start the quarter will mean we will see some compression in our adjusted net interest margin in the first quarter. From there, the net interest margin percentage will be a function of the mix of both earning assets and liabilities. During the quarter, we added $850 million in notional forward starting received fixed swaps against both loans and investment securities. Together with the changes in the composition of our balance sheet, we are now essentially neutral to changes in short term rates. In 2023, net interest income growth will come from a combination of net loan growth and the remixing of our assets out of securities into loans and our liabilities out of borrowings into deposits. Ex purchase accounting impacts, we expect Q1 2023 net interest income to be down compared to Q4 2022, primarily as a result of lower day count and some margin compression. For the full year 2023, we expect net interest income growth to be in the low double digits again, excluding purchase accounting accretion. As you can see on Slide 12 of the Investor Presentation, we expect scheduled purchase accounting accretion to be about $15.8 million in 2023. This does not include accretion from early payoffs, which will likely be immaterial in 2023, given the current interest rate environment. Overall for 2023, we expect average earning assets to remain relatively unchanged from Q4 2022 levels at around $29 billion. Our total non-interest income increased $18.7 million quarter-over-quarter to $41.6 million, primarily due to the loss on investment securities realized in the third quarter. Excluding investment securities losses, non-interest income fell short of our expectations declining by $5.5 million from the prior quarter. This included a net $400,000 reduction to the fair value of loans held for sale, a decline in swap revenue to near zero and lower payment services revenue resulting from declines in transaction volumes. We also increased our earnings credits in the quarter, which reduced our service charges on deposit accounts. For the full year 2023, as a result of the NSF and overdraft fee changes we made partway through 2022, lower swap revenue and other fee income expectations, we expect non-interest income to decline by low single digit percentage when compared to reported 2022 revenue excluding the securities losses. Second half results are likely to be stronger than the first half of the year as we begin to realize revenue synergies within the Great Western footprint. Moving to total non-interest expense, while it was a little messier this quarter than anticipated, on a run rate basis, we landed where we expected in the range of $163 million to $165 million. As noted earlier, reported results included a $3.9 million acquisition expense, $4.2 million in performance related incentive adjustments, a $1.3 million litigation accrual, as well as a $2.2 million expense related to the writedown of an OREO property. Net of these items, non-interest expense was $163.7 million and our run rate efficiency ratio would be closer to 53% in the fourth quarter, which by definition would also exclude the $4.1 million of intangible amortization expense. For the full year 2023, we expect operating expenses to increase in the 3% to 4% range from the full year 2022 expense base of about $647.1 million, excluding merger expenses. The two basis point FDIC surcharge accounts for 1% of that growth or around $6 million. Moving to the balance sheet, our loans held for investment increased $496 million from the end of the prior quarter with growth in all major portfolios with the exception of construction and commercial. As Kevin mentioned earlier, the decline in construction loans was primarily attributable to projects being completed and moving into our commercial real estate portfolio. On the liability side, our total deposits decreased $811 million with much of the decline coming in non-interest bearing deposits due to the seasonal outflows and clients utilizing some of their excess liquidity as Kevin noted earlier. This was partially offset by increases in our balances of term deposits as we see more customers taking advantage of the higher rates now being offered. The net outflow in business deposits and we were encouraged that consumer deposits held flat. Moving to asset quality, we continue to see positive trends with non-performing assets declining 24%. Criticized loans increased only modestly from last quarter. Our loss experience continues to be very low with net charge offs of just $1.1 million or two basis points of average loans in the quarter. Strong loan growth and qualitative additions related to a more conservative economic forecast push our funded allowance up by $7.1 million from the prior quarter, resulting in a modest increase to our ACL to 1.22% and an increase in our coverage of non-performing loans, which now stands at 3.3 times. Our total provision expense for the quarter was $14.7 million, which included $6.5 million related to unfunded commitments. Thanks, Marcy. Now I'll wrap up with a few comments on our outlook and priorities for 2023. 2023 is shaping up to be a more challenging year with more uncertainty around the macroeconomic environment and the path of future interest rates, which is complicated by the quantitative tightening. While we are mindful of these circumstances, our franchise has never been stronger and our balance sheet is in great shape with strong levels of capital, liquidity and reserves. We believe we are well positioned to effectively manage through a wide range of economic scenarios and continue to play offense. With a loan deposit ratio in the low seventies and strong credit quality, our fundamentals are strong. Our core deposit base will remain a focus this year, which as you all know is core to the strength of our franchise. We also will continue to focus on scalability, automating manual processes, enhancing our product sets and right sizing our departments while maintaining talent. As the company has grown over the past decade, we have not deviated from our conservative approach to loan underwriting and risk management. 2023 will be no different. As Marcy and I have alluded to, the piece of net interest income growth is likely to moderate when compared to the past few quarters. As such, we are focused on what we can control. We will remain highly selective in loan growth we are booking, which should yield mid-single digit growth in 2023 while moderating from the double-digit pace we have delivered in recent quarters. We believe this level of activity is prudent for what we see in our markets today. Going forward, we intend to have greater focus on C&I. To support this effort, we plan to launch an ABL business later this year and we will redouble our effort in our small business lending. We are actively pursuing new household growth and deepen existing relationships to generate favorable deposit trends. We are physically viciously pursuing the managed synergistic opportunities the Great Western acquisition affords us, which is a differentiator for First Interstate this year. We expect these to show up in payment services, home lending, treasury management and indirect. We have, and we will continue to be out front actively managing our credit book. As such, at this point, we do not see significant credit deterioration on the high rise. And finally, we'll remain vigilant in managing our expenses and expect to deliver a solid year of positive operating leverage as we drive toward a sustainable efficiency ratio in the low 50s. In wrapping up, I would be remiss not to thank Russ Lee, who retired at the end of the year. Russ joined us after our IMB acquisition and has been instrumental in moving us forward since that time. I'd also like to welcome Ashley Hayslip, our new Chief Banking Officer. Ashley has joined the team in a challenging banking environment, but we are confident that she will help us continue to grow our client base. With this addition, I have an executive team in place that I'm very excited about. They are diverse in age, gender, and background. I am confident they'd have the ability to continue to move the company forward. I would also like to take a moment to acknowledge Ross Leckie, who retired from our Board of Directors earlier this month after having served as a Director for more than a decade. On behalf of the entire board, I want to thank Ross for his many years of valuable service to our company. So in summary, while we expect 2023 to be a challenging year from a macro perspective, these are times when the strength of our franchise is most valuable. We are well positioned to protect shareholder value during an economic downturn, while continuing to make progress on strategic initiatives that we believe will continue to enhance the long-term value of our franchise. And ultimately, given the strong execution we are seeing throughout the organization, we believe 2023 will prove to be another positive year for the company and our shareholders. [Operator instructions] And our first question today comes from Jared Shaw of Wells Fargo. Jared, please go ahead. Your line is open. Just I guess a couple questions. Maybe first on funding, it definitely seems like there's been a shift in the outlook on funding in sort of your comments last quarter on the expectation for beta being smaller or lower. How should we be thinking about funding from here and do you think that we get back to DDA, when do DDA balances recover or should we expect that they continue to outflow and are the FHLB borrowings more temporary until we see that reversal? Or do you think we sit on higher FHLB borrowings for a while? Well, I think the FHLB will be here for a while, Jared, but hopefully during 2023, we see a shift, as they slowly go out and reduce over time. That's what we expect to see. So yes. So Jared at this point, we're -- we've said all along that our last cycle beta was 27%. We're still below that right now. We expect it to kind of still stay in that range. It may bump up a little as we increase deposit costs, but nothing material at this point. Okay. and then on the asset yields, the loan yields were a little weaker than we were looking for. I hear your comments on the funding of loans that were previously committed. Where should we be thinking the loan yields trend from here and maybe starting to see any ability for spreads? So new loan yields are coming on in the high five. We'll still be hampered by those construction loans that are funding at lower rates, which will be below kind of our core loan yield. Okay. All right. I guess maybe just shifting to expenses, when you look at the expense base that we should be growing off of, I guess that includes some of the stuff we're calling out as non-recurring this quarter. So is that one, the right way to be looking at it? And then two, when you look at that incentive comp that happened this quarter what are the incentive targets for next year that we should be thinking about, it says triggers for potential incentive payments through '23? Well, the incentive comp is going pretty much back to the normal incentive comp plan that we've had in our proxy for years. It's not going to change, but this was just a unique item so that the board and management would focus really on asset quality because going into the Great Western acquisition, that was probably the biggest question on everybody's mind. So that was just one additional aspect. There's no real other changes with incentive comp with regards to what we've, our normal practices have been. And, Jared as far as the 6.47%, if you -- we talked all year about the fourth quarter kind of base run rate to be around $160 million or $161 million. If you take that quarterly rent rate times somewhere between 3% and 4% inflation plus the FDIC insurance adjustment, you get to the same place. So again, we were just trying to simplify that by using the 6.47% expense base, with between 3% and 4% inflation and that includes the FDIC insurance. So you get the same place either way. Okay. Thanks. And then just finally for me, maybe you have thoughts on capital management here. You brought back stock earlier in the year at higher prices. How do you feel about capital ratios here and potential for buybacks? Well, Jared, as you know, you've been around us for a long time. We have a number of arrows in our quiver that we use. We look at how to effectively use our capital. That's one of them. And we always are analyzing our capital levels and what we might do going forward. So that's all I can pretty much say on that. And the next question -- the next question goes to Chris McGratty of KBW. Chris, please go ahead. Your line is open. Oh, great. Thanks for the question. I guess Kevin or Marcy, the math you gave us on the growth in the margin, maps very similarly to the earnings that you gave when the merger was announced, $3.65 or so, plus or minus. But we've had much higher rates and so it feels like there's been a notable change. Obviously the margin's getting harder for everyone, but I guess what am I missing is that changed so much in the earnings power Okay. Yeah, it feels like the, I got the NNSF and FDIC. It feels like it's more the NII in the deposits that are absolutely deposit, mainly deposits ground? Yep. I get it. Kevin, in terms of next step for maybe following on Jared's question, what are the thoughts on doing another deal? Obviously the balance sheet's in great shape. You got a ton of capital. Deals are -- good deals get struck when really no one wants to do them, but what are the thoughts on doing a deal? I get the next question as well, Tom. Maybe cause I do deals. The thing is, Chris, I'll be honest with you. Right now, I think when you -- when you look at banks, people are worried about the AOCI where that's going to go. People are worried about credit, where that might go. So, what we're focused mainly on right now is preparing this institution to be scalable. We're making all the operations and everything and get prepared if one comes about. But we're not going to rush in anything. We're, more focused on driving positive operating leverage within the institution. But if something comes up that's, that we believe, as you always know, we have a, a priority list of banks that we believe will increase the franchise value of this company. And we're kind of sticking to that list, and if something comes along, we'll look at it. But, as you probably know, there's a lot of banks out there for sale, but we're not interested in all the ones that are out there for sale. So we're just, we're going to stick to our knitting and, and make sure this bank is, is, is performing at the ultimate level of performance. And then if something comes up that's, that we believe will increase the franchise value, we'll go to it. But nothing is right currently on the horizon. This is Adam on for Matthew Clark. Just to go back to Jared's question on the deposit balances. Overall, they came down this linked quarter do you expect a similar decrease in the first quarter or maybe slower? Curious about your comments on that. Well, seasonally, if you go back, I mean, as you know, the pandemic through all sorts of seasonal trends out of whack. So if you go back earlier a week before the pandemic seasonally, we see a little bit of decline in the first quarter. And then we start seeing deposits start picking up in the second quarter and faster in the third. That's kind of the seasonal direction. So that's kind of what we're expecting this year because I think what we have seen as the excess deposits go out in 2022, that's slowing down. And then go back to our data in a sense where a lot of our deposits, we increased our deposit pricing a while back with the index money market account and CD rates. So a lot of our customers have been already migrated over to some of these products and are satisfied. So we're just expecting maybe a little bit of seasonal decline in the first quarter, but I feel like things will start moving in the right direction once we start going further into the year. And then moving over to credit. I know you mentioned that the uptick in criticized here isn't a concern, but I was wondering if you could provide some additional commentary on kind of where that came from? Was it several credits geography or sectors? Yes. So overall, the portfolio, there was no overall decline in the portfolio. In fact, it did fairly well. It was really driven by 3 relatively large credits that totaled a little over $98 million, which drove down our criticized performance that increased that by a corresponding $38 million. So you can't net those three credits out. But if you look at the overall portfolio, the trend was actually positive in criticized. Hey, Kevin, and Marcy. This is Zack on for Andrew. Just some housekeeping questions here. Do you have the monthly December NIM available? I appreciate it. Today's results were clearly a sizable operational miss on earnings reflected in the stock price today. Prior calls that I've listened to you guys have been very optimistic about the operations. It seems to me that there's a notable change in that viewpoint. Can you address why investors should have the same kind of confidence in you based on this quarter's results as they should have maybe previously? Well, that's pretty -- I would say that the operating performance is strong. It might not be -- if you go back and look at the earnings projections as people under thought what we were going to perform earlier in 2022 than they might believe they overestimated what we're going to end up. The performance of the company really hasn't changed much. The only thing that I would say that's different is that we had some deposit outflows in the fourth quarter that we didn't anticipate, but the fundamentals of the operation of this company have not changed at all, and quite frankly, get stronger and stronger month by month. Well, I get that, but this is clearly an operational miss by a significant amount. And I guess I'm a little bit taken back by why that's surprising? I know that Glacier reports at the same time as you. But in looking at cost of funds, your cost of funds widened compared to theirs. I mean you guys were at 28 basis points in the third quarter. They were 15. So there was a 13 bps gap. You're 64 in the fourth quarter, they're 35. So now it's a 29 bps gap. And I'm just wondering if you've had a chance to look at how they performed on that side, and you could explain maybe what the differences are and why yours gapped out more than theirs? So the thing is this, the gap out because we're trying to take care of our customers and retain deposits by paying up and putting people into money market accounts and CDs. And we started that back in the third quarter and taking care of our customers. The fact of the matter is, if you look at our performance, our margin has expanded. Their margin barely expanded over the second and third quarter. This quarter, it went down. I think the only net up in the core and the margin a little over six basis points for me. It's a whole different ballgame. We're making a lot more money on the rate increases, and we can afford and still have margin expansion by paying our depositors and trying to retain that business. So it's just a different model. I'm aware of that, but people are going off of the guidance that you provide on a quarterly basis, and there was clearly a difference in expectations versus what happened. And that's what's driving my question. You just said you made a lot of money, and I'm just asking if that's the case, why didn't it fall to the bottom line? Why wouldn't it have been better to sell some securities, let that part of the portfolio run off, let the loan-to-deposit ratio go up instead of taking on expensive borrowings? Well, if you -- I'm not going to get how you run a balance sheet because let somebody else talk about that. That's not an effective approach. So we will take the next question please. This is Andrew on for Jeff today. Just a couple of quick questions on loan growth. You guys mentioned -- you guys noted earlier, higher production in new markets, and you're seeing opportunities to grow new loans. I was just wondering what -- where you guys are seeing the most growth and the most opportunities by state or by region? The interesting thing, quite frankly, is pretty even across our whole footprint. There wasn't really any one market that outperformed another. So it's pretty level across our whole footprint. And then another one kind of following up on that. Are you guys winning new relationships in those new markets? Or are they just good markets in general? Well, I think we're winning relationships because we're growing the assets. So we have net customer account increases. So we are winning customers and it's, again, pretty much even across our footprint. The comment in the deck about being neutral to rates with the balance sheet today, it would feel like that's perhaps on the conservative side of the Fed cuts. So the Fed cuts, the pressure on the funding would seemingly ease. I guess, number one, you kind of agree with that? And then two, can you just remind me, Marcy, the beta -- the full beta assumption that's in the '23 guide? Yes, Chris, what we're trying to do is as we said in the past, many calls is that we were rotating our balance sheet to be less asset sensitive and to prepare for the downturn. And I think we struck some good derivatives or interest rate swap that Marcy mentioned earlier, to hedge that portfolio at a variable rate loans on the way down in a higher rate environment. As you can see, the yield curve has dropped off dramatically. So we're trying to protect the balance sheet on the way down. Just a quick question. Thinking about the mid-single-digit loan growth guidance. I guess, can you help me out with some color on just what's the incremental margin on a dollar of loan growth is for you today. Just understanding that the funding cost could be a little bit higher. But just what is the incremental spread that you're already seeing the big growth would look like relative to the 360 or so margin in the fourth quarter? Andrew, it's kind of a mixed bag. So new loan growth, again, is going on in the high-fives. What's going to dampen the overall yield is the construction book that's funding closer to kind of our core loan yield today, which is high-fours. So it's kind of be that mix of funding that kind of impacts of inflow. Do you have the dollar amount of that construction book that is funding in that kind of territory. I'm just trying to quantify that impact. And then the last one for me, just more housekeeping just the tax rate, what's driving the step-up in tax rate? And Kevin, as we look out across this year, what is your expectation for absolute growth in the balance sheet in terms of total assets? Well, it all depends really on deposit growth. So what we estimated and what I think Marcy alluded to is that earning assets should be flat for the year. And what we're kind of modeling is that the investment portfolio will run down and loans will go up. So earning assets on the balance sheet will kind of remain flat, but we'll get better yields on our earning assets in total. It's John. I think as Marcy said in her prepared remarks, at this point, the beta assumptions versus the prior cycle, we wouldn't be changing those assumptions. But we haven't specifically disclosed in the NII guidance that you gave, what those interest-bearing deposit cost assumptions would be. I want to thank everybody for their questions. And as always, we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions. Thank you for tuning in today, and goodbye.
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Hello and welcome to the ResMed Second Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Amy Wakeham, Vice President, Investor Relations and Corporate Communications. Amy, please go ahead. Great. Thank you, Kevin. Hi, everyone. Happy new year and welcome to ResMed's second quarter fiscal year 2023 earnings call. Thanks for joining us. This call is being webcast live and the replay will be available on the Investor Relations section of our corporate website later today, along with a copy of their earnings press release and presentation, both of which are available now. Joining me on the call today are Chief Executive Officer and Chairman, Mick Farrell; and Chief Financial Officer, Brett Sandercock. Mick will provide a brief high-level overview of our financial results, review our progress towards our ResMed's 2025 strategic goals, and discuss our progress as we continue to navigate the ongoing macro industry and supply chain challenges. Brett will then review our financial results in more detail. And we'll then move into the Q&A portion of our call. During the Q&A session, Mick and Brett will be joined by Rob Douglas, President and Chief Operating Officer; and David Pendarvis, Chief Administrative Officer and Global General Counsel. During today's, we will discuss several non-GAAP measures. For a reconciliation of the non-GAAP measures, please review the supporting schedules in today's earnings press release. And as a reminder, our discussion today will include some forward-looking statements, including, but not limited to, expectations about our future operating and financial performance. We do believe these statements are based on reasonable assumptions. However, our actual results may differ. Please review our SEC filings for a complete discussion of the risk factors that could affect our actual results to differ materially from any forward-looking statements made today. Thanks Amy and Kevin and thank you to all of our stakeholders for joining us today as we review results for the December quarter, our second quarter of fiscal year 2023. Our financial results reflect solid performance across our entire business, once again driven by strong sales growth in the Americas region as we were able to significantly increase both production and delivery of flow-generated devices. We're seeing ongoing high demand for our sleep and respiratory care devices worldwide and we're making steady progress, working with our suppliers to continue to increase our production to ultimately meet the needs of all customers and especially patients. Our mask sales growth was strong across the globe, reflecting a post-COVID pandemic awareness of the importance and need for respiratory hygiene and respiratory health. Resupply programs in the US continue to drive solid, ongoing sustained market mask growth catalyzed somewhat by the end of calendar year deductible momentum in the US geography. Masks sales across Europe, Asia, and the rest of world also improved, driven by increased new patient setups as connected device supply increased. Our teams worked incredibly hard to achieve these extraordinary numbers in the face of an ongoing industry supply chain constrained market. We see the supply environment improving every week, every month, and every quarter, and our access to the specific electronic components we need has increased. We are confident in our ability to fulfill all customer demand before the end of calendar year 2023 and we expect to see steady ongoing incremental device revenue growth in the third and fourth quarters of our fiscal year 2023. Customer acceptance of our reengineered AirSense 10 Card-to-Cloud device remains strong during the second quarter, particularly in the United States geography. As we increase the volume of fully connected AirSense 10 and fully connected AirSense 11 devices over the next few quarters, we will be able to phase out the AirSense 10 Card-to-Cloud device and refocus on our strategy which is based around the growth of 100% cloud connectable devices across the globe. Outside the US, we have not seen the same adoption rates of that AirSense 10 Card-to-Cloud Device. However, there have been pockets of success in some geographies and we see a strong growth path going forward as we ramp up our fully connected AirSense 10 and our fully connected AirSense 11 products and as we achieve regulatory clearance of the latter platform market-by-market. To that point, we introduced our newest product, the AirSense 11 platform into the Japanese market during December and we looked forward to continuing to support doctors and patients in Japan with our world leading 100% cloud connectable medical devices and our cloud-based software technology. Our number one priority across all of our markets will always be patients, doing our best to help those who need treatment for sleep apnea, COPD, respiratory insufficiency due to neuromuscular disease, asthma, and all those who need access to out-of-hospital health care. Our goal is to ensure that patients get the care that they need, where they need it, and when they need it. Let's now briefly review updates on ResMed's top three strategic priorities. Number one, to grow and differentiate our core sleep apnea and respiratory care businesses; number two, to design, develop and deliver market-leading medical devices as well as digital health solutions that can be scaled globally; number three, to innovate and grow the world's best software solutions for care delivered outside the hospital and especially in a patient's own home. The launch and acceptance of our AirSense 11 device platform continues to go very well. Patient feedback remains very positive and we continue to see very strong adoption of our myAir patient app. In fact, adoption rates are at more than double the adoption rate of myAir with the AirSense 10 platform at about 55% of all patients getting their data every day on their myAir app. Increasing production and delivery of the AirSense 11 platform remains a top priority for our RedMedians around the globe and we will continue to achieve better results and stronger market penetration each quarter. Earlier this month, we were able to take our AirSense 10 fully connected device off allocation in the US market. This is a very exciting development for our commercial team here in the Americas and for all of our customers. We look forward to continuing to expand the supply of fully connected AirSense 10 and fully connected AirSense 11 devices, so that supply can become unconstrained in all countries, but we will progress the throughout fiscal 2023 on this endeavor. An important aspect of our ResMed 2025 strategy is to reach hundreds of millions of patients with our respiratory care solutions, including non-invasive ventilation, and life support ventilation, as well as newer therapeutic areas such as cloud connected pharmaceutical delivery solutions and home-based high flow therapy solutions. We are continuing to drive growth and adoption of our ventilator devices around the world and we saw good uptake of both our life support and our non-life support ventilator platforms during the quarter. There is also ongoing adoption of Propeller's monitoring system. Its digital therapeutic platform is now integrated with the two leading US electronic health record systems Epic and Cerner. This digital health integration makes it easier for doctors and healthcare workers to onboard people to the Propeller platform. It's still early days for this technology, however, combined with our investments in home based high flow therapy for treatment of COPD in the home, we see this technology combination as an important clinical addition for treating lung disease and an integral part -- an important part of our 2025 growth strategy. Turning to our Software-as-a-Service offerings for outside hospital care, our SaaS fast business grew 18% year-over-year. This extraordinary growth includes sustained high single-digit organic growth of our US-based SaaS business at around 7% and is accelerated by the addition of approximately six weeks of MediFoxDarn revenue as we close that acquisition and welcomed that German team into the ResMed family of SaaS solutions just over midway through the December quarter. We continue to grow with outside hospital care customers as they increase their utilization of our software and data solutions to improve and optimize business efficiencies and patient care. As opposed to COVID patients' census continues to improve in our facilities verticals, we are seeing pent-up demand for technology investments that continue to come to the market. Our HME SaaS business under the Brightree brand continues to grow at a very rapid pace and we welcome tech solutions for our HME customers across the US market. As I just mentioned, during the quarter, we received final regulatory approval and closed our acquisition of MediFoxDarn, the leading provider of end-to-end software solutions for nursing homes and home health customers in Germany. We're now focused on integrating and growing this business as we accelerate SaaS innovation and SaaS growth in Germany and beyond. I've met in-person with many of the key leaders of the MediFoxDarn team and I can tell you, I'm excited about the cultural fit, the technology focus, the sharing and learning opportunities that they bring and we bring to our global SaaS team. This is our first investment in an outside hospital software business beyond the US market, but I can tell you, the global SaaS team is very much in sync and they have come out of the grade strongly not just in the revenue growth I just talked about, but also in the soft side, team collaboration, transparency, beyond. We look forward to updating you as we achieve key milestones in that business over the quarters and years ahead. Our team is ready to deliver. Our SaaS business is an important part of ResMed's future growth and complements the incredibly strong software and device solutions that we haven't had core sleep apnea and respiratory care businesses. One great example of the synergies between our SaaS business and our core business is the success of the Brightree ReSupply program. Brightree ReSupply automates the entire process from contacting the patient, interacting with the insurance company on coverage, and interacting directly with the patient and co-pays as well as managing the logistics and distribution process. The ultimate goal is to keep a CPAP, APAP available therapy user replenished with the supplies that they need to enable a better and longer lasting therapy experience. We have published clinical data that show that a patient on a ReSupply program has higher adherence to therapy and we also have peer reviewed published data in chest showing, it was called the ALASKA study that there is a 39% reduction in mortality for patients who are adherent to CPAP versus control. These are incredible data and they lead to these synergies not just being a good revenue opportunity, but being an incredible cost-saving opportunity for the healthcare system and life-saving opportunity for the patients involved. We will continue to identify and capitalize on synergy opportunities as we move forward. We are well-positioned as the leading global strategic provider of SaaS solutions for out-of-hospital care globally, and we have created differentiated value for customers and long term sustainable growth for our stakeholders. We are transforming out-of-hospital health care at scale, leading the market in digital health technology across our business. We now have over 13.5 billion nights of medical data in the cloud and over 19 million 100% cloud connectable medical devices on bedside tables in 140 countries worldwide. We are liberating data to the cloud every day and unlocking value for patients, providers, physicians, payers, and entire health care systems and communities. We are leading the industry, but I see this as just the start of the digital health marathon. And I can tell you, we love the race. As the overlap between digital health and consumer tech industries continues, it is important to note that ResMed's chief medical officer Dr. Carlos Nunez was recently named Chair of the Board of the Health Division of the Consumer Technology Association, or CTA, and the Health Division is the fastest growing division within CTA. The Health Division focuses on consumer-based technology-enabled health solutions to deliver better health outcomes for patients and reduce overall healthcare costs for the healthcare system. Their mission is fully aligned with our ResMed mission, and I'm delighted to see Carlos be recognized for his leadership and the sessions that he chaired at CES in Vegas a couple of weeks ago, show that ResMed's thought leadership and Carlos' thought leadership is helping to craft the future of digital health and bring it to consumers as we have done over the past decade. We're excited about the ways Carlos and CTA's Health Division can help continue to shape our industry for the future, lowering costs, and improving outcomes, and engaging consumers in their own health care. ResMed's mission and clear goal is to improve 250 million lives through better health care in 2025. This patient-centric mission drives and motivates ResMedians every day. We made excellent progress towards that inspiring goal over the last period. During the last 12 months, we improved over 149 million lives with delivery of a device platform to a patient, a full mask system to a patient, or a digital health software solution, helping people to sleep better, to breathe better, and to live higher quality lives with healthcare delivered right where they live, and mostly, in their own home. Before I close, I want to once again express my sincere gratitude to more than 10,000 ResMedians now for their perseverance, hard work, and dedication both today and every day. Thank you. With that I'll hand the call over to Brett in Sydney, and then we will move and open up for Q&A from the group. Brett over to you. Great. Thanks, Mick. In my remarks today, I will provide an overview of our results for the second quarter of fiscal year 2023. Unless noted, all comparisons are to the prior year quarter. We had strong financial performance in Q2. Group revenue was $1.03 billion, an increase of 16%. In constant currency terms, revenue increased by 20%. Revenue growth reflected increased demand for our sleep products across our portfolio and ongoing increase device demand generated by our competitors' product recall. Year-on-year movements in foreign currencies, in particular, the weaker euro negatively impacted revenue by approximately $36 million this quarter. As mentioned, we closed the MediFoxDarn acquisition on November 21, 2022 and accordingly, we have recognized MediFoxDarn revenue of $10.7 million in our Q2 FY 2023 results from this date. While we continue to experience ongoing challenges in securing sufficient electronic components to meet market demand, we are now seeing a more predictable and improving supply chain environment. We expect to continue to deliver sequentially higher quarterly device revenue through the balance of fiscal year 2023. Looking at geographic revenue distribution and excluding revenue from our Software-as-a-Service business, sales in US, Canada, and Latin America countries increased by 26%. Sales in Europe, Asia, and other markets increased by 8% in constant currency terms. By product segment, globally, in constant currency terms, device sales increased by 25%, while masks and others sales increased by 13%. Breaking it down by regional areas, device sales in the US, Canada, and Latin America increased by 41% as we benefited from incremental revenue derived from the introduction of the Card-to-Cloud device and improving availability of our connected devices. Masks and other sales increased by 11%, reflecting solid ReSupply revenue. In Europe, Asia, and other markets, device sales increased by 5% in constant currency terms, reflecting the ongoing supply constraints in those markets for our connected devices. Mask and other sales in Europe, Asia, and other markets increased by 14% in constant currency terms. Software-as-a-Service revenue, including revenue from our MediFoxDarn acquisition increased by 18% in the December quarter, driven by continued strong performance from our HME vertical. On an organic basis, SaaS revenue grew by 7% in the December quarter. During the rest of my commentary today, I will be referring to non-GAAP numbers. We have provided a full reconciliation of the non-GAAP to GAAP numbers in our second quarter earnings press release. Gross margins declined by 80 basis points to 56.8% in the December quarter. The decrease is predominantly attributable to product mix years due to increased flow generator sales as well as unfavorable foreign currency movements, partially offset by increases in average selling prices. Moving on to operating expenses, SG&A expenses for the second quarter increased by 14%, or in constant currency terms increased by 20%. The increase was predominantly attributable to increases in employee related costs, additional expenses related to our acquisitions, and travel and entertainment expenses. SG&A expense as a percentage of revenue was 20.5% compared to the 20.7% were recorded in the prior year period. Looking forward and subject to currency movements, we expect SG&A expense as a percentage of revenue to be in the range of 20% to 22% for the balance of fiscal year 2023. R&D expenses for the quarter increased by 4%, or in constant currency terms, increased by 15%. R&D expenses as a percentage of revenue was 6.8% compared to 7% in the prior year quarter. Looking forward and subject to currency movements, we expect R&D expenses as a percentage of revenue to be in the range of 7% to 8% for the balance of fiscal year 2023. Operating profit for the quarter increased by 14%, underpinned by strong revenue growth, partially offset by lower gross margin. Our effective tax rate for the December quarter was 18.3% compared to the prior year quarter rates of 15.6%. Looking forward, we estimate our effective tax rate for fiscal year 2023 will be in the range of 19% to 21%. Our net income for the December quarter increased by 13% and non-GAAP diluted earnings per share also increased by 13%. Cash flow from operations for the quarter was $129 million, reflecting solid underlying earnings, partially offset by higher levels of working capital. We recorded equity losses of $3.1 million in our income statement in the December quarter associated with the Primasun joint venture with Verily. We expect to record equity losses of approximately $3 million per quarter through the balance of fiscal year 2023 associated with the joint venture operation. On November 21, 2022, we completed our acquisition of MediFoxDarn for consideration of $997 million and this was funded through a drawdown on our existing revolver credit facility. During the quarter, we recorded acquisition related expenses of $8.4 million associated with the MediFoxDarn acquisition. The acquisition was EPS neutral on a non-GAAP basis in Q2, when we expect the acquisition to be mildly accretive to EPS on a non-GAAP basis in the second half of FY 2023. We ended the second quarter with a cash balance of $253 million. At December 31, we had $1.8 billion in gross debt and $1.5 billion in net debt, reflecting the funding of our MediFoxDarn acquisition. At December 31, we had approximately $390 million available for drawdown under our fleet revolver facility and we continue to maintain a solid liquidity position. Following the acquisition of MediFoxDarn, our net interest expense is expected to increase to approximately $15 million per quarter for the second half of fiscal year 2023, reflecting our increased debt position. Our Board of Directors today declared a quarterly dividend of $0.44 per share. Going forward, we plan to continue to reinvest in growth through R&D and also expect to continue to fund at future tuck-in acquisitions. Great, thanks, Brett and thanks Mick. Kevin, I'd like to now turn the call back over to you to provide the instructions and then run the Q&A portion of our call. Thanks. Good morning -- good afternoon. So, good to hear the fully connected AirSense 10 is now off allocation. Can I ask what happens with the CTCs that are effectively now I presume surplus to requirements? And are there any sort of impacts on pricing or inventory valuation we need to think about in the second half? Thanks for the question, Chris and it's a good one. Obviously, we're thrilled to have AirSense 10 fully connected now, unconstrained in the US geography. As you know, we operate in 140 countries worldwide. The AirSense 10 Card-to-Cloud inventory, we're working our way through that and it actually is moving very quickly. I'd stated at this way that we've got the number one device in the market, which is the AirSense 11 fully connected in terms of customer ratings. We also have the number two device in the market, which is the AirSense 10 fully connected. But then we have the number three device the third best device in the market, which is the AirSense 10 Card-to-Cloud, I believe that's better than the tier 2, 3, 4 competitors that are in the market. And so we've got the number one, two, and three device there and we're selling them and different customers want different things. And certainly the AirSense 11 fully connected is at a price premium. But we'll start to see, I think as worked through all of our inventory, the excess patient demand is still there globally. And I think we'll be there for a period of time, even after one of our competitors looks like they may come back into the market, hopefully sometime this this calendar year so that we can get our mask attachment rights onto them. But yes, Chris, we expect to work through all that AirSense 10 Card-to-Cloud inventory. Good question. Congrats on a great quarter. Hey, Mick, maybe I'm just trying to thread the needle here, but love to get some extra color. I heard you say by 2025, 250 million lives, that's the plan. If I use where you are currently, let's say 150 million, just rounding it off, that's a 70% almost jump in patient covered life -- covered by CPAP. How should I think about the implied guide? Am I jumping the gun here? Or are you sort of telegraphing you'll should be in a position for the next three years deliver about 17%, 18% CAGR? Thank you. Suraj, it's a great question and how we measure the lives changed is a pretty simple formula includes the CPAPs, APAPs, bi-level devices. But it also includes full mask systems, which you know, the sort of linear growth, if you like of the devices and some slight exponential growth of the mask systems because of replenishment rates and repeat customers coming back. But it also includes patients' lives touched through digital health. So, whether it's a Brightree patient who gets access to their device or other HME equipment, whether it's a patient in COPD medicines that gets an app that reminds them to take their medicine on a Propeller, or a patient that has a life support ventilator that gets a digital health reminder to get replenishment. And so combining all those impacts on a life. And the way I look at it is a life is changed as much by a brand new device arriving in their house as it is by an app that helps them take a medicine that keeps them out-of-hospital. So, that's how we sort of look at lives change. Yes, 150 million calendar year 2023, you got it, right. I mean, you got the math, the mathematics there is the CAGR is 17.5% volume growth of the lives that we touch over the next three calendar years through 2025 and we're going to do that. We're going to get more and more patients on CPAPs, APAPs, bi-levels, more and more on ReSupply and masks systems, and then more and more on our digital health platforms. And we've got -- it's a lofty goal and it's a stretch goal, but we believe we can get there and change 250 million lives by 2025. Thanks Suraj. Great question. Hey, good afternoon Mick. Just a quick question on the gross margin. Just how has the productivity of manufacturing and shipping improved over the last few months? Are you guys still working through, like high-cost inventory? How much spot buying is there? And then is sort of the decrease in gross margins -- slight decrease in gross margin, mainly on the mix of devices versus masks and accessories? Yes, Matt, I'll start and then I'll hand to Rob Douglas, our President and Chief Operating Officer to cover in detail. But just at the start, yes, there was a sequential decrease in gross margin. One way, Matt, I could have avoided that is tell the team don't sell all those CPAPs and APAPs, to create, right because it was great gross profit dollars to the business and was great to change a patient's life buy a new device, but I couldn't get my GM 70, 80 basis points up by saying slow down those CPAP and APAP sales. Of course, we didn't do that. The right thing is the humanitarian aspect to get those devices that we pivoted, our supply chain reengineered and redesigned to get them to market and you saw extraordinary growth, 41% growth in our US-based device market. Now, that's not our highest gross margin, its diluted to GM percentage, but it's contributory and positive to gross profit dollars. And so it's good for patients, and it's good for our stakeholders. So, that's what we did. But Rob, yes, that's a really good question -- first part of the question. Yes, Matt, thanks for question. There's lots of factors in that gross margin and you're asking specifically about productivity and productivity improvements. We've done a whole lot of work around volume improvements and really driving volume and all of our discussions with suppliers have been increasing volume and reliability of delivery. Our normal settings in normal world is we have a long-term outlook volume commitment and we're looking at optimization and pricing improvements and things like that. Those activities have pretty well been on hold while we've been doing these -- this sort of real scramble that drive volumes. Freights a similar situation, although we are seeing freights probably going to improve faster than some of these other costs that were in there. But totally in terms of our supply chain culture, we absolutely will be aiming to go back to our continuous improvement situation where we have a really strong volume leverage gain. We continue to drive the volumes in a systematic way and we use that to drive productivity and drive cost out of the system. Yes, thanks Mick. I just wanted to follow up on that gross margin question. In the previous quarter, I think it was -- Brett was talking to the efficiencies that you're achieving through doing more volume, was -- the margin benefit from that efficiency was sitting in your inventory balance and that's obviously been building and spilt again this quarter. I'm just interested is that still the case that when that inventory comes off the balance sheet, you should automatically start to see the efficiency gains that you've been able to achieve to-date? Yes, Mick thanks. So, Steve, yes, I mean, that's -- what we're doing -- I mean -- I think Rob articulated really, at the moment, we're optimizing for delivery rather than efficiency and we got things like we're running the three platforms at the moment. So, I'm really focused on delivering devices to patients. So, that's having an impact. The big one is work through inventory or the wash-through is the freight cost. So, we're seeing some reduction in freight costs. But that's not manifested in our P&L, yet, that's one for the Q3, Q4. So, there will be some benefits that starts wash through into Q3 and Q4 that we're not seeing it that's currently still in inventory. But on the efficiency side, we're really -- we will get there, but we're optimizing on delivery for the moment. But I think as we work through the fiscal, we'll be in a much better position to drive on efficiency measures. And I just pile on there -- it'll get -- Brett's guidance, nice conservative guidance is that our gross margin will be sort of steady as we go forward. I look on this and say, I think there's some upside. As we start to see mask rates start to improve, we saw 13% constant currency growth in masks during the quarter. I think, yes, as Brett said, the freight costs are washed through the inventory. And we're getting great scale from the biggest respiratory medical manufacturing plant in the planet, there in Singapore and the efficiency we've got a well above any competitor and we're doing really well on that and I think that'll come through. And then in addition to that, you'll get some upside from MediFoxDarn, which is accretive to revenue, gross margin, and EPS, as Brett said, throughout fiscal and beyond. So, that would be my guidance there as well, Steve. Thanks for the question. Yes, thanks very much. Morning Mick and Brett. Just got a question on new patient growth. Just thinking about patients who have been prescribed the device and waiting and also those yet to be diagnosed, just wondering if you could compare and contrast the US and rest of world? And then some comments on what you think it means for industry device growth for fiscal 2023 and 2024 relative to our historical growth rates? David, that's a great question. It's actually the answer. We could take the whole rest of the Q&A session to go through it because it's what we do is trying to reach out to the 936 million people in our core market that suffocate every night with sleep apnea around the world and we're laser-focused on it. As you saw, we delivered very strongly on those new patient setups 41% growth of devices in US, Canada, Latin America and we turned to positive there in Europe, Asia, and other. And what I can tell you is we're really working through that excess patient demand. Those numbers will tell you we're working faster through that excess demand in the US and getting closer to a state you get a prescription and you'll get a device in days or weeks versus it got months there at the peak of the crisis. And I think if you look across the other 140 countries we sell into, every country is different. We've got to get the regulatory approval for AirSense 11 there. We've got to work our way through, but we're going step-by-step on that journey. And so as I look at this excess patient demand, I made the comment there in my prep remarks, I think we will get to all of our customers' demand before the end of this calendar year and that tells you our confidence in increased supply and our ability to meet that need, and we're laser-focused on that humanitarian emergency of patients waiting too long for therapy and we just don't want that you suffocate. This is a case of life and death; we've got the data to show that. We want your path to therapy to be expedited. And in addition to that, the final thing I'll say is that we are looking at our patient demand generation activities that have been on hold these last 18 months. And I'm looking at our models in Australia, New Zealand, Korea, Japan, Singapore, UK, and beyond where we have these omnichannel markets availability to contact consumers or sleep concern consumers directly and get them into the funnel. And here in the US, we have direct models and also our joint venture there with Verily and Primasun that we've done some really good demand gen tests and a number of cities just waiting for me to fire the starting gun for that team. And we're getting very close to firing that starting gun. So, we have a smooth flow of -- from excess patient demand to now patient demand generation to continue our growth trajectory. Yes, thanks for taking my questions. I guess, Mick, I think you mentioned high flow therapy in your prepared remarks. I just wanted to get an update on kind of where things stand with commercializing that? And maybe talk about the -- just the market opportunity there? Thanks. Yes. Look, it's a great question, Mike. And our long-term goals there in 2025, a number of those 250 million lives are going to change in 2025 will be patients with neuromuscular disease or chronic obstructive pulmonary disease. And two of those great therapies, high flow therapy in the home, I want to be very specific, it's been used in the hospital during the pandemic. High flow therapy in the home, we see as a huge opportunity, probably 10 times the size of our ventilation market in COPD is available for home therapy, HFT therapy. And then Propeller, yes, early days and the pilots are going well. We're integrated to the payer provider EHR systems, which gives us the credibility now to go from pilots to start to scale some payer providers, particularly in the US geography. But Rob, any further details on our work on HFT and cloud connected inhalers for Mike there? Yes, Mike. We're pretty excited about this. It's a long-term project though, but as Mick said, we view this as a very large potential market, very significantly larger than some of our other respiratory care markets. And we believe that we're running tests -- we're really focusing on its complementariness with home oxygen therapy that is you'll get much better outcomes if you add this in. And we're working hard on all of the market access and evidence generation programs to do that. Now, most of those programs are trying either RCTs or real-world evidence trials. So, we're sort of in limited market release at the moment in specific markets where we're making these claims. But as that evidence evolves and we generate it and take it to the -- to payers and standard setting organizations, we see this is going to be a very strong market for us, but it is a multiyear project. Thank you. Just a question on the SaaS business. The 7% organic growth that you mentioned, I was wondering if much of that was benefiting from price increases or if the price increases you started through the quarter have a bigger benefit to come through in future periods? Yes, Craig, thanks for the question. No, that doesn't include a whole lot of price increases. In fact, we put price increases on hold during because of pandemic in some of our SaaS businesses and so we probably are changing to the area of price increases as we go forward. We've gone from pandemic to endemic, so that will happen and then flow out over the coming 12, 24 months. I'm really excited. We're looking at that domestic SaaS business in the worst of COVID getting down to low single-digits. We moved to mid-single-digits. And then Bobby, who's President of that division and his team have really accelerated that organic growth to 7% -- 8% last quarter, 7% this quarter, and so that high single-digits organic growth. And actually, we see upside from that in the organic, if you think about it, Brightree, MatrixCare, and Citus Health path. So, we see opportunities to move that up. And then when you add on MediFoxDarn and its capabilities, I think the combined business, obviously, the next four quarters, we'll call out the inorganic part will be double-digits on the inorganic, of course. But even going forward, as we look out towards 2025, we see opportunities for high single-digit and even low double-digit growth across that combined business as we lap the acquisition. So, really good growth there. Price increases will be a part of that going forward, but they weren't historically, to answer your question directly. Good morning Mick, hope you well. Mick my question is do you have enough visibility on the component pipeline to ascertain when you might be able to provide direct cloud connected devices in those markets that have an aversion to the Card-to-Cloud? Yes, Sean, I hope your Sydney morning is going well day after Australia Day. Look, the way we're looking at this is we've got 140 countries. We've got a very complex supply logistics program to get the patients minimize the time from prescription to therapy across all those markets, but it's a complex equation. The good news is we are seeing supply of those rate limited semiconductors for communications. The 3G, 4G, 5G chips are starting to see supply come back. The microprocessors, the next rate limited step are starting to increase and so we're seeing our path through this. And you saw in the quarter, we were able to deliver incredibly strongly on that, and we're off allocation for the AirSense 10 100% connected. Look, I'd love to tell you, we've got a very complex jigsaw puzzle here. I'd love to tell you it will be off allocation on AirSense11 in all of our markets. It's just not going to happen in the short-term. But as we go through this year, we'll update you as we go off allocation and it will happen market-by-market geography-by-geography. The only other comment, Sean, is some of this is driven by regulatory requirements around getting approvals and validations and also, several of these markets have different components that they need. So, they're different validation and engineering projects to do it. And we just have to sequence that through our prioritization process as well. So, that's actually true with all product launches. Yes, and the good news is it's not our first radio. We've done this launch platforms in 140 countries many times before, and we're back to our sort of meat and potatoes here. This is what we do all day every day. And going off supply chain constraints over the calendar year will be fantastic for us to be able to then just go back to what we do, which is helping people sleep better, breathe better, and live better lives outside hospital care. Thanks for the question Sean. Hi, good afternoon guys. Thanks for taking the questions. Good morning to Brett. I wanted to follow-up on the growth drivers as we think about this and next year, because I'm hearing there's patient backlog, obviously, there's core market demand generation that will start to pick up. And then from our perspective, we look at REPAPs as well. So, how do you layer those together over what time period? How much growth could you handle? And then maybe specific to REPAPs, since we haven't talked that much about them on this call, where have they been in the last two years? And when should they return to be a bigger piece of the mix itself? Thanks. Yes. Thanks Margaret. It's a great question and it's one we're thinking about a lot here. And we're thinking about all three prongs that you talked about. The first one, excess patient demand, how do we work through that. US, we're getting close to really working through it. We've got 140 other countries. And to Rob's point, it's a complex equation to get the supply chain and deliver in all 140, but we're working through that. Secondly, demand generation, yes, where we have omnichannel and have really established social media presences and abilities to drive demand gen, we'll be starting to turn those on country-by-country. And then thirdly, REPAPs, to your point, the last two and a half, three years of COVID crisis, pandemic crisis, competitor recall crisis, we have not turned the knob on REPAP. And in fact, we know our customers have been holding back when they're supply chain constrained on contacting patients who reach that three-year, five-year post-warranty, you're ready for a new device on insurance and/or patient making the call. So, I think all three of those are going to be applied in all 50 states here in the US and in all 140 countries worldwide. We do have scenarios and plans, I'm not going to detail them here on this call, but I can tell you that we expect to see steady growth throughout our market and we're going to drive that. And we're going to make sure that patients waiting lists are not long. We're not going to turn the needles until we're ready to get there in supply. I'm just happy we're having this conversation this quarter and it's so much better than the last eight quarters that we're talking about demand gen and driving REPAPs, because that's what we've done for 33.5 years in the business and it's what we love doing and we're going to do more of it. Great. Thank you for taking the question and good morning and good evening. I had a follow-up on that question. I guess I just wanted to understand what are your expectations if and when your competitor does come back? I mean, presumably, there could be some, I guess, impact on flow gens that would create pressure, but maybe you get some pickup in the mask. Could you characterize how quickly you would expect things to change dynamically in both directions? And then how much juice can you actually get out of the demand creation and ReSupply to backfill or you, kind of, increase growth? What are your pilot programs or places where you've done that telling you about how much of a quantitative pickup you can get? Yes. Thanks for the question Matt. I'll start and hand to Rob for further detail because it is a really important area for us. Look, if you think about -- our competitor has been out on the market for 18 months and who knows. They've got to -- we'll find out probably later this week, they got an earnings call, maybe they'll tell us what's happened at the consent decree and give us some timing. Frankly, give the market some time it'd be good. We've run scenarios, they come back Monday February 1, July 1, we've also run scenarios that it's January 1, 2024. And actually, in all those scenarios, ResMed grows and ResMed does really well, and ResMed does a really good job of taking care of the unmet patient need. So, if they come back earlier, come back Monday, we get a 60% plus or minus attach rate of our masks. So, we get good GM contribution, great patient care in terms of the best masks in the planet going to them, and we're able to drive that. Now, they'll be starting from 0%, new patient share, they're going to able to go and fight account-by-account. And they won't be fighting against ResMed out the gate. They'll be fighting against the Tier 2, 3, and 4 players that have come in to fill that part of the equation and they're doing an okay job. And so they have to fight against the okay players. Then they have to fight against us, the market leader. But I look forward to them coming back actually in terms of the mask side of the business, it will be really good. The scenario where it's further out, it's later this calendar year or early next calendar year or beyond. We're okay with that too because we're ramping up our supply, and we're going to get closer and closer to meet all of customer demand in this. So, frankly, it's not irrelevant, but it's not a big perturbation of our long-term strategy and our long-term business. And we've got the scenarios and the little pivots that we need to have more masks or more demand gen in the different scenarios. So, I think investors and some analysts are thinking more about this -- are worried -- more worried about this than we are because we thought so much about it and have the scenarios and the playbook ready for all three of those scenarios and 2020 beyond. I look forward to this sort of people calling a binary. I see there's a mild perturbation of the Monte Carlo sim that really doesn't change in the long-term outcomes for ResMed and our patients is not changed in any of those scenarios. But Rob, any further detail for Matt here? Yes, Matt the only other thing I'd add is we sort of think of sort of market growth rate in terms of the patient lifetime journey through this condition -- terrible condition, very serious and the biggest problem is awareness. And so you start off with how do you become aware of it. Does your primary care now to refer you to a sleep specialist? Can that specialist refer you to either home or lab testing? And then do you get a referral to a provider who's got the capacity to look after you. And basically, staff capacity is even a big issue for them. And so -- and then will that provide a look after long-term and keep the ReSupply programs. And our solutions are across all of those, but there's bottlenecks in all of those parts of the patient lifetime -- patient journey, if you like. And as I say, we're providing solutions across that and incrementally driving improvements across all of those. So, that provides a really good long-term outlook for steady growth in the business, as Mick was saying. Hey, good afternoon. Two quick ones if I can sneak them in. Is there a vision or strategy to convert Card-to-Cloud products to connected solutions over time? Or is the base case to lead those units that have gone into the market over the last year or so, as is? And then the second quick one is MediFoxDarn, the gross margin on that revenue ballpark, can you share what that is? Thank you so much. Thanks Mike and cheeky sneaking in two questions, but I'll answer both for sure. Card-to-Cloud, as those devices -- as those AirSense 10 Card-to-Cloud devices reach their either warranty period or payer allotted period at which a patient can get another device allocated to them, which is usually in the three years or five years, normally time horizon, those patients will get the opportunity to upgrade their devices from an AirSense 10 Card-to-Cloud to presumably an AirSense 11 device. And look, the first 26 years of ResMed's existence, we had, firstly, non-connected and then Card-to-Cloud pager-type technologies sort of sneaking that. It works. It can get you there. It's not as optimal. It doesnât get that sort of patient engagement on myAir and all the abilities that we can get to that 87% adherence, but it's darn good therapy. It's the smallest, quietest, the most comfortable therapy. And with the Card-to-Cloud, our HME -- mostly sold in the US, HME customers have done this for years and the data go to the cloud, and so the doctor doesn't see much difference because the doctor is seeing all the data in AirView on Card-to-Cloud and directly connected and so actually able to drive really good care with those patients. So, it will be a bolus of patients over that sort of 12-month period. And we've had, I would say, some pretty good success in humanitarian aid really and showing that ResMed isn't just going to stick to a strategy. It's going to say, if we need to pivot tactically to take care of patients, we'll do it and we'll take care of them long-term. But there will be a bolus of patients, I think, jumping at the front of REPAP a couple of years who want to get the latest and greatest technology and some on consumer pay markets might go quicker. The second question around gross margin. Yes, look, MediFoxDarn accretive to our group gross margin. I'm not going to quantify it exactly, but that's why I said you're going to see, I think, some upside to our GM as we go through the fiscal year, including MediFoxDarn. It's accretive to revenue, gross margin percentage, but also NOP dollars and our EPS performance over the fiscal and beyond. Thanks for the questions Mike. Good afternoon and good morning. Thanks for taking my question. Mick, just a quick one. Just the US flow generator growth rate of 41%, obviously, very strong. Just wondering if you can give us any color as to within that, how much was volume versus price and also mix? Yes, Saul, look, it's a great question. We don't split out our details on price. But I can give some sort of general color and maybe, Rob, Brett, maybe you want to add a little bit on for Saul to the color that we can provide. Competitive dynamics are very tight. Look, we were very open that we had a surcharge that we put the start of last year around the freight costs that were incredibly high, $12 and â¬12 across all devices and so on. We will start to actually take that away to get customer-by-customer and appropriately as we go through the year. And as we actually see -- to Rob's point earlier, as we see those freight costs come through our inventory, they don't just come in a spot change, it takes time for the COGS reduction there to come through. But in terms of that 41%, I can say it was materially improved by the AirSense 10 Card-to-Cloud and was able to get those devices there. But our ability, I think, also as we have started this quarter to turn AirSense 10 fully connected off-constraint, I think will continue to be a nice tailwind for our business there. But Brett, I'll hand to you for any further color we can provide to Saul to help on his modeling on this great US flow generator growth. Yes. Thanks Mick. I mean the only thing I'd add, Saul, is that we -- it was really the sleep devices or APAP devices are really strong as we got device availability that went straight into the market. So, that was really kind of driving that, which is obviously higher volume devices than, say, bi-levels, for example. So, that did definitely play a big part in that revenue growth. Thanks so much. Just a quick one. Mick you talked about being unconstrained on supply by the end of the calendar year and then I think to Sean's question, you talked about different markets and regulatory approvals. So, the question I've got is will the AirSense 11 be unconstrained more quickly in the US? And can you give us any sort of sense as to when you expect that will be the case? Yes. Thanks for the question David. Yes, clearly, AirSense 10 fully connected will be unconstrained first just because that platform has been in the market for a long period of time. We've got all the inventory, all the capabilities to drive it, and it's regulatory approved in virtually every market, 140 around the world. And so it's just much easier to turn that off-constraint and get it moving first. But yes, to your point, the smaller, the quieter, the more comfortable and the most connected and most clever device is the AirSense 11. As we get regulatory approvals and we're going country-by-country on this. As we said, we just got Japan during the last quarter and we're going to go country-by-country on this, when we get regulatory approvals and as we get supply starting to improve on those components, we can really ramp that up with all its great technology and really good cost advantages and patient-friendly advantages. It's got coaching capabilities and interaction with the patient on the screen that's interactive and can do some really good over-the-air upgrades, but also over-the-air interactions with physicians and its connectivity to myAir, 55%. I mean almost vast majority of patients are being offered and almost for all them are saying, yes, I want to see my data every day and get a myAir score. So, it will go faster and less constrained in those markets where it has approval. I'm not going to predict the exact date that that will happen because we've got scenarios around that. But I think we will start to see that go off-constraints before the end of the calendar year because that's when we're going to be able to meet all the customer demand, which is our goal and with on a fast-track to do it this calendar year. Rob, what did I miss there on David's question? The only other thing is, David, it's been really important for us to be able to supply those two platforms. It's been a great thing for us to have sort of a double. Basically, we've got so much extra capability and capacity because we've got two platform lines designed for the market. Thank you. Next question is coming from Dan Hurren from MST Macquarie -- I'm sorry Marquee. Your line is now live. Hi, good morning everyone. Thanks for taking the question. Look, it's pretty clear that a lot of the growth is now coming from products that have been reengineered and didn't really even exist in their current form a little while ago. So, -- and we've seen AirSense 10 connected as you're talking about [Indiscernible] of parts and alternate supplier and so forth. But we've also seen some early regulatory approvals for an AirSense 11 with apparently different communication chipset. Is there any reason why that product couldnât launch within the next few months as you've seen roughly the same time line between approval [Indiscernible] something like the AirSense 10 connected? Yes. Thanks Dan. And clearly, you're very diligent looking at FDA and different regulatory approvals around the world. Look, what I'll say to this is that the AirSense 10 Card-to-Cloud was a reengineered re-pivoted device, absolutely. And the AirSense 10 fully connected, we did rejig the comms chip to get one that was less supply chain constraints. So, those two are reengineering back in the line. We didn't reengineer the AirSense 11 that's selling right now. But of course, there will be variance. This is a long-term platform. This platform, the AirSense 11 is going to do CPAP, APAP, bi-level, all sorts of amazing therapy models. If you even look at the work that we're doing on the Lumis HFT device that we talked about earlier in the Q&A and during my prep remarks, that's on a platform of the AirSense 10 and obviously, AirSense 11 will become the platform of note for us over the coming years. But we don't go into details of our future product pipeline. So, thanks for the question. But look, I can tell you, those three products in the market are number one, two, and three and as you saw this quarter, they're selling well, and we expect them to continue to. Good morning all. I might just come back to that full customer demand comment by the end of calendar 2023. Mick, is that in relation to just the new starts? Or do you also expect that you'll meet the demand for the backlog of REPAP as well that we've had over the last few years? Yes, Lyanne, you're getting to some of the complexities behind that. Look, our goal is to get off the supply constraint during this calendar and we know we can get there. We won't get there if we turn on every single knob that we have for demand generation and REPAP generation around the world. And so we will be turning those dials, if you like, for demand generation and REPAP generation through our customers and directly as we get supply improving country-by-country. And so yes, I think we can get to all customer demand if we do no change faster, but our goal is to take care of not just the patients who are currently in the pipeline, but also the 80% -- 90% in many countries who are undiagnosed and untreated. And so our mission is to do that and it's aligned with altruism but also our profit motive. And the overlap of those is a really powerful tool for us to have sustainable long-term growth as we have the last 33.5 years. And so clearly, if we turn every dial to max, we wouldn't be able to get off a constraint this year. We won't turn all to max, but we will and we are starting to turn those dials and getting the programs up in running indifferent cities, different states, different geographies around the world as we start to get off-constraint. So, I won't go into further detail than that to say that, Lyanne, yes, you're digging in, it is more complex than just we get there. It's we get there and then we start turning on the market growth rate as the market leader, which is our sort of our duty and our obligation and we're going to do both. We're going to grow the market and grow our share and deliver for patients. Yes, thanks for taking my question. This question is about the diagnosis rate in the US, in particular, for OSA. There has been some frustration to the ability to diagnose patients. So, I just wonder what you're seeing from -- during the quarter from an improvement on that front with regard to diagnosis? Yes, Steve, thanks and thanks for coming for your second question at the end of the queue. It shows that the system works and you can get the second question in. It's a good one. Our diagnosis rate in the US, obviously, impacted the start of COVID with all the labs being shut down and then we saw that big pivot and adoption of home sleep apnea testing and some great models from ResMed and many other players in the market to help physicians find ways to remotely screen, diagnose, treat, and manage sleep apnea patients. As we come out from pandemic to endemic in the US, we've definitely seen -- I'd say, our data show that at least 50% of patients are going through home sleep apnea testing. And then of the other 50%, some of them do home sleep apnea test and then just a follow-up in a lab for titration and mask fit and so on. And so really good adoption of home sleep apnea testing. It's sort of related to our demand generation area that demand generation isn't just going out there on social media and advertising and finding that customer acquisition cost and appropriate place well under lifetime value and getting them into the channel. It's also working with the channel to understand where we have capacity, what cities, what geographies that we have. And as you know, Steve following us closely, we purchased a company called Ectosense, and their product called NightOwl. And I have one sitting on the desk right here. This thing is the size of my fingertip and it has the ability to have highly sensitive and specific screening and diagnosis of sleep apnea with reimbursement in a geography like the US, and we're actually experimenting in Asia and Latin America and around the world on this. And the technology is originally European, so hopefully, it gets adopted there, too. I love Ectosense, and I love home sleep apnea testing happening where it's small, it's quiet, it's convenient, and its cloud connected similar to our therapeutics. And yes, so I think you're going to see that diagnostic rate in the US pick up post-pandemic because people learned that telemedicine, digital health, remote screening, remote diagnostics work, and we can scale them. But it won't just be here in the US. It might be pioneered, launched here, and scaled here. but it's going to work in many other countries around the world. And I can tell you we're really excited about partnerships with the physicians and the patients themselves to find their path to better sleep and better breathing. Thanks for the question. Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Mick for any further or closing comments. Thanks Kevin and thank you again to all of our shareholders and stakeholders for joining us on this call. I'd want to thank once again the opportunity for all 10,000 ResMedians, many of whom of you are also shareholders. So, thank you for that. Thank you also for your dedication, hard work, helping people breathe, sleep, and live better lives in over 140 countries. You delivered these numbers. Thank you for all that you do. And I'll hand back to you, Amy. Great. Thank you, Mick and thanks everyone for joining us. We appreciate your interest and your time. And as always, if you have any additional questions or need to follow-up, please don't hesitate to reach out directly. This does conclude ResMed's second quarter 2023 conference call. Kevin, I'll turn it back to you to close things out. Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.
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EarningCall_1244
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Good morning, ladies and gentlemen, and welcome to Monro, Incâs Earnings Conference Call for the Third Quarter of Fiscal 2023. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] And as a reminder, this conference call is being recorded and may not be reproduced in whole or in part without permission from the company. Before we get started, please note that as part of this call, we will be referencing a presentation that is available on the Investors section of our website at corporate.monro.com/investors. If I could draw your attention to the Safe Harbor statement on slide two, I'd like to remind participants that our presentation includes some forward-looking statements about Monro's future performance. Actual results may differ materially from those suggested by our comments today. The most significant factors that could affect future results are outlined in Monro's filings with the SEC and in our earnings release. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. Additionally, on today's call, management's statements include a discussion of certain non-GAAP financial measures which are intended to supplement, and not be substitutes for comparable GAAP measures. Reconciliations of such supplemental information to the comparable GAAP measures will be included as part of today's presentation and in our earnings release. Thank you, Felix, and good morning, everyone. I'll spend the first part of our call this morning outlining a series of customer focused initiatives we recently implemented across our store base. These initiatives will enable us to drive additional sales of our higher margin service categories and position us as an even stronger competitor in every market we serve. After that, I'll walk through our third quarter results and the continued progress we've made despite inflationary pressures impacting the consumer and our business. I'll then conclude with an update on our cash creation and capital allocation. Before I get started, I would be remiss if I didn't recognize and thank all of our teammates for their tremendous efforts in serving the needs of our customers in the communities where we operate. Now starting with a series of customer focused initiatives we recently implemented across our store base. While batteries currently represent a small fraction of our overall sales, the battery market is large and growing. In response to this, we have made changes in the way we sell and service batteries. We now offer free battery checks and in departure from industry standards, we are waiving installation charges for most batteries. Our customer safety is our primary concern and when we install the battery, it gives us an opportunity to assess a vehicle's entire electrical system through a free quality courtesy inspection to ensure that everything is in good working order. We know that our customers are busy and they value convenience, personal service and purchasing options tailored to their needs. To meet these demands, we've rolled out several enhanced offerings, including a walk in oil service option to provide hassle free service, which is in addition to our existing online employment system. Number two, a good, better, best oil service package updates to give customers competitively priced options that meet their budgets. Number 3, a callback program to personally remind customers when their next oil service is due. And finally, a new integration with CARFAX to provide customers with their vehicle service history and manufacture recalls while in-store with service recommendations to enable more informed decision making. Additionally, we started offering combined tire and service packages to better connect activity and momentum in tire sales to our service categories. While these initiatives are aligned with delivering an outstanding guest experience, they have been strategically designed to boost customer traffic at our locations, enable us to drive additional sales of our higher margin service categories and fulfill our commitment to maintain a balanced approach between tire and service categories to deliver enhanced profitability at our stores, grow market share and position us as an even stronger competitor in every market we serve. While these initiatives are still in their early days, we will be sure to provide updates on our progress in the quarters to come. Now, turning to our third quarter results and how inflation pressures are impacting the consumer and our business. Driven by strength in tires, we delivered mid-single digit comp store sales growth in the third quarter of approximately 6%. We continue to execute on our strategy to improve our 300 small or underperforming stores. Which represent about a quarter of our overall store base. These stores delivered comp store sales growth of approximately 12% in the third quarter, which is on top of the double digit comp growth in the first half of this fiscal year. Our sales results for the group of stores through the first three quarters shows that our strategy is working. As a reminder, comp store sales at these stores decreased 8% in fiscal 2022 compared to fiscal 2020. The continued acceleration in sales at these locations is a direct result of our strategy to improve technician staffing levels as well as our training initiatives that allow us to better meet customer demand. Comp store sales in our remaining stores were up approximately 5%. Similar to last quarter, broad based inflationary pressures on the consumer continued to affect customer purchasing behavior in the third quarter. We saw customers trading down to lower priced tire options. We actively repositioned our tire assortment to give our customers the right tire at the right price. We are staying relevant on opening price points to provide customers with more choice and greater value. In preparation for the winter selling season, we raised in stock levels in our stores with an expanded snow tier offering, a more established regional inventory for opening price point and altering tires and an upgraded inventory system to allow daily review and replenishment. We drove additional customer traffic to our store through manufacturer rebates on six tire brands and a free lifetime tire installation package. Encouragingly, our tire units were positive in the third quarter with tire comp store sales up high single digits. Based on third party syndicated U.S. replacement tire data, all of this contributed to our outperformance in tire units versus the industry in the third quarter. We also saw stretch consumers continue making decisions to defer vehicle maintenance, which put pressure on sales in some of our key service categories. As a result, we chose to not fully pass through inflationary cost increases to an already stretched consumer. The voice of our customer has indicated that raising price is at a time when they're struggling to accept them would likely result in the immediate loss of a sale and has the potential to jeopardize a longer term relationship. And as a reminder, developing this longer term relationship with our customers is a key element of our strategy. While our higher sales mix of tires versus service, customer trade down to opening price point tires. Our investment in price and our continued labor cost pressures impacted our gross margin. Prudent cost control in the third quarter allowed us to leverage operating expenses on a mid-single digit comp. As we continue to drive our business stores consistently delivering mid-single digit comp store sales growth, we also remain committed to a more balanced approach between the tire and service categories. That will deliver enhanced profitability of our stores. The series of initiatives that I outlined at the outset of our call this morning will allow us to achieve these expectations. Our business is well positioned with the right strategy in place to take advantage of longer term industry challenges. While the current macro environment remains challenging, we continue to gain market share in our tire category with a keen focus on driving traffic to our stores and serving the car care needs of our customers. The largely nondiscretionary nature of our business gives us confidence that as long as our stores are properly staffed, our pricing is competitive with the right assortment and we continue to improve our in store execution, weâll be able to capture market share gains in both our tire and service categories. And encouragingly, sales momentum has continued into fiscal January with our preliminary comp store sales up approximately 8%. Lastly, an update on our cash creation and capital allocation. The strength of our financial position and cash flow is a competitive advantage which enables us to make investments in price and labor to grow market share and capture new customers for the long term. As a reminder, an important focus of our strategy is cash creation. We are continuing to unlock cash by optimizing inventory and leveraging the strength of our vendor partners for better availability, quality and cost of tires and parts in our stores. And then in the third quarter, we continued to generate strong operating cash flow led by reductions in our working capital. Excess cash being generated by our operations and the strength of our balance sheet allowed us to continue returning capital to our shareholders in parallel to pursuing our growth strategy. During the third quarter, we continued our long standing policy of sharing our results with our shareholders through our dividend and we continue deploying cash on our share repurchase program, which authorizes us to repurchase up to $150 million of the company's common stock. After a careful review, which included our disciplined approach in evaluating multiples, we executed a definitive asset purchase agreement to acquire four additional stores in Iowa and one additional store in Illinois. This acquisition is expected to close in the fourth quarter and is expected to add annualized sales of approximately $6 million. As part of our growth strategy, we continue to have significant capacity to acquire businesses which fit into our overall strategic plan. In summary, we have implemented a series of customer focused initiatives that will benefit our business. We delivered mid-single digit comp store sales growth in the third quarter, our strategy to improve our small or underperforming stores through our staffing and training initiatives is working. We will continue to drive our business towards consistently delivering mid-single digit comp growth with a commitment to a more balanced approach between tire and service categories that will allow us to leverage our cost structure to deliver enhanced profitability. Although we continue to navigate an uncertain macro environment, we have the right strategy in place to take advantage of the longer term industry tailwinds. We are focused on gaining market share and driving traffic to our stores through competitive pricing and the right assortment to meet the needs of our customers. Our in store execution is firmly in our control and remains our greatest opportunity for improving our results. As our training and productivity initiatives continue to take hold, we expect to deliver improvements in sales and earnings. Significant cash flow generation through operational improvements and working capital reductions will allow us to continue returning capital to shareholders through healthy dividend and share repurchase programs, as well as capitalize on acquisitions. With that, I'll now turn the call over to Brian who will provide an overview of Monro's third quarter performance, strong financial position and additional color regarding the remainder of fiscal 2023. Brian? Thank you, Mike, and good morning, everyone. Turning to slide eight, sales decreased 1.9% year-over-year to $335.2 million in the third quarter, which was due to the divestiture of our wholesale tire and distribution assets in the first quarter of fiscal 2023. Sales for these divested assets were approximately $28 million in the prior year third quarter. Comparable store sales increased 5.6% and sales from new stores increased $6 million. When adjusted for one additional selling day in the current year quarter due to a shift in the timing of the Christmas holiday from the third quarter in fiscal 2022 to the fourth quarter in fiscal 2023, comparable store sales increased 4.4%. Gross margin decreased 150 basis points from the prior year to 33.8%. A higher mix of tire sales in our retail locations, customer trade down to opening price point tires, as well as parts inflation that we intentionally did not fully pass through to the consumer increased material cost as a percentage of sales from the prior year. In addition, incremental investments in technician, labor and wages to support current and future top line growth increased labor costs 80 basis points from the prior year. These increases more than offset the benefits to gross margin from the divestiture of our wholesale tire and distribution assets. Total operating expenses were $89.6 million or 26.7% of sales as compared to $93.1 million or 27.3% of sales in the prior year period. The decrease as a percentage of sales was principally due to prudent cost control, which allowed us to leverage operating expenses on mid-single digit comparable store sales growth. Operating income for the third quarter declined to $23.8 million or 7.1% of sales. This is compared to $27.4 million or 8% of sales in the prior year period. Net interest expense increased to $5.9 million as compared to $5.7 million in the same period last year. This was principally due to higher year-over-year interest rate. Income tax expense was $5 million or an effective tax rate of 27.6% compared to $5.5 million or an effective tax rate of 25.3% in the prior year period. The increase in effective tax rate was due to a higher discrete tax impact related to share based awards, as well as other state income tax impacts from the divestiture of our wholesale and tire distribution assets. Net income was $13 million as compared to $16.3 million in the same period last year. Diluted earnings per share was $0.41 compared to $0.48 for the same period last year. Adjusted diluted earnings per share, a non GAAP measure, was $0.43. This compared to adjusted diluted earnings per share of $0.49 in the third quarter of fiscal 2022. Please refer to our reconciliation of adjusted diluted EPS in this morning's earnings press release and on slide eight in our earnings presentation for further details regarding excluded costs in the third quarter of both fiscal years. As highlighted on slide nine, we continue to maintain a very solid financial position. We generated a record $171 million of cash from operations during the first nine months of fiscal 2023, including $71 million in working capital reductions. This has reduced our cash conversion cycle by approximately 35 days at the end of the third quarter compared to the prior year period. Our AP to inventory ratio at the end of the fiscal third quarter was 162% versus 79% at the end of fiscal 2022. We received $66 million in divestiture proceeds, of which $5 million are currently being held in escrow. We invested $29 million in capital expenditures, spent $30 million in principal payments for financing leases and distributed $27 million in dividends. Lastly, cumulative repurchases of our common stock were approximately $97 million under our board authorized share repurchase program. We have used our significant cash flow to reduce invested capital by $180 million during the first nine months of fiscal 2023. At the end of the third quarter, we had bank debt of $130 million, cash and cash equivalents of $13 million and a net bank debt to EBITDA ratio of $0.7 times. While we are not providing guidance for the remainder of fiscal 2023, we are providing color to assist in your modeling. Note that our comments for the remainder of fiscal 2023 continue to factor in the divestiture, which generated about $115 million in sales in fiscal 2022. As we continue to focus on gaining market share and driving traffic, we expect to continue maintaining appropriate staffing levels as well as competitive pricing to attract customers to our stores. This will likely continue to put pressure on gross margin in the fourth quarter of fiscal 2023. In order to mitigate that, we will be focused on driving sales in our higher margin service categories, managing mix within our product categories to improve profitability and taking opportunistic pricing actions. Total operating expenses in the fourth quarter are expected to be consistent as a percentage of sales on a year-over-year basis. Our tax rate should be approximately 25% for fiscal 2023. Regarding our capital expenditures, we expect to spend approximately $35 million to $45 million in fiscal 2023. We also expect to continue improving our operating cash flow, driven by continued working capital reductions, our balanced approach of returning capital to shareholders as well as completing value enhancing acquisitions will meaningfully increase our return on invested capital. Thanks, Brian. We're optimistic about our outlook for the remainder of fiscal 2023 and beyond. Although we still have important work to do, we remain well positioned to execute our growth strategy and deliver long term value creation for our shareholders. Thank you. [Operator Instructions] Thank you. Our first question for today comes from Brian Nagel Oppenheimer. Brian, your line is now open. Please go ahead. Thanks for all the color. So, a couple of questions. I mean, first off, just with respect to the underperforming stores and now we've seen some -- for a trend in improving performance. How much potential is left in those stores for the outsized comp growth we've seen? Brian, good morning. It's Mike. I would say that it's part of our strategy. Just to remind everybody that was year-over-year-over-year declines that we are now starting to reverse. So I would look at the strategy as the exact opposite. We're actually walking these stores back year-over-year-over-year. So my expectation and I know my field team understands the expectation that we're expecting double digit comps to really start reversing. And we expect this type of growth for our, I would say, the next one to two years going forward. Got it. That's helpful. And then my second question -- Mike, it is my follow-up question. Maybe I'll merge a couple together, but -- so as you look at the results today, you're calling out this kind of shift in buying patterns as a result of, to some extent, consumers trade down amid economic pressures. So the question I have is, as you look at that, a better demand for to gets these more opening price tires, what gives you the confidence that this does in fact reflect market share gains as opposed to potentially existing customers now just reacting to a more expanded product offering as part of Monro? First of all, we look at syndicated data and we actually can see the breakdown based on Tier 1 through Tier 4 performance based on tires, opening price point being Tier 4, premium tires being Tier 1. So I can actually see our performance by tier. Now when I look at our performance right now, Brian, this is what we're focused on from the day we've been on this call together is, sales margin and cash creation. We are now finally seeing with our -- really with our partnership with ATD we're actually seeing real tire unit creation. And it's not just because we're -- I think we have a better assortment for our customers. And that started with really activating on opening price point. But our greatest opportunity that we have is, obviously, through field execution and part of field execution's job is to really take that opening price point opportunity and sell up through the screen based on the features, benefits and advantages. But ultimately, what drives us is market share. We can see the activities that we're deploying the stocking decision, the assortment, the pricing decisions and it's coming to life in unit gain in the markets that we serve. And I think that is the successful [indiscernible] for years to come. So it looks like the three year stack from monthly comps accelerated sequentially from December to January pretty meaningfully. Could you maybe provide some color on how you think the consumer is receiving the increased promotional activity right now and maybe how that trended through the quarter? Joe, I'll take that one. I would say that just on the promotional activity, very clearly what we did is, we executed using our supplier partners' promotional activity similar to really our competition in the marketplace. So we are very disciplined in our approach using our vendor support to be able to drive and attract customers through pricing incentives. I would say, going forward from December into January, I'm actually pleased with, although we had a very strong December in tires driven by tires, and you can see that in my margin. But in January, it actually flipped where I had a very strong break month. So ultimately, January is not a trend, but I actually like to see how we're meeting our customers' needs, not just on tires, but also in our service categories. And I believe most of that's just driven through all the activities that we're deploying at the local level. We're really -- we're leading the customers, not just with tires, but also service categories. And just to really just go back to the fundamentals of this business. We have to have a balanced approach. We have to have tires growing and our service categories growing, brakes leading that service category for us to really drive profitable sales. That's super helpful. Thank you. And then maybe as a follow-up, could you maybe provide some thoughts on not this year, but maybe the long-term SG&A growth rate or margin if you are comping at your mid-single-digit comp goal? Yes, this is Brian. I would say that as it relates to kind of our outlook, maybe just for Q4, we expect some improvement in our gross margin level somewhere between where we ran in Q2 at 35 -- mid-35 and where we ran here in Q3, which is just south of 34. So we expect to trend somewhere in that range, improvement off of Q3, though. The gross -- I'm sorry, the SG&A, we expect to be about flattish year-over-year. We have a little bit lighter of a volume month or volume quarter in Q4 historically based on seasonality. So we delever a little bit from where we traditionally run in Q3. As it relates to the long term, we're not providing longer-term guidance. But as we've been -- as we've said, as we achieve our mid-single digit comp growth, we expect to improve both margins as well as leverage our fixed costs and SG&A. And we think that, that gives us a good path to return our operating margins back to where they've run historically, certainly double digits. Thank you. Guys, I wanted to dive in a little bit more about the supply side of things. One of the things that surprised me a little bit is you guys talking about the manufacturers may be giving you some more support and rebates on things. So I would just love to kind of hear kind of what you have seen there or maybe how that's changed? And could that actually begin to buffer gross margin later this year? And are you starting to see or at least this calendar year -- are you starting to see manufacturers roll back any price increases or go beyond just giving you maybe some support on the sales side in the field? John, I'll take care of that. I'll take that one. It's Mike. I think it's less about the manufacturers. It's all about Monro. We were -- as we really become a bigger customer with fewer suppliers, they're investing behind us. And that's not only on the tire side, but the parts side. So what we deployed in the fourth quarter is really we took advantage of what they normally have in the marketplace for our competitors, but Monro really stepped up, activated against it, really partnered with fewer suppliers, and we just became more relevant. And it really benefited us. On top of that, we actually lived into what we committed to. We deployed tires. We really gave our teams the assortment that they need to compete in the marketplace. We kept them in stock. And these are the things that our suppliers are looking for from a large customer like Monro. So I really have to give credit to not only the field team, but the merchandising organization, our inventory teams really making ourselves getting ourselves ready for basically a winter season that came over 10 days. Great. And then I just want to ask just -- I feel like the commentary on the M&A pipeline was maybe a little bit different than I was expecting. So I just love to hear what you guys are seeing there? Is it sellers come to you? Are you looking at anything that maybe would be bigger in size than what you've kind of normally looked at? Or just kind of -- any color on how the M&A pipeline has seemed to fill up here, because I thought maybe we were taking a little bit more of a conservative tone there, at least -- that's what I thought at least. Yes. No. I mean there's really -- as we look at our M&A opportunity, the activity that we've been working, we have more than 10 NDAs signed. We continue to evaluate deals. We've always been a very disciplined financial buyer. And I think adding to that now, we're a very disciplined operational buyer, meaning, that we're going to take on stores that have a really clear path to quick accretion for us with limited kind of investments in our team's time for needing to improve those stores immediately. We have a lot of focus on our bottom 300 stores like we talked about. We need to continue that focus. We have a real focus on improving our business, delivering those mid-single-digit comps and improving our profitability across all of our categories. So with that focus, we want to be really disciplined in our acquisition approach. We had a deal that we announced this quarter. It was one of those that met all of the criteria that allowed for a nice acquisition and a nice integration, and we look forward to closing that in Q4. But there will be continued M&A as we move forward for the deals that make sense for us operationally and financially. To adjust for, I guess, sort of a lot of the pricing moving pieces, do you have a day adjusted car count comp that we could look at just sort of to think about traffic versus the lower price point tires and sort of the other moving parts? Yes. We don't provide -- we have provided kind of a traffic number even unadjusted for days. So the quarter was continued to be led by ticket. And tire units, we said were positive. Those were positive, both reported and adjusted. Okay. And then, I guess, it sounds like the January service has picked up. But did you see anything sort of structural in the demand for the service side of the business? Was it either a feeling that maybe the surge in the prior year or pull forward or lack of weather or anything drove the negative service comp? Or is it just more focused on tires in the quarter, but service picked up in January? I would say that it's a continuation of our strategy. I mean, we've been talking a lot about service over the last years, so having a balanced approach. I'd like to not talk so much about January because it's only one month, and there's a lot of things changed. So like when we talked about last quarter, October, had a strong service component. This will be a really important quarter for us as we continue to get this mix right. December was very strong in tires. I would say that we could potentially be going against a soft January from last year. I'm happy to see a double-digit growth in brakes. And that is the expectation going forward is continue to get the balance right. And I like that double-digit number, especially in the service categories. Okay. And then the housekeeping question. Brian, could you give us the monthlies? And is there any regional dispersion to talk about? Yes. From a regional standpoint, all regions were up, a little bit weaker in the West, but not too meaningful. As it relates to the monthlies, 3.7% in October, 3.5% in November, 10.5% in December as reported, and that gets you to the 5.6%. December would have been 6.5% if you're looking at the 4.4%. All right. Well, thank you for joining us today. This continues to be an exciting time to be part of Monro. We have a strong foundation to build upon to create long-term value for all our stakeholders. I look forward to keeping you updated on our progress. Have a great day.
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EarningCall_1245
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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Northern Technologies International Corporation First Quarter 2023 Earnings Conference Call and Webcast. [Operator Instructions]. As part of today's discussion today, the representatives from NTIC will be making certain forward-looking statements regarding NTIC's future financial and operating results as well as their business plans, objectives, and expectations. Please be advised that these forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and that NTIC desires to avail itself of the protections of the Safe Harbor for these statements. Please also be advised that actual results could differ materially from those stated or implied by the forward-looking statements due to certain risks and uncertainties, including those described in NTIC's most recent Annual Report on Form 10-K, subsequent quarterly reports on Form 10-Q, and recent press releases. Please read these reports and other future filings that NTIC will make with the SEC. NTIC disclaims any duty to update or revise its forward-looking statements. This call also may include references to certain financial measures that are not calculated in accordance with Generally Accepted Accounting Principles, or GAAP, which are generally referred to as non-GAAP financial measures. Reconciliations of the historical non-GAAP financial measures to the most comparable measures calculated and presented in accordance with GAAP are available in the earnings press release NTIC issued this morning on the Investor Relations portion of its corporate website at ntic.com. I want to begin this morning's call by wishing everyone a happy, healthy, and prosperous New Year 2023. Please note that a press release regarding our fiscal 2023 first quarter was issued earlier this morning and is available at ntic.com. During today's call, we will review various key aspects of our fiscal 2023 first quarter financial results, provide a brief business update, and then conclude with a question-and-answer session. Stable demand for our Zerust industrial products and services in North America, coupled with growing interest in our Natur-Tec and Zerust Oil & Gas products, both in the U.S. and abroad provided record sales again in this first quarter. This is particularly encouraging considering the prevailing complex business environment. NTIC has continued to navigate supply chain and shipping issues, persistent inflation, raw material cost increases, geopolitical conflicts in Europe, and the lingering effects of the COVID-19 pandemic in Asia, with the intent of minimizing the impact of these challenges on our business. Price adjustments made during the last fiscal year helped improve net sales and profitability in North America. While we expect some inflationary pressures and supply chain issues to persist throughout the second quarter, we continue to see improvements, most notably, being the increased availability of raw materials for our Natur-Tec bioplastics business during the quarter. Overall, momentum has remained positive, and we expect that NTIC will continue to offset near-term uncertainty within our European and Asian markets. In addition, we expect annual profitability to improve in fiscal 2023 as we continue to focus on rebuilding our margins. So with this overview, let's examine the drivers for the first quarter in more detail. For the first quarter ended November 30, 2022, our total consolidated net sales increased 9.7% to a first quarter record of nearly $20 million as compared to the first quarter ended November 30, 2021. Broken down by the business units, this includes a 66.9% increase in Zerust Oil & Gas net sales, a 21.6% increase in Natur-Tec net sales, and a 4% increase in Zerust industrial net sales. Total net sales for the fiscal 2023 first quarter by our joint ventures, which we do not consolidate in our financial statements, decreased 8.5% to $24.7 million. This decrease was due primarily to slower demand across the territories serviced by our global joint ventures due to certain geopolitical conflicts and their impact on higher energy costs and availability. Fiscal 2023 first quarter net sales by our wholly-owned NTIC China subsidiary decreased by 7.7% to $3.7 million due to the negative impact of severe COVID-19 related lockdowns across much of that country during the quarter and the weaker economic conditions as a result thereof. We continue to closely watch market conditions in China, and we are hopeful the recent suspension of that country's Zero-COVID policy will help to improve demand in China later this fiscal year. Overall, we remain committed to the Chinese market and the long-term opportunities it represents for NTIC. We have taken steps to enhance and protect our Chinese operations, and we continue to believe China will likely become our largest geographic market in the future. Now moving on to Zerust Oil & Gas. The fiscal 2023 first quarter was one of the strongest quarters we have ever had for Zerust Oil & Gas as sales increased 66.9% to $1.6 million. The first quarter of fiscal 2023 is also the third consecutive quarter of Zerust Oil & Gas sales over $1.5 million, reflecting the positive momentum within our oil and gas business. We believe interest is growing for our Zerust Oil & Gas solutions, which include applications to protect above-ground oil storage tanks and pipeline casings from corrosion. And we believe the second quarter of fiscal 2023 will be another good quarter of oil and gas sales and growth. The expanding adoption of our Zerust Oil & Gas solutions within the oil and gas industry is supporting bigger opportunities for our Zerust Oil & Gas products and technologies. As a result, we believe fiscal 2023 will be a transformative year for Zerust Oil & Gas as this business scales and begins to contribute to profitability. Turning to our Natur-Tec bioplastics business. Fiscal 2023 first quarter Natur-Tec sales were $4.6 million, a 21.6% increase over the prior fiscal year period. Sales trends within the Natur-Tec have been encouraging and show that demand patterns have begun to return to pre-pandemic levels, especially in North America and India. Furthermore, the supply chain and logistics challenges that impacted Natur-Tec's results last fiscal year continued to ease during the first quarter and contributed to the strong year-over-year growth we experienced. We believe this is a testament to our strong position within the bioplastics industry and close relationships with important raw material suppliers. We've continued to see growing market demand for new applications of certified compostable plastic products and resin compounds, as well as increased interest in commercial and municipal programs that use certified compostable plastics as alternatives to conventional plastics. As a result, we believe we are well positioned for long-term sustainable growth within our Natur-Tec bioplastics business. While prevailing geopolitical and economic uncertainty continues to impact our outlook on the overall economy in recent months, especially in Europe and China, we believe we can continue to grow sales and improve profitability as we benefit from favorable North American demand trends, higher sales into the oil and gas industry, and higher Natur-Tec sales. With this overview, let me now turn the call over to Matt Wolsfeld to summarize our financial results for the fiscal 2023 first quarter. Compared to the prior fiscal year period, NTIC's consolidated net sales increased 9.7% to a first quarter record because of the positive trends Patrick reviewed in his prepared remarks. An 8.5% decrease in first quarter sales across our joint ventures drove a 10% decrease in first quarter joint venture operating income compared to the prior fiscal year period. Total operating expenses for the fiscal 2023 first quarter were $7.9 million, 11.7% increase over the prior fiscal year period. It was primarily due to increased personnel expenses and expenses incurred during the current fiscal year period in connection with the startup of a new indirect majority-owned subsidiary formed to assume the operations of a former joint venture in Taiwan. Operating expenses, as a percentage of net sales, were 39.6% compared to 38.9% for the prior fiscal year period. Gross profit as a percentage of net sales improved to 31.8% during the three months ended November 30, 2022, compared to 31.3% during the prior fiscal period, primarily a result of improved pricing to offset inflationary pressures and increase sales to customers in the oil and gas industry as products within this end market carry higher margins that our Zerust industrial products. NTIC reported net income of $502,000, or $0.05 per diluted share, for the fiscal 2023 first quarter compared to $4.5 million, or $0.46 per diluted share, for the fiscal 2022 first quarter. Recall that first quarter of fiscal 2022 net income reflected a gain of over $3.9 million related to our acquisition of the remaining ownership interest of Zerust India. For fiscal 2023 first quarter, NTIC's non-GAAP adjusted net income was $608,000, or $0.06 per diluted share, compared to non-GAAP net income of $781,000, or $0.08 per diluted share, for fiscal 2022. NTIC's non-GAAP adjusted net income excludes the gain of over $3.9 million relating to our acquisition of the remaining ownership interest of Zerust India and other adjustments as set forth in the GAAP and non-GAAP reconciliation at the end of our first quarter earnings press release that was issued this morning. As of November 30, 2022, working capital was $25.4 million, including $6 million in cash and cash equivalents compared to $23.2 million, including $5.3 million in cash and cash equivalents as of August 31, 2022. As of November 30, 2022, we had $5.5 million outstanding under our revolving line of credit compared to $5.9 million at August 31, 2022. On November 30, 2022, the company had $20.3 million in investments in joint ventures, of which approximately 48% are just over $9.7 million was in cash, with the remaining balance primarily invested in other working capital. During the fiscal 2023 first quarter NTIC's board of directors declared a quarterly cash dividend of $0.07 per common share that was payable on November 16, 2022, to stockholders of record on November 3, 2022. So, to conclude our prepared remarks, our established product, end market, and geographic diversification strategies are helping the company navigate a complex and fluid business environment. We are seeing stable North American demand trends and accelerating growth across our global oil and gas and bioplastics markets. While the economic environment remains uncertain, we continue to believe fiscal 2023 will be another good year of sales and profitability for NTIC, and we're excited by our prospects. [Operator Instructions] Our first question or comment comes from the line of Tim Clarkson from Vanclemens.com. Mr. Clarkson, your line is now open. Hi, Patrick and Matt. Another good quarter. I just wanted to ask exactly how much expenses were tied to the Taiwan deal. Well, the Taiwan deal, in general, just to give a little bit of color on it, Taiwan is an entity that was owned under one of our other subsidiaries in prior years, it had about somewhere just under $1 million in revenue. We had a situation where the former partner in Taiwan passed away, and because of that we decided to liquidate the entity and start up a new subsidiary that is owned under NTI Asean. So NTIC owns 60% of NTI Asean, thereby through passthrough, NTIC now owns 60% of the Taiwan entity. There were simply some liquidation costs associated with the old entity to basically write down the investment that we had to zero, and also some expenses associated with starting up the new entity. Total impact from the transaction in first quarter was probably around $300,000 as far as comparing what we -- the net amount that we had previously to what we did in the first quarter was about $300 million -- a little over $300,000. The expectation is that going forward that will obviously stabilize, and it will just be a consolidated entity similar to our other subs. So it's kind of a one-time charge. Also part of the reason why our total operating expenses for the quarter were slightly up compared to expectations and last year total operating expenses were up a little over 11%, I would expect that operating expense increase for the full year to be back in the middle single digits from an operating expense growth standpoint. Great, great. And in terms of the oil and gas deal, it's at $1.5 million a quarter, $6 million annual pace. I mean, how big can this division potentially get? I mean, is this a potential division that can be $10 million or $20 million annually? Right. And in terms of suddenly now we're starting to see this consistent high growth, again, what are the drivers that are getting people to want to buy these products? I think that we've just been pushing this now for long enough that we have a reputation in the industry, and people are coming to us now. I think one important thing to remember is also that the reason why we got into the oil and gas space originally years and years ago, as we've obviously been developing it for some time, is because of the size of the opportunity and that opportunity being significantly bigger than the opportunity with the core Zerust products. It's certainly taken longer than any of us expected to develop, but we're happy that we're finally starting to see some of these larger opportunities and what I've always referred to as kind of the base level of oil and gas business kind of establishing itself. And so the fact we've now been able to put several quarters in a row where we're not seeing as much volatility as we were over the past few years and really starting to build on that business. Specifically, if you look at the expectations that we have for kind of second quarter and the remainder of the year, the expectations that the oil and gas is going to perform better -- significantly better in second quarter because of some orders we have coming in, we announced before the BP contract. We have some business from that contract that will be coming in the second quarter and some other additional business that will be coming in in the last three quarters of the year that give us a lot more optimism with the oil and gas business overall. In terms of people, I mean is there a limit to how much volume you can do in terms of how many people you have in that division? I know it's a relatively small division in terms of how many people are working there. But it's scalable because we primarily have just a supervisor, engineers that then work with crews in the various geographic locations that are already vetted, trained, bonded, what have you. So we don't really have an issue in terms of scalability. Right, right. And really it's a little unconventional, but certainly the technology mitigates pollution in a couple of ways: one, by obviously not allowing the oil and gas to leak into groundwater, which is really bad; but also in terms of not having these huge metal tanks that have to be replaced every 30 years instead of the 10-year deal, which is obviously steel is an extremely polluting process to create. So I mean this is also a technology that really enhances the environment as we transition away from oil and gas eventually towards 100% non-fossil fuels. But in the meantime, they're there, and we want to mitigate the pollution obviously. Thank you. [Operator Instructions] Our next question or comment comes from the line of Gregory Weaver from the Invicta Fund. Mr. Weaver, your line is now open. Happy New Year. Nice to see the oil and gas. I've been patiently waiting and hopefully this is it. It's good stuff if you can get that mixed in with the rest of your business. Patrick, when you say that income will be up, profitability will be up in fiscal '23, is that including joint venture income or is this just the corporate level? It's kind of across the board. I mean, the expectations is from a joint venture standpoint, we are seeing -- we're continuing to see -- let's say, the biggest influence to the decreased profitability at the joint ventures was the raw material prices of polyethylene. And we are starting to see polyethylene decline -- the price of raw material decline slightly on a global level, and so all the different subsidiaries and joint ventures are starting to experience that benefit. Similarly, we're starting to get a little bit of a tailwind from a currency standpoint as far as the change in the euro to U.S. dollar. Those two factors will impact profitability at the joint venture level with the expectations that we're also going to start to see some sales growth. So that's one factor. Additionally, in North America, the continued growth that we're seeing in Natur-Tec will benefit it, the growth we're seeing in oil and gas at the very positive margins that we have there will also benefit. So it's kind of across the board the expectations of finally having some of these headwinds turn into tailwinds. The biggest, I don't want to say headwind we still face, but obviously still a headwind that we face is in China. That is an entity that we have that previously was contributing, was profitable, and was contributing cash that right now is in a bit of a state of flux right now given what's going on in China, specifically with COVID. However, with talking to various people, specifically about what's going on in China, it appears that there should be a nice rebound once they've dealt with COVID issues and things start to normalize there that there'll be a rebound on the ground level. The expectations are that our sales people and travel restrictions and things like that will free up certainly in the second half of the year. And so that leads us to believe there's going to be a nicer rebound in China from a profitability standpoint as well. So certainly, expectations are that we'll see some nice growth going from first quarter to second quarter and then into what's traditionally the rust season of third and fourth quarter that it should be a solid year from a profitability standpoint. Okay, great. Thanks, Matt. That helps. And you hit my next question on China. So just in the current fiscal Q2 here, is it getting worse or is it about the same as what you saw in the just reported quarter? Well, in the just-reported quarter our Q1, it was -- China in our first quarter was in a loss position given everything that was going on there compared to first quarter last year China made $200,000 of profit, which is still down compared to where it was a couple years ago as far as the amount of income that it was contributing. And first quarter this year was actually a loss position. Second quarter, I don't know if second quarter is going to be significantly better. You're also dealing in second quarter with Chinese New Year. I think from my expectation it's after Chinese New Year, into our third and fourth quarter is when we're going to see a rebound in China. Okay, fair enough. All right. And the Taiwanese thing, so I guess how long does it take to get back those sales that you had before? We got them all? Basically, the widow of the former partner sold the business to us, but she didn't sell us the company. We just took the book of business. Okay. And now that it's under your direct control, what do you think about growth prospects there? Maybe a little more robust than they've been historically? I don't know how the guy was running it. Yes. Okay, good. All right. That pretty much does it for me, and appreciate the hard work and maybe get Gautam on the call one time here to tell us about all the good stuff going on in oil and gas. So thanks. [Operator Instructions] I'm showing no additional questions in the queue at this time. Gentlemen, I'd like to turn the conference back over to you for any closing remarks. Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.
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EarningCall_1246
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Good morning, everybody. I'm Chris Schott at J.P. Morgan. And it's my pleasure to be hosting a fireside chat with Chris Viehbacher, who joined Biogen Inc. a little bit less than two months ago as CEO. So, Chris, happy New Year, and thanks for joining us today. So, maybe just to kick off, it seems like you're joining a company that's kind of at crossroads. So, we've got, obviously, a very exciting new launch in the Alzheimer's side. We've got a large pipeline, but one I think is viewed as kind of high-risk, high-reward. And we've got a base business that's got some LOE pressures. So, can you talk about the key challenges that you see facing Biogen right now? And how your kind of plan to prioritize these as you think about your tenure as CEO? Yes. I mean -- so, Biogen was founded over 40 years ago. I'm guessing they were at the very first of this J.P. Morgan conferences 41 times ago, right, because I think it's probably more than 41 years ago. And it's been a very narrowly-focused company on multiple sclerosis and very successful, but of course, that is now something we're calling, basically, a melting iceberg. It's not a patent cliff, but it's not got growth perspectives. And my job, as I see it, is to restore the company to sustainable growth. So, there are a number of levers for that. First, we look inside the company, and the two biggest opportunities, I mean, quite honestly, having two blockbuster products to launch almost simultaneously. I never had that privilege actually at Sanofi, I have to say, or you [would've seen] (ph) for that matter. So, it is a huge opportunity. Now, they're not simple launches, and we can go into that. But lecanemab, clearly, is a breakthrough, and so is actually zuranolone. I mean, most people don't realize, it's probably the first new mode of action in mental health in 20 years, certainly, for depression. So, after that, we have our existing business. The MS franchise, actually, it's quite interesting is there's still a lot of people love TYSABRI, love even AVONEX. I think, we have to look at, are we really spending the right amount of money on that, and we'll have to look at our cost base. But SPINRAZA, I think, actually has opportunity as well, particularly in the adult population. Obviously, in small children, babies, they're being screened now for SMA, but there's an awful lot of undiagnosed or misdiagnosed cases in the adult population. Third opportunity is really the cost base. We still -- we have $5 billion less of profit than we did in 2019. I have to say that hasn't completely percolated through the company so far. And then, the fourth is we're in a very healthy financial position and we'll start to look at some external growth. Yes. So, I guess maybe one of the things I think about is you've had, obviously, some prior experiences at very large companies. How has that prepared you for kind of taking a company like Biogen and taking kind of a fresh look at a business like that? I'd say there's -- I've got two different experiences. I've got -- I've grown up in the large company model, where -- certainly, there's always an element to leading complex organizations being global. But I actually really enjoyed the last seven years in an entrepreneurial environment. And one of the things I learned was -- one of the reasons I think the biotech sector has become so strong is because of weak decision making in large pharma -- in large biopharma. This need to have validation at every milestone before you can raise money, I think, is a healthy thing. And I'd like to bring some of that actually into the company, particularly on earlier-stage projects. Obviously, Sanofi needed turning around as well and rebuilding. So, there's an opportunity to bring some of the, I think, potential to look at value creating, either acquisitions or business development. So, I'd say those things, too, have helped. But, of course, we're a much smaller organization. I actually like the nimbleness of Biogen. I think we had 110,000 people at Sanofi. And we got 8,500 -- now, 8,500 is a whole lot more than I've dealt with the last seven years I have to say. Bring those two together. I guess, are you envisioning any strategic shifts for Biogen? You touched on this a little bit. Moving forward, I guess, as you think about whether it's the focus of the pipeline, whether it's the kind of mix of internal versus external, like just how are you thinking about that? No radical left turns, I would say some redefinition of what we're about. I think Biogen has typically presented itself as a neuroscience company. And I would argue we're already broader than that. Multiple sclerosis is really an autoimmune disease, and I think that gives us some legitimacy to go towards immunology. With zuranolone, we're getting into psychiatry. And with SPINRAZA, yes, it's a neurodegenerative disease, but it's also a rare disease. And so, I think we could legitimately expand into the rare disease space. So, I don't see us getting into oncology tomorrow. There's enough other people in that space, or into cardiology. But I do think we'll widen our aperture a little bit. One of the terrific things about Biogen is it has had the courage and the persistence to go after some areas of real unmet need. But the issue in neurology is that these conditions evolve so slowly that the trials have to be long and they're expensive. And so, you get this high-risk, high-reward type situation, and I think we need to balance that a little bit. Okay. So, when I think about your ability to do that, does that -- is that something you can do internally? Because you mentioned you've got some strengths in markets that are maybe outside of traditional neurology. Or is that going to be maybe more a push on the external side of things? I think there's -- on the near-term side, I think it's going to come externally. We're in psychiatry with our partner Sage, but we really don't have another product in that area, and I think it would be nice to flesh that out. I see actually Alzheimer's is becoming a franchise for us. So, with our partners, Eisai, this isn't just about the launch of lecanemab. Important as that is, we have two other assets in development. There's an awful lot of studies that can be done as well to build out that franchise, but, yes, it will be a little bit of growth. But one of the other areas is research. And I split the role of R&D into development and research. Development is really there for the next three to five years of growth. Research is there for the five to 15 year timeframe. And I wanted research to be a little disconnected almost or unencumbered by, here's where our business is today, and be able to pursue science in a little broader way. Not again dramatically differently, but through research, I think, over time, we can actually build out a pipeline that's a little broader than just pure neurology. Does that broadening of the pipeline inherently assume that there's some culling back of the more traditional neurology kind of opportunities, or can this be just additive to what you're already doing? At this stage, I think, it's going to be more additive. I think there is an interesting pipeline in there. I think one of the assets I'm particularly interested in is the Ionis-partnered asset for anti-tau. Obviously, major breakthrough data. Alois Alzheimer discovered these plaques and tau tangles in patients that autopsied 100 years ago, and it's taken us a century to actually have the first definitive data that says, if you remove plaque, you can have a cognitive function. But I think we'd all agree that there's still more to be done. And so, tau is promising. We also have two compounds in for lupus, SLE and CLE, and I think that's actually a promising area. Got a project in stroke, but that's another one of these high-risk, high-rewards, and you'll find out at the last chapter whether it works or not. Yes, exactly. And if I think about just Biogen, traditionally, I think, has done business development through a series, maybe smaller partnerships. Is that -- would you envision that, that you're going to stay the course there? Or could we see the company look at larger, say, like multibillion-dollar acquisitions as you look to broaden out the focus of the organization? Well, I'm going to focus on getting really the things right within the company sort of the first half of this year. I do think we'll have to turn our attention to some external growth in the second half. And then, it's just -- you can have a strategy, but after 35 years, I've discovered you got to be still pretty opportunistic. You can go fishing, but you don't know whether you're going to eat bass tonight or anything for that matter. And so, I think the -- I wouldn't shy away from an acquisition, but obviously, that gets you into a different risk profile. I would say, within Biogen, there's a lot that's already good. So, I don't feel a pressure that we have to go do something quickly. But equally, we've got the financial wherewithal and it is an opportunity to shape the company. I really like these collaborations. When I was at Sanofi, we had a very prolific one with Regeneron. I think Biogen is a really good partner. We're partnered with Ionis. We're partnered with UCB. We're partnered with Denali. We're partnered with Eisai. And that's a cultural, I think, strength of the company that they can do that, and that is capital sparing in a lot of ways. Okay. So, when I think about that, it seems like that kind of evolves over time, you've got the firepower to do it, but it maybe is⦠But you don't want to do an acquisition unless you've really got your own house in order. I don't think we're quite there yet. Okay, that's helpful. Biogen has made some significant cost cuts, I guess, over the last year or so. I think it's about $1 billion of expense been pulled from the budget. Would you envision those additional cuts to come as we think about that cost base? Or at this point, you're in a pretty good place? No, we definitely can look at the cost base. If you strip out the collaboration revenue and the royalties, and start doing ratio analysis, I think everybody here knows that we probably got -- we have ratios that are not competitive with our sector. So, we're certainly looking short term at things like G&A. I think we can look at return on investment in multiple sclerosis. Remember, this has been the bread and butter of the company. And so, getting that company to reduce the investment on that is -- you really want to make sure that you know what you're doing with that. There are some costs that are inherent in what we're doing. I mean, we built a factory to produce lecanemab. That is not currently occupied. So, we have a number of idle costs. We are continuing to spend money on ADUHELM. And to be honest, that's a question that we'll have to figure out. We have to do a confirmatory study by the terms of the NDA. So, if we don't do it, we lose the NDA. But if you lose the NDA, maybe this is an asset that has value to others and we have to evaluate that. And I think we can be bringing a lot more of a return-on-investment-type culture. It's a very gung-ho culture at Biogen and I don't want to lose that. It's entrepreneurial. It really goes after things. But somewhere along the line, we also have to have some capital discipline. The timelines around this? Is this -- I think, you mentioned kind of getting the house in order. Is that -- is this like kind of a first half '23, or is it⦠Okay. Perfect. Maybe kind of pivoting into some individual products. Alzheimer's, obviously, very exciting opportunity here. I guess, what are you seeing as the biggest challenges on the lecanemab launch? And as we maybe just kind of couple that with what lessons you learned from ADUHELM? So, lecanemab is actually a really interesting product. You think after 35 years in this business you've seen it all, and yet you have something like this come along that's completely new. It's -- it has all the hallmarks of a specialty pharma drug. We're the specialist, biologic, a lot of medical services wrapped around this, but we have the volume of a primary care product. And so that actually creates its own unique challenges. To get diagnosed, you're going to need either a PET scan or lumbar puncture. There's going to be three MRIs over the first six months. It's a biweekly, every two week infusion. And you're talking about huge numbers, specialty pharma, you're thinking about tens of thousands, maybe hundreds of thousands of patients here. One day, you could be thinking about millions. And of course -- so there's a whole element of how the healthcare infrastructure has to evolve for this. And of course, then we're also dealing with Medicare in a lot of cases. And so, there's going to be budget issues that we have to all be cognizant of. So, we have to -- we'll have to work carefully with the system. I think as you've heard from Eisai, we're thinking about maybe 100,000 patients after the first three years. But I -- this launch is not really a reach and frequency model, thinking about just sending out reps, it's really around working with the system to make sure that we can expand it and make this new treatment available. We're also doing other studies around this. It seems like the earlier you treat, the more benefit you can have. So, we have a study called AHEAD that is ongoing in pre-symptomatic patients. And as I say, we also have two other assets in this space that we wanted to develop. So, well, portfolio kind of builds that over time. Reimbursement, obviously, kind of big controversy around this. How do you see reimbursement evolving over the next year or so? Well, CMS has obviously confirmed that if you get -- if we get full approval, we will reimburse on the basis that there's a registry. Exactly what the timing is? We first have to see how long it's going to take to get full approval. Full approval was just submitted on Friday evening, late in the evening. It's just going to be a six-month, nine-month, 12-month review, we don't know yet. In general, I think though, I believe that CMS -- my personal view is that CMS will approve and reimburse us. Unlike ADUHELM, we've got very clear data with the Clarity study. I mean, statistical significance everywhere, not only on the CDR- Sum of Boxes, but also ADAS-Cog, and also the activities of daily life. I think the safety issues have been -- are understood and you have to obviously be careful on that front. So, I don't really see why this wouldn't be made available. I think what we have as a job to do is really to explain the real benefit of this to patients. So, people say, âOh, well, you know, you had a 27% increase or whatever,â that doesn't really tell the story. Maybe what I look at from more of a commercial point of view is the activities of daily life, with a 37% improvement in that. And that's not -- I think people have this view sometimes in the -- not in this type of audience, but in the more general public that Alzheimer's is a little bit of memory loss. People don't, I think, fully understand that this is a fatal disease. And this is a progressive disease that puts a massive burden on the caregivers. People have to quit their jobs to go and take care of loved ones. You progressively lose your ability to look after yourself. So, this activities of daily care is not only memory loss, but it's orientation, it's personal care, it's ability to continue with hobbies to be active in the social environment. And that is, I think, quite significant. There's something like 16 million people who today are actively involved with -- taken care of someone with Alzheimer's, many of those family members. So, there's a massive societal burden that is only going to grow. And I think we have to really do a good job of explaining that, because that sort of comes up in just about every conversation, what's the clinical benefit. This Sum of Boxes is not actually used by physicians when they see patients. So, I think as we get this in the hands of physicians, we'll see who actually is really responding. We're going to do an awful data analysis to try to predict who is a responder, but also can we start to predict who might have more moderate to severe ARIA. So -- but I do think this is really an opportunity to provide hope for so many people. Just kind of back to the reimbursement, just comment whether it's yourselves or Eisai, has there been much engagement with CMS at this point in terms of their willingness to kind of consider a different outcome in terms of the reimbursement? So, I only know that from what -- this is in the hands of Eisai. We've been working for eight years together, and Biogen had the lead on a number of things for ADUHELM, and Eisai has the lead for LEQEMBI. So, they're the ones who are actually engaging with CMS and I haven't been privy to the actual detailed conversation. Speaking of just how the commercialization will work, can you just talk about individual responsibilities of the companies and how that's going to split up? So, I's say, it's not really a reach and frequency model. To start, usually you launch, it's a real education campaign and just getting out there and educating physician here. There is an awful lot to think about in terms of this whole healthcare infrastructure build. So, at least in the U.S., Eisai will take on the lead with getting a first initial wave of field force out there, and we are working then with them collaboratively on marketing, on thinking about additional clinical study that we may want to do, and how do we build up in Alzheimer's business together over the longer term? We're going to do that country by country. So, I think we have a very strong presence in Europe, for example, so we'll be looking at that. There are some parts of the world like Latin America, where we have a greater presence. They have a much greater presence in Asia. Remember, this is a 50-50 deal. So, we have an inherent interest in making this efficient as well. And the reality is that co-promotion and co-marketing, on the one hand, you leverage the abilities of two companies, but on the other hand, you can create some duplication. So, what we want to do is make this as both effective and also as cost efficient as possible. In your time in the CEO role, have you had much in your kind of engagement with your counterpart at Eisai in terms of how is that really -- how has that generally been? So, Haruo Naito and I have known each other for many years. My first trip as CEO of Biogen was to Japan. We spent most of the Sunday together, thinking about how we wanted to work together. I talked to him at least three this week. So, we have an awful lot of interaction. And I would say, because we've known each other, there is actually a tremendous amount of mutual respect. Most importantly, and this is what you really need in the partnership, we have shared values, and a shared vision of what we want to build. Yes. Great. Then there's been lot -- I think you mentioned before focus on subcu. Can you just talk about what you believe you and Eisai have to do to get a subcu formulation to market? That's in progress. There's a multipronged approach on that. And we haven't talked about timing, but that is well in hand. Okay. What does that do, I think, as you think about kind of what this could mean for the market as a whole of getting this away from an infusion into something so easier to manage? So, the interesting thing is in market research, the biweekly infusion is not necessarily the burden you might think it is, because actually -- well, to be honest, what we've seen is sometimes this is a way of getting out of the house and getting some outside contact for patients. But obviously, a subcu would be better. One of the most interesting things is we don't really understand how when the plaque builds up, that, that leads directly to neuronal death, but it does in some sort of cascade, which is why the studies that have worked have been in earlier stage patients. So, we have a study ongoing called AHEAD or A 3-45 that is looking in pre-symptomatic patients. So, if you go earlier, are you going to get an even bigger benefit? And I think if you start to -- if you did get success there, then I think actually subcu would be particularly important. But we're also looking at different dosing regimens. Clearly, we have to make sure that we can make this as convenient for the patient as possible. Okay. And then just one last one on, I guess, Alzheimer's side is how do you just think about the competitive landscape? Do you just kind of think of this as a split market or more of a winner-take-all kind of approach, as I guess, we're thinking about donanemab kind of readouts as we go for this year? For most -- this is a brand-new market that never really existed before, and that doesn't happen that much. I had a lot of experience at the start of my career in the HIV, and actually more entrants really actually helped develop the market. So, I actually -- I'm not too concerned. I think actually, if Lilly is successful, that they'll come in now. They're completely different products. And I think actually, we're pretty confident that we could take a bigger share, largely because we don't know how long patients are really going to be on the product. I mean, we studied this for 18 months, but we'll have extended data. What happens if you're treating longer? And we haven't seen any data from Lilly, so it's hard to comment on it. But I actually think having several entrants could actually be beneficial to everybody. Turning to the base business, I think you mentioned earlier, Biogen is a clear leader in the MS space, in fact, clearly some impact to the franchise with generics. How do you think about the kind of goals for that MS franchise at this point? Well, first is to make sure the iceberg melts slowly, if I can put it that way. It's interesting. I mean, TYSABRI is actually -- I actually was visiting a neurologist in New York. And if you actually said what do you think is the best drug out there, for them, it's TYSABRI. Now, Ocrevus has clearly come in and had a lot of success, largely on the convenience. But people are saying, well, beta cell depletion, how long do you really want to do that? And if you have COVID? And actually, what would have been good is to probably do a lot more outreach to patients to give them the balance view of that. But at this stage of the life cycle, I'm not sure that, that makes sense. We are still busy doing research, and we have not given up, and would like to also bring more new products to patients in this space. So, is the goal here to kind of more manage the profitability of this franchise? Is that fair to say versus trying to grow it, I guess? Again, you're going to find with marketers, they love their products. And typically, you get to -- for instance, if you get to -- in the old small molecule business, you generally stop doing promotions somewhere 18 to 12 months before patent expiry. You have no idea how hard that is. I remember one time with [indiscernible] we had to give an order that you're [inspired] (ph) if people are starting to promote that. And it's hard for people to give up. And this has been the history of the company for 40 years. So, we do have to do a better job, I think, of really understanding the promotions. There is a lot of competition out there, and a lot of people are tied to these products, but I think we can do a better job on the profitability. So, you've got, obviously, an oral, but the oral really only goes to 25 kilograms in length, so that's really for children at this point in time. There seems to be some sort of evidence that the gene therapy may not be as durable as one might think, which is interesting. And we actually have a study going on looking at what happens with gene therapy, because if that is the case, then that is an opportunity for SPINRAZA to come. Again, there's a quite a large adult population. And I think the low-hanging fruit in that market, if I can, or the easy to diagnose patients, if I can put it in a better way, have been done. The adult population is not quite so easy to diagnose and has been misdiagnosed. And the whole secret to rare diseases is really hunting for new patients. And I remember when we acquired Genzyme years ago and the Head of Marketing, saying, "Marketing strategy is looking for needles in haystacks." And that is amazing what can be done. I mean you follow family trees and go out there and hunt for patients. So, I actually think there's a reservoir of growth there. Okay. And is that growth dependent on, I guess, some of these ongoing studies you're running? Or is there some element of this is just kind of a different commercial approach? I think a lot of this is [blocking and packing] (ph). And we're going to have a company-wide day in the first quarter, really just to share best practices and think about where we go. Because I'm not so sure that we've really gone the full mile on really understanding how to go build rare diseases within the company. So, I think zuranolone is the biggest undervalued potential of Biogen. There's an awful lot of people say, "Well, it's every two weeks. You know, how is this going to work?" I've done years of market research. And one of the things that you learn over the years is that, as long as you are taking a medicine, you are sick. And if you're not taking a medicine, you are well. That is how patients think about things. It's why people -- you have to have television ad saying take your antibiotics until the end of the therapy. Here, you've got an opportunity. I had in my previous life, we had a company that operated clinics at Microsoft and Facebook, the demand for mental health treatment is enormous. And SSRIs have been helpful, but they're not really solving all of the problem. So, you've got, on the one hand, an unmet need. And the second is I like this idea of, okay, two weeks of therapy, and then, you don't have to take anything. And there's always a stigma associated with mental health. Do you really go and talk to your friends about, "I'm taking this from my depression? What about you?" I mean that doesn't happen at barbecues. So here, you have an opportunity to say, I'm treated, and I'm well, and I don't have to take anything. Now, you may have to have another treatment later in the year, and we have a trial called SHORELINE that is looking at exactly when that is. I think this will be a little bit trickier for payers, because you now have to price kind of a year's therapy in blocks of two weeks. So that's not going to be simple. And it is a change in the way physicians look at this, because they're used to just putting some an antidepressant. But I do think that from a patient perspective, I can see an awful lot that they would like in this. And as I say, this is -- there's something like over 20 million people who have had a depressive episode. And I think also the ability for potentially fast-acting is important. I mean, I have a -- I know a number of friends who are concerned their children are often at college, and one friend just a couple of weeks ago, had to fly down because they are really worried for the safety of their child. Now, if you say we have the therapy for that, you just have to wait six weeks, that doesn't necessarily correspond to the sense of urgency that you have in that circumstance. So, I do think that there is -- there are a number of things that I certainly learned -- I mean, I was at GlaxoSmithKline when we had Paxil and Wellbutrin, I know this market, I know those products. I think this is a product that really does add an awful lot of value that isn't there in the marketplace today. And I think the -- when I look at forecast for the product, I think it's tremendously undervalued. Yes. The -- there is a lot of generics here. So, I guess the question is you, from a payer perspective, do you think the payers get the differentiation of something like this? That's where we'll have a lot of work to do. And we're also looking at these value-based agreements. I will say that the demand for mental health is pretty well established. And I think the payers are interested in making sure that treatments are available. It doesn't mean it's going to be a walk in the park, but I actually think we will get there with the payers. And as this ramps, I guess, I think you made a comment earlier on this, is there a broader push at Biogen to move more into psychiatry as a vertical? Well, once you build the field force and build the capability -- remember, Biogen, if I said, where is the risk in this? To me, it's more risk of execution. Biogen has never gone and visited primary care physicians. And that's a different skill set. It's a much bigger target audience than what we have visited before. We may be into television advertising. We've not done that before. Even just back office, things like sales ops are going to be different, because we have relatively small field forces. If you're starting to go visit primary care, that is a different thing. And then, we also have to think about the postpartum depression, and that probably takes a slightly different team because they're visiting a different type of physician. So, there are some things that we have to do internally, but I do think that this is something that really is -- I think, offers a huge benefit for patients and could be quite a big opportunity. And as you think building out a portfolio there, would that be kind of get this up and running and then add... Yeah. Well, because then now you only have one product in the bank, right? So, it would make sense to start looking at other things in this space. But I think we want to get this thing well launched and on a good trajectory before we do that. Okay, that makes sense. Moving over to immunology. I know you've got a number of late-stage studies in lupus across two different programs. Is immunology an area that is a kind of area of focus for Biogen going forward? Yes, I do think that. Elias Zerhouni, that I brought in as Head of R&D years ago, always like to say, we described so many diseases by their symptoms or where we happen to -- where the disease manifests itself, and increasingly, we should be thinking about what are the causes of disease. And there are so many diseases that are caused by the immune system. And so, I think we actually do understand some of that have that capability. So, I think it's a legitimate space. Now, are we going to get into RA? I'm not sure. But I think, certainly, neuroimmunology is a fair game for us. Okay. And then just a last question here. Just as you think about the pipeline, what are the major opportunities for growth that we should be paying attention to as you've kind of evaluated what the company has internally? Well, lupus is certainly one. I mean there's a -- it's a huge potential market as I was at GSK when we developed Benlysta, so we looked at it already back then. But we all know that Benlysta is limited efficacy. And -- but in the meantime, it has also been a graveyard of a lot of difficulty. So, now AstraZeneca has been successful. I think if we can be successful at this disease, this could be massive growth drivers, both products. And I think the cutaneous lupus is actually a particularly interesting product, and I think we've seen some good early-stage results on that. So, I think lupus is a huge opportunity. And as I say, I think Alzheimer's will grow. If we can be successful, we had some very good early-stage data with the Ionis-partnered compound on the anti-tau, for example. They say there's a stroke compound, but it's very difficult to tell what that one will do. But it does come back to this, if it works, we're good, right? But the question that I think a lot of investors pose is, will it work? And can we do a little bit more to de-risk our growth profile? And that's going to be a slight shift in what we're putting into development and also what we're looking at in terms of external growth. Great. So, let me just sum it up. As I think about the path you're going down here, it sounds like kind of first half of the year is some evaluation of the cost structure. You got -- big launches you've got under your belt. How long does it take to kind of pivot the organization to get to that profile you're envisioning where we're going to end up with a more balanced pipeline and cost structure in the right place? Is this kind of a multiyear process? Or is this something you can... Yes. I mean, I always used to say, in this business, three years is tomorrow. And I actually just ran into Dan O'Day this morning and congratulating him on how he's doing with Gilead. But he's been CEO for four years, and it's the first couple of years, you had to believe as well. I think actually with Biogen, it could be a little faster because we have these two launches. We don't have to -- we're not relying on business development and acquisitions to deliver on some of the growth story. So, from that point of view, it could go a little faster. But the regulatory timeframes, you know well, Chris, and it just -- it does take some time. And cultural change is not that easy. But I do believe that there's an awful lot of strong fundamentals in the company. This is a company with great people. This is a company that has spawned so much talent in so many of the companies that are now at this conference around the table. So, I actually have a lot of confidence in the development organization. We have an opportunity with a new Head of Research to perhaps move ourselves in some different directions. But lecanemab and zuranolone, if we get those right, that's going to account for an awful lot of the new Biogen. Great. I think we're just out of time here. Really appreciate the comments, and we look forward to seeing the progress of the company over the year.
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EarningCall_1247
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Good morning. This is the conference operator. Welcome, and thank you for joining SEB's Q4 2022 Results Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Johan Torgeby, President and CEO. Please go ahead, sir. So turning to Page number 2 on the PowerPoint presentation that we posted online, we start with just saying a humble thank you to all of our clients. We've just received this -- the last 12 months customer satisfaction, and it was a very supportive result of SEB. And we were top ranked both amongst corporates and financial institutions in the Nordics for the second year running. For the full year, we've had a good performance. Return on equity amounted to 14.7% in the quarter, and it was driven by strong trading activity and, of course, a more benign environment as interest rates have been at a higher level than in the past. This was done on a core equity Tier 1 ratio of 19% with a capital buffer of 470 basis points. Our strategy that we launched in January last year is broadly intact, and we have checked all the assumptions, and we think it still holds. However, we've done some minor changes in the short run, which we will get back to and concluded that we will continue to invest in SEB and have set a new cost target for 2023 in the range of SEK26.5 billion to SEK27 billion, assuming constant FX as of 2022. The Board of Directors has also proposed to the AGM to pay a dividend of SEK6.75 per share. And now as we have switched into quarterly share buyback continued for now with the annual pace of SEK5 billion amounting to SEK1.25 billion for the next quarter and then a new decision will be taken. Flipping to Page number 3, we can see the financial year of 2022 in numbers. And Masih will come back to these numbers, but I'll just state that underlying results was very strong. However, after the imposed levies and the adjustment for Russia and the tax line, operating -- net profit grew by 6% and return on equity marginally fell to 13.8%. This was on a cost -- led to a cost/income of 0.39 and expected credit loss level of 7 basis points. On Page 4, we look at the credit exposure, the credit portfolio development. And we have seen a 3% to 4% adjusted for a reclassification Q-on-Q growth for corporate FX adjusted. So continuation of good demand for credit to be provided and also the annual number becomes 5%, mostly now falling because of the base effect as Q4 last year was very strong. We have had somewhat lower volumes in Swedish mortgages and also real estate, commercial real estate, it looks like it's up 6%, but it's a flat underlying. And there's been a minor reclassification of some of the corporate exposures that we've had to be put into the real estate category. So I'm going to focus on the quarter, and we're at Page 6 now. So if you look at Q4, we've seen income grew by 33% compared to the same quarter last year. That's largely driven by net interest income, as well as net financial income, whereas fees and commission are slightly down compared to the last quarter in 2021. As you can see, it is true also for the full year, the expected credit losses are higher than last quarter -- in '21 and because of the introduction of the tax fee, bank tax, as well as the higher resolution fund fee, the imposed levies have increased as well. Just a couple of comments on the item affecting comparability. This is an impairment we've done in our Russian business, and it's an impairment of the equity that we place at the Russian Central Bank. Because of the dividend restrictions that the Russian Federation has imposed, it will take us many, many decades to be able to transfer this equity to the parent company. And because of this and because of the time value of money, we've decided to be prudent and do an impairment of the equity we have, which is almost the full amount of equity that we have in the Russian subsidiary, and this amounts to SEK1.4 billion. So in the quarter, we had a return on equity of 14.7%, a cost/income ratio of 0.36 and we took 8 basis points of expected credit losses. If I move to Slide 7 and we look at the long-term development of the bank in terms of income expenses and profit before ECL and Imposed levies, we can see that since 1990, we've seen an average income growth of 6% and expense growth of 4%, leading to a profit growth of 6% before ECL and imposed levies. The numbers look fairly similar if you look at the last 10-year period, but if you look at the last six years, we have seen slightly higher income growth and slightly lower cost expense growth than we've done in the very long term. So for now, at least, it seems like we found a better balance between how we invest in the bank and what type of income growth that lead to. If I move to Slide 8, net interest income, up 28% or just over SEK7 billion in 2022 compared to 2021. You can see that the contribution from the lending side has come down during the quarter compared to the same quarter last year, but we've seen positive development in all divisions. So because of this -- this is mainly driven by the deposit side. And if I move to the next slide, you can see a bridge. So we're on Slide 9 of the development of NII during 2022. So this increase of SEK7.3 billion, SEK1.1 billion is coming from increased corporate lending during the year and SEK4.1 billion is corporate deposits. And the absolute majority here is deposit margins and deposit volumes, even though they're up, the contribution from that is fairly small. We have another positive effect of about SEK600 million from our fixed income currencies and commodities business. On Swedish households, we've seen declining mortgage margins that have led to a negative effect of SEK0.5 billion but that's more than offset by improved deposit margins from Swedish households and the contribution from our Baltic business, if you look at the household side, is about SEK1 billion year-over-year. So the issue or what we want to conclude with this slide is that, for this bank, 80% of the net interest income improvement during 2022 is coming from our corporate and financial institutions business. And this is pretty natural as that's the dominating part of the business as we run. If you look at Slide 10 and the net fee and commission income development that grew by 2% during 2022. The main contribution here comes from the cards and payments business, which grew by about 25% during 2022. And this is basically a full recovery of the sort of the lower level we had during the pandemic and now we've seen a full recovery, especially on the corporate card side. And we've seen an extra boost on this line due to the high level of inflation. We've also seen a positive development of lending fees as the balance sheet has grown. But on the other hand, we've seen the negative development from advisory fees. So DCM, equity capital markets and M&A, that type of activity has been lower in 2022. What I think is positive here is asset management and custody fees, which are largely flat during the year, even though asset values are down quite a bit. And the reason it is flat is that, we've had large custody inflows by the end of '21 and early parts of '22 that has offset the valuation decline during the year. Moving to Slide 11 and the development of net financial income. We've seen a 13% growth in '22 versus 2021 and Q4 was especially strong with a total amount of SEK3.5 billion. We've seen good underlying development within our fixed income business in the quarter, and we continue to see elevated levels of activity within FX and commodities, albeit a bit lower than we've seen in Q2 and Q3. We've also had some positive effects related to XVA, as well as positive effects within our treasury business. We've always guided on this line and the guidance has been and it stays that this should be between SEK1.5 billion and SEK1.7 billion, excluding treasury and XVA. Here, we have, for the first time, added what the average has been, if you look at the total amount of NFI over the last 16 quarters, and we've seen an average of SEK2 billion with a standard deviation of about SEK1 billion. So we think that the combination of the guidance of SEK1.5 billion to SEK1.7 billion, excluding treasury and XVA and this historical level we've been at is the best possible guidance we can give. If I move to Slide 12 and the capital development during the quarter. We've seen an improvement of the buffer of about 60 basis points in Q4. A large part of this is driven by the strong underlying capital generation, which has added 47 basis points net of the dividend that the Board has proposed to the AGM. We have a negative effect from the item affecting comparability, the Russian impairment of 16 basis points gross. One should note here that there's also a reduction of the risk exposure amount related to this. So the net effect of the Russian impairment is only about 5 basis points. We've seen an improvement of asset quality. This is mainly due to the fact that the new business that we've written during the quarter has been to corporates that are high-quality and better than the back book average of the bank. And we've seen a reduction of the market risk capital comments during the quarter, although they are still at elevated levels compared to the history. On the right-hand side, you can see that during the course of 2022, the capital buffer above the requirements came down by 120 basis points from 590 basis points to 470 basis points. So in the first year of the 3-year business plan, we have reduced the capital buffer by about 120 basis points. And we think we are on track of reaching the guidance we've given to be within our target range of 100 to 300 basis points by year-end 2024. If I move to Slide 13 and look at the expected credit losses. So in the quarter, we took about SEK0.5 billion of the expected credit losses. About SEK190 million of this amount was driven by adjustments to macro scenarios. So driven by the IFRS 9 rules and due to lower GDP and consumption estimates going forward. The remaining part is due to a new portfolio overlay for our real estate portfolio of about SEK300 million. What we've done here is to do a bottom-up screening of the real estate portfolio and look at what could be potential vulnerable clients. What we've looked at here is, for example, access to market financing, how much of that, that is needed to be done in the near term and the ownership of these companies. For this part of the portfolio, we've assumed that there will be a 10% default rate and that at that point in time, the collateral values will have dropped by 20%. When doing this exercise, this leads to a portfolio overlay of SEK300 million. This is pretty much the edge of what we can do at this point in terms of being within the accounting rules and being proactive and take reserves for this portfolio. You should obviously put this reserve of about SEK300 million in connection with the total size of the portfolio of about or over SEK300 billion. Overall, you can see that Stage 3 loans in the quarter came down quite a lot and that we today have more reserves than the total amount of Stage 3 loans. The total reserves in the bank is SEK8.6 billion, of which SEK2.2 billion are portfolio overlays. Moving to Slide 14 and looking at some key ratios. So we saw customer deposits grow by about SEK100 billion during the year. We've seen that liquidity ratios, both the short term, the LCR, liquidity coverage ratio, as well as the NSFR, net stable fund ratio are stable and that we've gone through the capital buffers before, and the leverage ratio, I should add, is stable compared to the end of 2021. So now we turn to Page 16 and switch gear a bit. And we start with just a quick little key highlights from what we achieved and what we did in 2022 and divided by the four pillars of the strategy that we launched last year. So first, we have had a modest expansion of our corporate banking business in the Netherlands, Austria and Switzerland, and this is broadly in line with what we plan to do. Investment Management has launched several new investment products, and we are on track, both when it comes to The Green activity, the Sustainability Index and The Brown, the Carbon Exposure Index, where we want to improve The Green activity and reduce the exposure to carbon. On the strategic change, we've launched new functionalities in the app that meets our clients, and we've continued to expand Private Wealth Management & Family Office division and established an office in South of France in Nice to support Nordic customers that we signed there. We've also decided that as a spin-off of SEBx to commercialize Banking-as-a-Service, and we've launched a business area we call SEB Embedded, which is a very exciting new leg to stand on for the future. Still early days where we support and give access to our clients, our industrial and retail clients to use banking-like services in turn for their clients. On partnerships, the most noticeable is the Private Wealth Management initiative in Denmark, where we partnered up with Ringkjoebing Landbobank to support private banking customers, making us reach much more customers in Denmark in the future and also focusing on getting more clients into the Family Office initiative. We've done six investments in clean tech and green tech entrepreneurs, and this is, of course, to help early-stage companies to finance new innovations in order to improve the transition to a carbon-free economy. And lastly, we continue to solidify the cooperation with authorities, most noticeably the police in order for us to work together to combat financial crime. On efficiency, we've done many small and operationally organic improvement in automation, but most notably, I'd like to highlight the one in sub-custody as we have onboarded about SEK5,000 billion over the last 18 months. And this is, of course, meant that we have a completely different version of how to handle that volume in the future. We've also set up a Financial Intelligence Unit to help us to combat financial crime, but also using intelligence that we can find in-house and we've improved and launched a new data governance and appointed a new Head of Data in the bank. Going to Page 17, we now have the full year result of all customer surveys that we do. And broadly speaking, the outcome is such that we are either on top or we are flat, except for one, which is the business bank at the -- in the bottom row. So this is a very good result for us. We're going to work hard to maintain this position or even improvement, and there are still many things that we can improve. Then looking at the particular initiatives that we did last year from the perspective of what did we say on the trends that we want to capitalize on and support our customers in. This is on Page 18. We have a very optimistic and long-term positive view on corporate and investment banking, and we've had a very strong underlying growth for some time. However, during 2022, not at all planned in January 2022, we saw a sharp shift in activity, particularly within ECM, M&A, DCM, corporate finance, investment banking, and we had significantly dampened activity due to volatility and lower asset prices and higher risk outlook. Savings and investment, we had a very, very solid starting point with one of the highest savings ratios we've seen. This has also changed quite dramatically, and that is, of course, that the cost of living has gone up and also the ability to save has gone down, therefore. So we are still very positive on savings and investments and corporate and investment bank move in the long run, but clearly, there's been a cyclical headwind in the near term. On technology and sustainability and on nonfinancial risks, we would say more or less more of the same. So we have not changed either short- or long-term view. If anything, cybersecurity has been accentuated around the new technologies that we can do. Sustainability continues to be a top priority, and we met, broadly speaking, all the targets that we set out on The Green and The Brown and nonfinancial risk, the trend continues that in the past, majority of the risk CROs of banks would identify would be of financial nature. Today, the majority of risks are nonfinancial in nature, operating risk. And that is really something that all banks need to relate to because the risk landscape is changing. Next page, Page 19, is more or less just a plain repeat. So for the ones -- for time stepping the strategy 2030, we've included here as a reminder. So looking at Page 21 and the cost development and the cost target we've given out today for 2023. As you can see here, for the first time, we are giving out an interval of SEK26.5 billion and SEK27 billion in 2023, assuming average FX rates of 2022. The reason we have given out an interval rather than the point estimate, which has been customary for us is the uncertainty around inflation in general, both when it comes to salary inflation, as well as inflation on other areas impacting the bank, such as premises, information services and energy prices. When it comes to the things that we can do something about ourselves, that means efficiencies, those are a bit clearer. So we'll do more efficiency work during 2023, or we'll take out more costs related to efficiencies, and this can be achieved through measures we've taken over the last few years in terms of automation and so forth. And we'll invest as much in 2023, as we've done in 2022 on top of the investments we do going into the year, so SEK800 million to SEK900 million extra in 2023. And here, you can see what we are investing in. Just a few examples. So in the front, the customer-facing part of the bank, we will continue to develop our remote advisory. We will continue to expand our Private Wealth Management & Family Office division, and we'll continue with the expansion within Austria, Switzerland and Netherlands and within sustainability, we'll continue to improve our customer offering, as well as our disclosure and reporting. When it comes to future-proofing the core, cybersecurity is a very important area in the bank, as well as the whole society, and we'll continue to develop our cloud capabilities. On and off-boarding is both a future-proofing, but it's also something that will enable us to become more efficient in the future doing that process much more automatically than historically. And then finally, house in order. We've invested a lot within financial crime prevention in the last few years, and we'll continue to increase those investments in 2023. That will also, over time, lead to efficiencies for the bank. And risk and compliance are areas that we've seen increased investments in for the last decade or so, and those will continue in 2023. On the next page, Page 22, we've done some minor revisions to the financial aspirations or different divisions of the bank. As a reminder, we do a review of these aspirations every year depending on how our peers have performed, but as well as taking into account any potential accounting changes or organizational changes. This year, there are two minor changes, so a slightly lower cost/income ratio aspiration for the large corporate and financial institutions divisions -- division and a slightly higher cost/income aspiration for Investment Management, and this is mainly related to organizational change, moving one unit from one of the divisions to the other. On group level, we have a slightly lower aspiration on cost/income ratio instead of around 0.45. We now aspire to be between 0.4 and 0.45. And this is mainly related to the fact that we've done a reclassification of the resolution fund fee out of the net interest income line to imposed levies. So therefore, everything else equal, the bank, on a group level, needs to have a slightly lower cost/income ratio to reach the group aspiration of 15% return on equity. And again, a reminder here, the cost/income aspirations, those are not explicit targets. Those are implicit targets. What we think is needed for each part of the bank to achieve what we think is the explicit target a certain level of return on business equity. And then finally, just a reminder of our group financial targets to pay out 50% of the earnings per share adjusted for items affecting comparability every year to be within our management target range of 100 to 300 basis points and to have return on equity that's competitive with peers and aspire to reach 15% in the long term. Yes. Good morning. If I start with NII, just if you could give us some flavor around the competitive situation on deposits? For example, I note that your deposits shrink -- your household deposits and corporate deposits are shrinking quarter-on-quarter and is primarily in the -- when I look at the retail-oriented deposits there. And also, if you, on deposits, could share with us what share of the Baltic deposits have -- still have zero interest rates? Secondly, on NII, just you're talking about volatile -- more volatile items in your favor in -- from Q1, really, bridge financings and a strong FICC-related NII in Q3, for example, what's the status is there right now? So that's an NII. And then secondly, just on capital. Last year, you gave us a capital repatriation outlook or outlook for buybacks of SEK5 billion to SEK10 billion. Now we know that you have announced SEK1.25 billion for Q1. So my question is just this, SEK5 billion then the annualized level are the best expectations for 2003 or could anything change that? Thank you. Thank you. I think I'll start on the three questions, and I ask Masih to fill in on all three. If we start with deposit, I think it's a macro trend, which is quite interesting, and that is for many, many years of QE, we are now going into QT and higher rates. So the whole point of what's happening right now is to drain the economic system of liquidity. That is, I think, what we are seeing overall in the market right now. So this is a deposit that has continuously increased. Liquidity has been very, very ample. That has, of course, supported real economy and now with higher interest rates potentially QT that will be withdrawn from the system. A few other points. The cost of living has gone up and the cost of input goods for corporates have gone up. So we can clearly see that corporates needs to spend more to produce their services, and that's a working capital squeeze. A corporate only have to access to capital that you need to pay your bills to get the input goods, either you take from your cash or you ask a bank to give you the money through a loan. And we can clearly see that lending growth has not really gone up. There has been a little bit less deposits in the bank. Hence, that has been used for something, but credit exposure has gone up. So the number of loans that we have written has increased. So this is also a part of potentially explaining that. And for the retail side, I would say, it's the macroeconomic monetary change, and it is, of course, spending more on the same basket for energy, mortgage rates, et cetera, that has also drained it, but predominantly corporate for the deposits. Yes. I'll just add on the sort of deposit decrease during the quarter. So we can track what's happening to deposits, and we can see that we are not losing deposits to competition, especially on the retail side. So the outsource we've had during the quarter is driven by increased cost of living so that we can see that customers are using their deposits to a large degree to be able to pay for bills, and there's not money going out from SEB to competition on the deposit side. Just adding on to your question about the Baltic business, I can't really say how much is zero interest rates. But if you look at the fact book, you can see how large share of deposits that are in transaction accounts and how large share we have in saving accounts. So you can assume that on the part that is in transaction accounts has zero rates and on saving counts, we're paying something. So that's the sort of -- that's the best guidance you can get there. On the volatile items, we still have a couple of larger bridges on the books. The contribution from that is fairly small. I would say, if anything, during the quarter, maybe net interest income is slightly understated. And this has to do with what happened to the three months STIBOR during the quarter in the -- if you remember, early parts of the quarter, the three months STIBOR starts to take in the bank tax and the resolution fund fee that is payable by year-end. So there was a very low STIBOR print for the beginning parts of the quarter, and a lot of fixings are made at that point. This is fairly technical, but that has corrected itself now, but it probably has led to maybe the net financial income line being slightly overstated in the quarter, and the net interest income line being slightly understated in the quarter. On the capital side, you're correct. I mean, we are executing on the mandate we have to do SEK1.25 billion of share buybacks until the AGM. This is not a guidance for what the pace will be post the AGM. It could be same. It could be lower, it could be higher. The guidance we can give, and this was obviously confirmed by the Board yesterday is that, we plan to be within our target range by the end of 2024, whether that's going to be reached through continued organic growth, through any potential acquisitions, or whether that's going to be due to dividends or share buybacks and what combination of that, we can't say at this point, but the plan is still to be within that target range in two years' time. Sorry. I'll just add two things. On the deposit side, this is more a reflection. But for many, many years, as we are pitching to clients how to manage their liquid funds, there's not been an alternative because also the government bond rates have been very low or negative. And right now, this is changing. So in SEB, we are offering quite change now in terms of managing short-term liquidity. You've gone from zero to some of our investment products yielding 4%. This is not a net number, but gross number is very good that you actually now when the rates have come up, you can start looking at fixed income securities that is clearly yielding more than you would get in just a transaction account. And that's also a potential explanation and it's a very good thing because we would love the money to be more productively placed. Thank you. And just a follow-up there on deposits. Have you also seen amortization going up in the mortgage book? Is that part of the explanation? Yes, we have seen that happen. It's a very small increase from low numbers, but this has been a new trend since September that we have seen more applications for amortizations, and we are approving a larger share of those applications for every month really. So the increase started in September, and it was higher in December than it was in September. Good morning. Thank you very much for making the time. I just wanted to explore the deposit volume point just a little bit more. I guess, if we look at system level trends, deposits were down about 0.3% in November. So they're still fairly flattish. So I was hoping you could perhaps comment on whether why SEB's trends look a little bit different from the system. Or did something happened in December that's a little bit different? And just related to that, we've seen quite a nice development in terms of the deposit margin, and we're expecting to get another, I guess, the market saying 50 basis point rate hike from the Riksbank. Could you help us perhaps think about the various moving parts on NII going forward in terms of what benefit from rate sensitivity we can get? What net new volumes look to be doing? And what lending margins look to be doing? Thank you. Okay, thank you, Omar. I really wouldn't make a big number of the deposit decrease in Q4. If you look at the full year number, we've seen deposit inflows in the bank. We've seen the largest deposit outflows in Q4 is related to the corporate business. And this has to do with that over the course of the year in 2022, some of these corporates seek up new funding from us for a purpose and some of the purposes have been to acquire other companies. And you can see that when they do the actual payment of that acquisition, they have taken out liquidity from us. They put it in the bank as deposits. And when they do the actual acquisitions, they use those deposits to do that. So that's a big part of the deposit outflow. As I said before, on the retail side, this has to do with -- and that's a very small proportion of the deposit outflows in the quarter, that has to do with the cost of living, really. So it's really no drama in it. And since we are a predominantly corporate and financial institutions bank, there will be more volatility in our deposit base than if it will be just a pure retail bank. So I wouldn't say that we have a different trend on deposits than what you can see in the overall market. When it comes to deposit margins going forward, it's difficult to say what's going to happen. It has a lot to do with competition, really, and how customers will behave. The increases in rates that we've seen has been very rapid. So financial actors, both corporates and households haven't really had time to act. And now we'll see what they will do. What we do know is that, we have about SEK200 billion of equity in the bank. So if you just do it very sort of technically, if rates go up by 50 basis points, obviously, we don't pay any interest on the equity. The positive effect of that is about SEK1 billion annualized basis. So that's sort of what we can guide on, and the rest is going to be up to competition and what's going to happen in the markets. We do see right now or our view is that, lending margins, especially on mortgages are unsustainably low. They are very depressed. And you can argue that some parts of deposits, margins are high or higher than they've been historically. So we are in a process of the market really finding a new equilibrium between lending margins and deposit margins. And it seems reasonable to believe that, to some extent, lending margins should improve from current levels, also given that what's happened to credit spreads in the market, at the same time, as maybe deposit margins will come down. And what the net effect of this will be? It's very difficult to predict. We've had such a fast-moving environment in terms of rates. It's going to take some time to find this equilibrium, and it's just difficult to predict where that's going to be. On lending volume side, there is subdued lending demand. We did see quite a lot of credit demand in Q4 from high-quality investment-grade corporates, adding on liquidity facilities in Q4. These haven't been drawn yet, but obviously, to some degree, these could be drawn. These are not CapEx investments. So these are backup facilities to a large degree with shorter tenors than CapEx investments would have. But we did see quite a lot of that activity in Q4, a sort of a mini pandemic effect, if you can say. So, as you recall, in the early parts of the pandemic, we did SEK140 billion of new credit facilities over six weeks. Now we did about SEK60 billion in Q4, so almost half of that amount. So fairly large, and we'll have to wait and see how much of that will be drawn in the coming months or so. Okay. Thank you very much. I guess, just on the deposit point, I was referring to the household deposits. If I look at the CPC deposits, they were down 2% in the quarter, and it doesn't look like system trends are showing that. Yes. In C&PC, more than 50% of the deposits are from corporates. So less than half of that is households. So if you look at the household side, it's a very small decline. And when we track the flows and see where the money is going, it's not going to other banks. It's going to pay bills, basically. Thank you. So first, a question on growth, please, in your balance sheet and your strategy here. So the credit portfolio was flat quarter-on-quarter and Masih, I see you just commented that your lending demand is currently subdued. So assuming what looks like a possible scenario for the next couple of years with very limited and possibly even negative loan growth on both the corporate and household side, how would you think about your growth strategy in such environment? Do you find it critical to continue to grow your kind of credit and lending? Or do you think you could be content with absence of growth and rather focus on protecting profitability and distribute earnings to shareholders rather than reinvesting into the business? If I start and just so we have the same mindset. We don't dictate how much a corporate needs to borrow. That's very much driven by every institution's desire to invest. And right now, that is subdued. We have still a recession coming our way. Many large corporates are still very cautious and careful and worried, but that is also good for loan demand, namely for the rainy day argument. So we have seen these facilities now put in place, but they're not drawn because they are drawn if there's something to happen. The growth strategy for SEB is completely not driven by macro. It's driven by increasing our market share amongst large corporates and financial institutions. It's driven by increasing the number of clients that we service, and that's predominantly outside Sweden. So there's still a little bit of growth in Norway, Denmark, Finland. There are significant opportunities in the long run to grow this bank in Germany, Austria, Switzerland, U.K., et cetera. And the other part of the growth strategy is to increase the proportion of any client's business to us. That's a very organic, very powerful change in how much market share you have on one client. And the data points, of course, to a fantastic 2022, and there's no reason to believe that we're not going to continue where we've increased market share and gained more clients. Then on your kind of estimate of what will volumes be? I don't know. It's very much a macro-driven question in my book. The margins on corporates are more or less global. So there's a market price set in the international financial market, you cannot do anything about it. That has, of course, been a positive. It's supported right now by higher credit spreads than we used to have. So that's a very positive thing that money is becoming more expensive. And therefore, also the credit curve, the difference between credit quality has clearly widened out, even though it stabilized in this quarter. That margin that we receive is, of course, very much driven, if we are efficient, if we have a low funding cost and if we're cost-efficient, which I hope to be able to say that we are, and therefore, there will be a good margin development. Okay. Thank you. And then a second question, please, on your ROE aspiration. So looking at the underlying ROE in Q4, it seems to be pretty close to 15%. So, I was wondering whether you think it would be a stretch for you to aspire higher, in particular, given your -- yes, current strong capital position and maybe some further NII tailwinds going into 2023. Do you think you could aim higher with the slimmer equity base? And also, if you could please elaborate what drivers you see impacting your ROE positively and negatively from the current level over the next couple of years? Okay. I'll start there, Nicolas. The Board confirmed our financial targets yesterday. So the ROE aspiration continues to be 15%. I think for us, it's about trying to strike a good balance between adding value to the shareholders. So having a return on equity that is sufficiently above the cost of equity, but also making sure that we can grow the business. So there's going to be a balance there, the higher ROE aspirations you set, the more you're going to potentially limit your growth or potentially you could sort of take on too much risk as a higher ROE aspiration would -- could incentivize you to take on higher margin business and, therefore, take on higher risk. But in the end, I mean, it's going to be about competition as well. Obviously, a lot of our peers who have move to other ROE targets, that's something we'd have to reflect upon and take into account when we set our own targets. But here and now, this is the aspiration we have. If we can get help from the interest rate environment being different than what we've been used to, that's obviously great. And hopefully, we can grow our business at this higher return on equity level for the coming years. Perfect. And then final question, please, on commissions for 2023, given where stock markets are currently and the activity pipeline you see for 2023 at this point. So how do you view the commission outlook for this year? Do you expect to grow net commissions in 2023 versus last year? It's going to be very dependent on what happens to asset values and balance sheet growth when it comes to lending fees, for example. Compared to 2022, what we don't have going into 2023 is a further recovery in the cards business. So we've seen a full recovery there. So that's behind us. At the same time, the advisory-related fees are clearly lower in 2022 than 2021. So if asset values stabilized, it's possible that that business could pick up. So that's the potential. On Asset Management, I mean, it's going to depend a lot on what happens to the stock market and asset prices in general. I should just note that we are a bit more geared towards fixed income than equities compared to many peers. So you should also look at what happens to fixed income prices to try to sort of track or understand what's going to happen to our assets on management and asset on the cost of business and the development there. It's very difficult to say what the fee income line will do in 2023 as it's, again, very macro dependent. First, on the capital outlook, maybe near term because [technical difficulty] Okay, I have a couple of questions. First, on capital trajectory. Maybe near term, we used to see a higher market risk, risk-weighted assets in the first quarter, if you expect seamless seasonality this time around? And then maybe kind of over the year horizon, if you have [technical difficulty] the impact of IRB model overhaul. Yes, I'll take that, Maria. You're right. I mean, typically, market risk REA comes down in Q4 and it goes up slightly in Q1. This time around, it's more unlikely that's going to happen as the market risk REA is already elevated in Q4 compared to historical levels. So hopefully, that won't happen. Hopefully, that could come down. It's going to depend a bit about on the volatility in financial markets as those have been elevated during 2022. And more recently, that type of volatility has come down. So we'll see. On the sort of full year, we do have the IRB overhaul. That process will likely end during the course of this year. As we've said before, based on what we apply for, based on our historical default rates, which we base our models on, we don't see that this overhaul should lead to any net effect on our capital requirements on our risk weights. But in the end, it's going to be the FSA that approves the model. So we can't say, but we think that we have a good application and we have a good -- sort of good assumptions behind this conclusion that, in the end, it shouldn't lead to any meaningful net effect for us. And just to follow up, do you have a sense of where your portfolio is different from key peer? Because Swedbank provided quite a different outlook for the net impact from this process. I can't really compare it to peers. What I can do is to look at our historical observed default frequencies in the portfolios and the risk weights we use and look at that general data for European banks, we can see that we have clearly higher buffers in our risk weights than other banks have on average compared to the historical default rates. So given that we have larger buffers to start with, it's difficult for us to assume that we would have to have even larger buffers compared to average European banks. So that's what I base that conclusion on that we start out with clearly higher buffers than the average bank. Thank you for your comments. And then the other question on asset quality outlook. Maybe first on commercial property lending. You stood out among other Swedish banks with a quite conservative approach and portfolio didn't increase. But I see that it grew in the fourth quarter. I know if you changed your view on the specific sector. And maybe you could comment what's your risk appetite for adding new CRE exposures in 2023. And then more broadly, I believe previously, you included in the report some kind of commentary on your outlook for expected credit losses. So we were at 7 basis points in 2022 to get a sense of how high can we get this year given your forecast recession? Okay. Yes, on the CRE portfolio, it is right. We believe that we are conservative to the extent that the accounting rules allow us to be. So we've done this bottom-up analysis and the best number we can come up with at this point is the portfolio overlay of about SEK300 million. This is not a guarantee that that's going to be sort of how much we lose in the end, it could be lower than that. It could also be higher. But the accounting rules allows you to be forward-looking to an extent, and we have been as forward-looking as those allow you to be at this point. The risk appetite, we didn't grow CRE portfolio Q4. As Johan said before, it's that growth rate is driven by reclassification. So the underlying growth in the quarter is 0. Our risk appetite is such that we will continue to support the core customers that we have, and we will not add market share during this period of elevated risks in that market. On the outlook on credit losses, we're not giving any guidance on that for this year. There is obviously a higher uncertainty related to that. What I would say is that, we are going into 2023, in my view, with probably the sort of cleanest and healthiest balance sheet we've ever had. If you look at the reserves, we have against Stage 3 loans, how much Stage 3 loans we have as a share of the total book, how much reserves we have, how much portfolio overlays we have, it's a good position to be in when going into a more uncertain environment. So very comfortable in that sense that we have good buffers going into what is likely to be an uncertain environment. Thank you. And just a minor clarification question, if I may, on your cost guidance. Just to check if it's based on the average FX rate in 2022 or the year-end FX rate? It's based on the average FX rates. That's a good point. So year-end FX rates are higher than average. So everything if they stay where they are, we're going to be sort of, not at the lower end of that interval. So that's correct. Hi, everyone. We've gone through most areas, but a few follow-ups. On the mortgage margins, Masih, you said that you think that they are unsustainably low at the moment. But when I look at how you've been pricing your mortgages, it seems like you've been probably the most aggressive in terms of mortgage prices, and we see that the average price at the moment is even below step quite a lot below some of your bigger peers. So could you tell us a little bit about your strategy and why you're doing this? Yes, we can do that. I think -- I mean, first of all, it's a timing issue here. So at any point in time, we could be either cheaper or more expensive than our peers on mortgages, especially if you look at the list price, I think it's wiser to look at the actual price. So you can both change the list price or you can do something about the underlying model and yes, change those prices, what kind of discounts you give depending on what kind of customer it is. So I think the main issue, it's a timing issue. We -- going into 2022, we had a view on the mortgage market and the real estate prices that they were a bit elevated, and there were some risks. We start to see inflation come up. And we didn't feel that this was the best point in time to advise customers to take on mortgages at the very low rates we had when we could see that prices were a bit elevated and that rates would go up. So that's the stance we took back then. Now we think the market is more balanced. Prices are down 15% or so. And now it's more visible to households, what mortgage rates will be, and they've gone up quite significantly. So we have a different outlook on the market as such. At the same time, we have lost some customers that we didn't want to lose during 2022. So we're trying to make sure that we don't lose good customers going forward. And the plan is to come back to our back book market share. So that is also behind sort of the reasoning we've had. But I think the main issue here is that, it's a timing question, when do you change prices and what price do you change? Is it the list price? Or is it the underlying negotiated price depending on what type of customer you are? Yes. I mean, I'm obviously looking at the average prices, but -- so getting back to clients, I mean, we see that you're actually shrinking your mortgage book at the moment. But are you going to do that by offering a lower price? Or are you going to do that by offering new services? Or how do you plan to get back into that market? In the end, it's going to be a combination that we have a total offering that is competitive. And we've done a lot with service during 2022. So, if you call into the telephone bank, you'll notice that telephone queues are very short today, and they've been short for several months now. So our service has improved quite a bit. We've improved also the access you have and what you can do yourself in the app. And then we have a slightly lower price compared to what we had about a year ago. So it's about finding the best combination of these based on what customers want. Obviously, in the end, I mean, we want to improve the service as much as possible. We think the customers appreciate that. But obviously, there's a lot of competition in the market. Mortgage growth in the market is very, very low. It's basically zero at this point. So -- which means that a lot of banks are chasing less volumes and that increases the competition and that's one of the main reasons behind why mortgage margins are so depressed at this point. Okay. Thanks. And then, Johan, when you talked about capital, you mentioned M&A. Could you tell us -- I would assume it's -- we're talking about smaller transactions. But within what areas would you be interested? Is it asset management? Is it international? Or what would fit your strategy? When I said it, I meant corporate finance, M&A advisory, so I didn't mean SEB M&A, but I'll answer the question as I meant that. So there is no -- in the plan we decided off with the Board yesterday, there is no M&A included. So the organic stance, the base case for what we are talking about costs, capital, everything on this call is assuming no meaningful acquisitions or disposals by SEB. That doesn't mean that things can't happen. As things happen in the market, we always have to look at it. It's our fiduciary duty. And there are, of course, areas where we could expand. But the -- so it's very clear. There is no M&A in the current plan. Should there ever be one, we would, of course, have to come back because that would change how we view the statements that we see today. Yes. Here is Sofie from JPMorgan. So I just wanted to go back to the cost target because if I assume the average FX rate for 2022, and I look for the euro versus SEK currently, it's almost 5% higher. So if I adjust for the latest FX rate, does it mean that I get to SEK27 billion or does it mean that I would get more to SEK27.5 billion, if I can get offer? And like if we take the kind of current FX rate, what would the cost targets for 2023 will be? That will be my first question. Yes. I don't know what the current FX rate is compared to the average for 2022. But you're right that it's probably sort of worse in the sense that the cost target we've given out would imply a higher cost level. So if -- so the interval we've given out is based on uncertainty around inflation, not uncertainty around FX. So if inflation is such that we would land at SEK27 billion, and then you would have to add whatever FX does on top of that. So yes, it is possible that we end at SEK27.5 billion if FX rates move in the direction of that. But recall, if you look at 2022, the FX effect of our cost line was about SEK0.5 billion, but we had a positive FX effect on our income line of SEK1.3 billion. So whatever you do -- so we are more profitable and have a lower cost/income ratio outside of Swedish kronor than we have in Swedish krona. So, a weakening Swedish krona, although it increases the cost level of the bank, it actually improves the profit level by more. So in the end, the net effect of a depreciating Swedish krona is positive for our results. Okay. That's very clear. And could you just kind of reiterate your rate sensitivity guidance? Does it still hold SEK750 million for a 25 basis point rate hike in Sweden and another SEK250 million in the Baltics? And could you also just remind us what your rate sensitivity is 25 basis point got in interest rates? Yes. So if you look at that guidance, that was based on that we don't pay anything on transaction accounts when rates go up. And that obviously, we don't pay anything on the equity base that we hold. So with the same assumptions, you would have the same sensitivity. The question now is, can you make the same assumptions? Is it reasonable to believe that if rates go up further than they have that we wouldn't have to pay anything on transaction accounts? And what we're saying now is that, at this rate level, that assumption is less likely to hold. So competition in the market is more likely to lead to banks generally having to pay up for all types of deposits in line with interest rates moving upwards or downwards. So what we do have is, obviously, the equity base of SEK200 billion, which we don't pay interest on. So it's -- with the same assumptions, it's the same sensitivity. You can just question the assumptions more at this point in time. So that's the point we want to make. There is still some tailwind from the rate hikes we've seen so far. So, obviously, the whole lending book hasn't been repriced. That's going to happen over time. It takes maybe up to two years before that happens. So I think there is still some tailwind from the hikes we've seen. But the question is, will there be further potential tailwinds if we get additional hikes at this stage? And I think that's a much more sort of uncertain issue. And then you also have some headwinds on NII from higher wholesale funding costs. My understanding is that, they are also funding go in to reprice all at ones. Yes. Well, the question is how those potential headwinds are offset by. On the lending side, I would say that, if anything, lending margins are depressed at this point relative to credit spreads. So hopefully, going forward, we could have some improvement in lending margins. And obviously, that's related to the wholesale funding costs. So net-net, hopefully, that will be positive going forward. Okay. That's very clear. And then just a final question. You did SEK1.4 billion provision for Russia writing down the equity base. Or do you still have SEK7 billion of exposure to kind of Russia? How should we think about any future write-downs? And if you don't believe there will be any more write-downs against Russia, why is that? What makes you profitable? Yes. So we had SEK1.6 billion of equity in our Russian business. We've written down SEK1.4 billion of that. So the maximum additional potential risk we have is SEK200 million. The deposits we have in addition to that is customer deposits that we're taking from customers and place at the Central Bank, and we have parent guarantees for those deposits. So, even if you would assume that there will be any losses related to those deposits, which is just -- well, it couldn't happen. But even if you assume that we still have SEK1.6 billion of equity in the subsidiary that could cover any potential losses for the parent bank, we have impaired that. So, yes, I would say the maximum potential further impairment in Russia is SEK200 million. But why wouldn't you see any write-downs on the asset side, considering that most other European banks have written down most of the assets that they have in Russia? Why would you only see it on your equity? Because it's not our assets, it's the customers' assets, it's their deposits that we take in and we place it in the Central Bank in Russia. So it's not our own assets, and we have parent guarantees for those assets. These are Nordic companies or German companies doing business in Russia, it's not our assets. If you're asking about lending, it's very different if you compare to other international banks in Russia because we don't have any Russians in Russia. We are only there for the Nordic and Northern European companies that we already have. And therefore, there's no real exposure to be compared to if you are a bank in Russia for Russia because we have then a parent company in some of the Nordic countries or in Germany, who has a more often than not a guarantee. So the credit risk is still going to be on the industrial company, typically speaking, from the Nordics or Germany. And therefore, the credit risk in that sense is the same as the overall bank regardless of the problems that might be created. And that's why that is a separate issue, which we feel very comfortable with compared to the equity -- the money that we own, our money, which we are not allowed to take out, and therefore, we take it -- we do the prudent thing to write most of it off. Hi, good morning. So starting off with the first question on Swedish mortgages. Given that you have not hiked prices in line with the competitors recently, but at the same time, sort of a comment that mortgage margins are very low. Would you say that, that indicates that you're more likely to move your prices ahead going forward in line with the sort of peers in general? And also a follow-up question there on sort of given that volume growth is now approaching close to 2% on sort of an annualized basis. If we start seeing volumes coming down to zero or even negative, just if you could comment how you would prioritize between sort of keeping volumes up between that and sort of keeping your -- protecting your margins? Yes, Rickard, I'll try to answer that. I can't give you any indication of what we'll do with prices. Going forward, that's going to happen when it happens. And so, yes, we just have to wait and see. On volumes, we don't really look at the volumes in that sense. We look at customers. So we want to keep good customers in the bank. And whether those customers at any point in time, want to borrow or not, that's going to be cyclical. You're going to see scenarios where they're going to borrow and scenarios where they won't borrow and we won't force them to do either. So -- but we want to make sure that we're going to keep the customers that we think we can service. So at this point in time, you have very low mortgage lending growth and then that's fine. And if it goes up, then that's fine too. That's something that sort of happens in the market. That's not something we can dictate really. Over time, we think that the mortgage market will rebalance that the depressed margins you can see today are too depressed for that business to be viable, but it's going to happen over time, and it's going to be probably a combination of something happened to deposit margins and something happened to lending margins, and we're going to find a new equilibrium somewhere at some point. But it just -- it's been such a fast-moving environment. So it's very difficult to say whether -- when and at what point this will sort of stabilize. But I'm sure that a lot of things will happen during the course of this year. And may I add, it's -- I understand the question, and we are having -- we're posting a claim. So let me answer the question about what we are not saying. We are not saying that we're going to be cheaper or have lower volume or less profitability in order to gain market share. That's not part of the strategy. The overall composition of return on equity or profitability in retail banking, you can see the aspiration we have. So we need to both deposit taking, savings and investment, mortgages, cards to kind of fit that bill. And we need to have a competitive offer that clients like to choose, both with the right price and the right service. So that's how we box it in. What that's going to lead to in terms of dollars, euros and kroner next year, volume, I don't know. But it's just like Masih said, it is important that we maintain our position in the market, and this has gone so fast. And the heights you referred to, some of them were a few days ago. So we are talking about real-time, and we don't change the mortgage price every day, but there are -- there's a little bit of lag and the time -- and timing issue in this discussion. Then a follow-up question also on the SEK300 million overlay you do on commercial real estate. I guess, this is an overlay, you have not really started to see any impaired asset quality yet. Or if you have -- or how do you expect the timing of this sort of to play out for your customers there? Where you're somewhat more concerned compared to previously? Yes, you're right. We haven't seen anything yet. So the underlying portfolio, both in CRE and the balance sheet in general looks very solid. Nothing has happened. As I said before, we are trying to stretch the accounting rules to the extent that we can to be prudent and take into account what potentially could happen. If I just give you an example. So here, we have assumed that we will have defaults in parts of the portfolio and that collateral price will go down by 20%. If in a year's time, this hasn't happened, then we have to rethink this and see whether we should recover this overlay. Or if something more sort of negative has happened, then we would have to do the opposite, maybe add a bit more in overlay if nothing has happened to the other line portfolio. So this is something we will reassess basically every quarter and whether it's going to be sort of higher or lower than this amount that we have put aside at this point, it just depends on market developments. But for now, there is no difference or no change in the underlying quality. If anything, during the quarter, as you can see, our Stage 3 loans came down and the reserves we have come down less. So we have more reserves relative to any potential issues in the balance sheet today than we had prior to Q4. Hi, thanks for the questions. My first one is, what confidence can you give us that the investment of SEK800 million to SEK900 million has a decent return? And who is accountable for this? Because if I look at asset management flows, they've been negative for the past few years, and this has been an area where you have stated previously where investment spend has gone. Yes. I'll start, if Johan came support me. I think that's a good question. It's very difficult, obviously, to evaluate the investments you do, especially in the short-term. We have now allowed the cost base of the Bank to increase for four years or so after keeping it flat for 10 years. The only thing we can see at this point is that when we compare ourselves to other banks, we have seen a higher income growth in the last four years than others have, which clearly sort of is over and above the cost inflation we've seen. But it's, at the same time, it's difficult to conclude whether that income growth is fully driven by the additional investments we've done or if it's something else. And then it's difficult to say what would have happened if you take your example of the asset management business, if we hadn't done the additional investments, how would the flows look like in that scenario. So that you should compare with, but it's difficult to know what that -- how that scenario would look like. We have sort of accountability on all of the investments based on who's responsible. So what division is the investments going into, and then we have KPIs we follow for every part of the bank and make sure that they are following the trajectory that we have assumed that they need to follow, given what we allow them to invest. So I can assure you that we have good accountability in the Bank when it comes to the investments that we do. And then I've just got a question on ESG, because I saw this article and Dagens industri, stating SEB is one of RWEs that German energy company, main banks for financing. But the article states, SEB's support undermines the global climate goals and violate the Paris agreement. It also states it violates SEB's policy, which excludes loans to companies whose operations are more than 15% of coal operations. So I'm just wondering, are these comments true from the article? And do you have any additional comments? Yes. I can take that. I would start normally by saying we don't comment on a single relationship. At this time, I'll make an exception, because we asked RWE and had it as part of the update on the sustainability representation we gave quite recently. This is a very tricky area. So there is not an answer if it's true or not. It's a matter of opinions. People think very differently about RWE or any utility who is not 100% renewable. We have a luxury position here in the Nordics, not because we are great or better than anyone, but Sweden and Norway particularly has an extremely high density of non-fossil energy generation. We are a very large bank in Germany and no other Nordic banks is at all comparable to us. So if you were to look at a corporate bank who is in Germany, you would not look like you are a corporate bank in Sweden. You will, by nature, have a lot more fossil dependence. And as you might have seen, gas is now being increased quite a lot, and there has been coal-fired plants, and there has been a lot of oil discussions since the invasion of Ukraine, and it's pretty clear to everyone, this is huge investments going in. This is the explanation why it is correct when you compare us to our peers around this square, what we said that we are the only large corporate and investment bank in Germany. The financing, I actually explained on the corporate day, it was the acquisition of Con Edison Energy. So it was a $6 billion. So it's absolutely correct, we did part of that financing together with a large group of international banks, and it was 100% renewable investment, which was not a part of the narrative in the paper. Yes, good morning. Maybe just a final question for me on the CRE overlay. I wonder if you could just explain how you factor refinancing risk into your models and your assumptions, because when I look at the CRE sector in Sweden, it looks like the main risk is not really collateral values per se, it's the possible inability of these customers to refinance, particularly in 2024, if the wholesale markets remain shut. So if you could just maybe shed some light on what sort of assumptions you're using for cost of debt for these companies as we move into next year, that would be very helpful. Thanks. Yes. I'll try to do that, it's probably a bit too detailed, we have to ask the risk organization exactly how they've done that. But I know what factors they've looked at. So they've looked at capital market dependency, access to equity, for example, and exactly where they've sort of put the thresholds and how much access you need to have and how dependent you need to be. I actually don't know the details. But these are sort of, to some extent, crude assumptions that you take a portion of the book, you look at what kind of dependencies you have, and you assume that 10% of it will default and then you assume a certain decline in collateral values in that scenario. And then the model gives you a potential loss in that scenario, which, in this case, is about 300 million. So that's sort of how -- what we've done. Just to note that when it comes to collateral values, they are unchanged to-date. So even though we've had this volatile environment for about a year or so, nothing has happened to collateral values, mainly because rents have gone up equal amount compared to discount rates for the collateral. So as I try to say, I mean, this is as much as we can do. We want to be prudent and conservative, and this is as much as we can do given the outlook we have today. If the outlook changes and if things deteriorate, then it could be possible to take further reserves, portfolio overlays or if something materializes in the portfolio, then these overlays could be used against any potential underlying deterioration of that credit book. But so far, nothing has happened, and we are trying to be prudent. And may I just add, it is a cash flow, first and foremost, dependent analysis. Thereafter, it's an event of default announces where LTVs come into play. But that's after the event where you cannot, as a real estate company, meet your legal obligations to repay loans or other things. And we did show a few quarters ago, one of, I think, could be helpful, that where we put in, was it 200 basis points, we just increased the funding cost or we put STIBOR at the time we increase it to 4%. And we just check the interest cover ratio. And you could see there that no one in that scenario we did a few months ago was breaking the one. And it's still the case. I hear my Head of IRs telling me. So that is still a valid analysis. So we have to do this, what we've done here. We have to put something on top, which is not easy to -- you cannot really calculate it. It would indicate zero increased risk. And here's the forward-looking, like liquidity risk, equity markets tells you something about what they think about the outlook, but they are not particularly part of the liquidity model or the credit risk remodel. So this is what we've done. Yes, that's interesting. And then I guess, if I look at the wholesale markets, it looks like these companies would probably need to be paying 7% plus to rollover wholesale debt. From what you're saying, the spreads the banks are asking for are putting the cost of debt from a bank perspective on a lower level. So 4%, do you think it's still a sort of realistic number for kind of sort of model the -- No, no, sorry, we are using the credit spread, which you alluded to. We are using the reference rate. We put it up. So we increased -- if it's 7% in your example, it would be 9% or 10% that we would assume. But many of these would even pay 10% or 20%. So it's not a credit spread widening number I gave you. It's actually the benchmark number, which is a different assumption. So it's all clear. And then the analysis we do is not on the market. So that is on our clients that we have. We have, of course, a very ample ability to service existing clients. As Masih said in the beginning on the CRE strategy, we will support the clients that we like and that we have. But we don't have an -- and that means that's very different from saying that we would increase or do more CRE. We will not -- we're very cautious continues to be that. But if we have clients that are depending us, also if they have bond maturities that they might struggle with, of course, we're going to be there. That's what we do. We do the bonds and we do the loans to support them. Thanks a lot for taking my questions. Just to get back one second to NII. If I recall correctly at the beginning of the call, you stated that we have some items, some traveling between NII and NFI in the quarter so that one is a bit understated, the other one may be a bit overstated. Now knowing that this is probably a volatile item, would you be in the position to, let's say, to throw a ballpark on what you think might have been the traveling path between these two lines. This is the first question. The second question I have is on capital repatriation. Just to understand, the SEK1.25 billion buyback consumes roughly 15 basis points of capital. It's not exactly effective in helping you achieving 15% ROE target. My understanding, and please correct me if I'm wrong, is that you intend to -- you see this SEK1.25 billion as a quarterly buyback. So we should assume this to keep going more or less at the same level every single quarter over the course of '23, provided, nothing really horrendous happens this year, do I get it correctly? And then the other thing I want to -- then is a curiosity. Why impairment in Russia now are not six months and not at the time of first half results '22, even then sanctions have been there since a while, why now? Okay, Ricardo, on the NII and NFI traffic, it's difficult to quantify what the amount is. I think if you just look at market risk rates, mainly the three months' time, where you'll see that it dropped quite dramatically in the beginning of October, and it took some time for that to recover and sort of be at the past, it should be at, given the expectations of policy rates from the Swedish Central Bank. So it's that drop I'm referring to, and there were a lot of fixings on the corporate book in relation to that drop. So those fixings were probably at lower levels than they otherwise would be. And now when the -- those fixings will be done again in December, January, it will be at sort of more correct levels. And exactly what the effect of that is, it's just -- it's difficult to say. I was just referring to the question I got whether there is anything additional in NII, I think if anything, the opposite in Q4 that it's probably slightly understated. On capital repatriation. So the SEK1.25 billion we're doing until the AGM is not a guidance of what we will do post the AGM. It could be a higher amount. It could be a lower amount, it could be the same amount. The only guidance we can give at this point is that we plan to be within our target range of 100 basis points to 300 basis points by the end of 2024. And whether that's going to be reached by increasing buybacks or doing anything with a dividend or growing faster or buying something, we can say or obviously, an accident happens and credit losses increased, because the environment is uncertain, we can say at this point, we only know that that's where we want to end up by the end of 2024. And then finally, on the impairment in Russia, I think, if anything, I mean, we are being conservative in that impairment. And just to be clear on that, we still have that equity in Russia SEK1.6 billion, and we will do what we can to make sure that, that comes back to the parent company and the shareholders of the Bank. We just feel that at this point in time, it's going to be difficult to guarantee that's going to happen anytime soon. But it's been -- it takes some time to conclude that this is a restriction that will be in place for some time, just as difficult it's been to conclude whether the war is going to continue for a long period of time. And these rules have sort of stabilized themselves during the course of the year. And we felt that in Q4, we could discuss this with the authors and allow ourselves to be prudent and make this impairment. So that's the reasoning behind it. Yes, it takes just time to understand exactly how things will pan out. Good morning. Thank you for answering -- for taking my questions and thank you for your time today answering all the questions. Really, just one question from my side. And I was just wondering, the strong NII trend in the fourth quarter, the strong progression in NII over the last essentially two years. Do you think the 4Q '22 NII trend represents peak NII, peak NIM for SEB? I'm just trying to squaring up all the various comments in terms of NII progression from here and that would shape -- there are a lot of moving parts. But I was just wondering from today's perspective, looking at implied policy rate, looking at the assumption in terms of mortgage pricing, deposit attrition and migration, would you expect NII on a quarterly basis to continue to edge higher? Or is there potential for this to either stabilize or even decrease from here? Thank you. Yes. Good question. It depends on what view you have on all the types of margins and policy rates. It's difficult to say. I guess if policy rates go higher than they are, that increases the likelihood for NII to continue to go up. If policy rates are cut, that increases the likelihood for NII to go down. In addition to that, I'll just say that we probably still have some tailwinds from the policy rate changes we've seen during 2022 as the whole balance sheet hasn't been repriced at the higher levels. So that's pretty much the guidance I can give you. And then you have to add your own assumptions of loan growth going from here. And obviously, everything that's going to happen with margins. But yes, that's -- I don't know if Johan, if you want to add something. Maybe I could just step back and spend two minutes on the history. So you understand that why the benefit is coming? Is that for households and for the majority of non-financial corporates? We never introduced the negative interest rates. So we have had many years of zero or negative cash flow or profitability we wouldn't even speak to. And this is why this enormous shift is happening that as we never lowered the savings rate or the interest rate on deposits for a year or 2, when still the policy rates were going down, that was just put more and more in the rent. Now this with enormous speed and power reverses. And right now, we are normalizing the interest rate level in the economy, and we're all trying to adapt and it takes a year or 2. That's what the positive is. So I don't know where it's going to go from here, but it is reasonable to assume that whatever has happened will not happen again, because we're not going to -- from now on, go from negative territory to significantly positive normal rates. That's just what I wanted to add. Hi, thank you. Just to follow-up on one of the questions from the floor. Would you be able to just say anything about -- in the treasury NII, how much of that was currency transfer pricing? And if there were any other effects impacting that weak treasury income line? And I guess related, when you talk about this NII versus trading income moves, if you could say anything, to what kind of magnitude you're talking about there? And then finally, on NII, just in the Baltic, the strong NII growth in Q4, does that -- to what extent does that fully reflect the rate hike already seen? And how much sort of additional tailwinds from rate hikes already happening -- would you expect to sort of see in Q1 or Q2 this year? Thank you. Yes. Thank you, Jacob. On Treasury, this quarter, it's a fairly small proportion of the NII drop in treasury that's related to internal funds transfer pricing. As you can see in the report, it's more now related to that the cost of short-term funding has increased, which has impacted treasury's NII negatively. On the traffic between NFI, I can't really add anything on that. It is probably slightly understated, but exactly the magnitude of that, I don't know, and it's difficult to estimate, I would say. But we'll see, obviously, in the coming quarters. On the Baltic NII, it's probably so that there is still some tailwind there because of rate hikes we've seen. And I would assume that since ECB is slightly behind or the rate hikes have come slightly later than the RICS bank, you probably have a bit more effect from further hikes going from here into Baltic business. And as you can see, we have clearly more deposits relative to lending in the Baltic division compared to what we have in the Group as a whole. So while it's prudent to assume that further rate hikes in Sweden wouldn't add too much, it's more likely that in the Baltic business, there will be some benefits going forward. Okay. Thank you. And are you seeing any sort of dynamic moves there already in terms of competition or deposit flows or anything like that, that's been going on in Sweden in the Baltic business? No. I mean you can see in the disclosure that in the quarter in CNPC, there were some flows, fairly small, from transaction accounts to saving accounts. So we're seeing that customers are starting to understand that if they shift money from certain accounts to other accounts and maybe to some extent, lock in their deposits, they can get a better yield. So that process is ongoing and probably that's going to sort of continue for the coming year when people now adapt to positive rates and yes, try to manage their portfolios. Yes. Sorry for that. It's been going on for a long time already. But just on your -- we saw a macro report from you guys coming out just a couple of days ago, where you actually started to upgrade a few of your GDP forecasts. Were these assumptions that went into IFRS 9 model? Or was it from a previous report where you were cutting GDP forecasts? Yes. No, it's the previous report. So it's based on what we had in -- back in November, really. And obviously, these estimates or whatever they will be revised to later in Q1 will be used for the Q1 sort of IFRS 9 overlay or macro assumptions. So you're right that there were some smaller positive revisions. Okay. Then I'll thank everyone for spending a bit more than 1.5 hours with us. Very much appreciated, and we hope to see you soon. Thank you very much.
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EarningCall_1248
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Good day, ladies and gentlemen, and welcome to the Baker Hughes Company Fourth Quarter and Full Year 2022 Earnings Call [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Jud Bailey, Vice President of Investor Relations. Sir, you may begin. Thank you. Good morning, everyone, and welcome to the Baker Hughes Fourth Quarter 2022 Earnings Conference Call. Here with me are our Chairman and CEO, Lorenzo Simonelli; and our CFO, Nancy Buese. The earnings release we issued earlier today can be found on our Web site at bakerhughes.com. As a reminder, during the course of this conference call, we will provide forward-looking statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. Please review our SEC filings and Web site for a discussion of the factors that could cause actual results to differ materially. As you know, reconciliations of operating income and other GAAP to non-GAAP measures can be found in our earnings release. Thank you, Jud. Good morning, everyone, and thanks for joining us. I'd like to start off by highlighting a couple of changes for this earnings call. For the first time, we are hosting our earnings call from Florence, Italy, where we will host our Board meeting later this week and welcome over 2,000 customers and industry experts next week at our Annual Meeting. We will also be using a presentation during this webcast, which has also been published on our investor Web site that we will reference over the course of our prepared remarks. As you can see on Slide 4, we were very pleased to end 2022 with solid momentum across our two business segments. In the fourth quarter, we saw continued margin improvement in our OFSE segment and an extremely strong level of orders for IET, which was driven by multiple awards across different end markets. 2022 was an important year for Baker Hughes on a number of fronts. Strategically, we took a large step forward in reshaping the company as we announced our formal restructuring and resegmentation of Baker Hughes into two business segments. This kicked off a major transformation effort across the organization, including key executive management changes, which will fundamentally improve the way the company operates. Operationally, our performance for the year was mixed. During the first half of this year, we experienced multiple headwinds across our organization as well as a number of operational challenges. While our performance improved over the second half, we still have more work to do and are focused on various initiatives to improve shorter term execution and meet the longer term financial objectives we laid out at an investor conference last September. Commercially, orders performance in LNG and new energy hit new highs and are poised to remain strong into 2023. In 2022, we booked almost $3.5 billion in LNG equipment orders, our highest ever and booked over $400 million in new energy orders, showing over 50% growth versus 2021. Although not yet back to previous historical levels, orders for our offshore exposed businesses also accelerated. Within OFSE, SSPS booked over $3 billion in orders in 2022, representing 36% growth versus 2021. In IET, onshore/offshore production recorded equipment orders of almost $1.9 billion in 2022. We are also seeing improvements in our industrial segments with industrial technology orders of $3.3 billion in 2022, up 6% year-over-year. As we look ahead to 2023, we expect order momentum to continue across both OFSE and IET despite what is likely to be a mixed macro environment. Turning to Slide 5. In 2023, the global economy is expected to experience some challenges under the weight of inflationary pressures and tightening monetary conditions. Despite recessionary pressures in some of the world's largest economies, we maintain a positive outlook for the energy sector. With years of under-investments now being amplified by recent geopolitical factors, global spare capacity for oil and gas has deteriorated and will likely require years of investment growth to meet forecasted future demand. For this reason, we continue to believe that we are in the early stages of a multiyear upturn in global activity and are poised to see a second consecutive year of solid double digit increases in global upstream spending in 2023. In addition to strong growth in traditional oil and gas spending we also believe that the Inflation Reduction Act in the US and potential new legislation in Europe will support significant growth opportunities in new energy in 2023 and beyond. We also remain positive on the near term and long term prospects for the natural gas and LNG investment cycle. Near term, we believe that the likely reopening of China, combined with Europe's need to refill gas storage supplies will play a critical role in keeping global gas and LNG markets tight. Longer term, we remain optimistic on the structural growth outlook for natural gas and LNG as the world looks to lower emissions and displace the consumption of coal. While cost inflation and higher interest rates slowed the pace of new LNG FIDs in 2022, we are seeing progress on a number of fronts. We continue to expect significant growth in new project sanctions in 2023 with elevated activity levels likely continuing into 2024. Following 36 MTPA of LNG FIDs in 2022 we continue to expect to see an additional 65 to 115 MTPA of LNG projects reach FID in 2023. Just as important as the near term outlook for LNG orders, we are now gaining visibility into new project opportunities that are developing towards the middle of the decade. Most notably, we are seeing progress on a number of brownfield initiatives and advancements in our new modular concept that is likely to extend the current wave of activity several more years. Turning to Slide 6. Given this macro backdrop, Baker Hughes is intensely focused on four key areas in 2023 in order to drive future value for shareholders. First, we are well positioned to capitalize on the significant growth opportunities that are building across both business segments. These opportunities reach across the entire OFSE portfolio as well as in IET, most notably in LNG, onshore/offshore production and new energy. Second, we remain focused on optimizing our corporate structure and transforming the Baker Hughes organization to drive improvements in our margin and returns profile. While we are still in the early stages of this process, we are increasingly confident in driving at least $150 million of cost out by the end of 2023 as well as structural changes that will simplify the organization and enhance our operational efficiency. The cost out and integration initiatives we are undertaking over the next 12 to 18 months will play a key role in hitting our EBITDA margin target of 20% in OFSE and IET over the next two to three years, and delivering return on invested capital of 15% and 20% for OFSE and IET, respectively. Third, we continue to develop our portfolio of new energy technologies. We've been particularly active over the last few years acquiring and investing in multiple new technologies around hydrogen, carbon capture, clean power and geothermal. We are now transitioning more towards the incubation of the existing portfolio. This will enable our new energy portfolio to achieve its full commercial potential with a particular focus on high impact technologies like Met Power and Mosaic. Finally, we will continue to focus on all these initiatives and while also generating strong free cash flow and returning 60% to 80% of this to shareholders through a combination of share buybacks and dividends. In 2022, we increased our dividend for the first time since 2017. Going forward, our goal is to continue to increase shareholder returns with an emphasis on continuing to grow the dividend as the IET business experiences broader structural growth in revenue and earnings. Turning to Slide 7. I'll provide an update on each of our segments. In Oilfield Services and Equipment, the outlook remains promising with growth trends shifting more in favor of international and offshore markets, while North America activity levels off. Importantly, the team continues to execute well as supply chain pressures moderate and the pricing environment remains favorable. Geographically, the Middle East retains the most promising outlook with activity scheduled to increase in multiple countries this year and likely next year. In Latin America and West Africa, offshore activity is driving growth in several countries and creating opportunities across our diverse portfolio. In North America, visibility remains limited given the current oil and gas price environment and generally expect range bound activity from current levels over the course of 2023. Within our OFSE product lines, we have seen strong growth for well construction driven by opportunities across our drilling portfolio and for SIM, where our completions portfolio continues to see solid improvement. In production solutions, we saw strong volume growth and margin improvement in our chemicals business throughout the year as supply chain constraints continue to ease and profitability normalizes. For 2023, we expect further improvement in our chemicals business as margin levels normalize back to historical levels and our Singapore plant becomes fully operational. Our legacy OFS segment executed well in the fourth quarter and we were pleased to see them achieve 19.6% EBITDA margins and 20% when normalizing for the impact of Russia. In SSPS, order activity remains strong as offshore activity continues to pick up. Importantly, we saw good order traction in both subsea trees and flexibles in the fourth quarter. After a record year in 2022 in flexibles orders, we expect another strong year in 2023 as well as a significant increase in subsea trees awards. We also continue to make progress on integrating SSPS into our OFSE segment as well as restructuring the business to drive better profitability and returns. After a thorough review of the SSPS business, Maria Claudia and her team are finalizing plans to rationalize approximately 40% to 50% of the manufacturing capacity in subsea production systems. These steps will be in addition to the cost savings gained from removing management layers and will largely come into effect in 2024. For 2023, we expect OFSE to deliver double digit revenue growth and solid improvements in margins as activity increases in multiple regions, inflationary pressures subside and we execute our cost out program and pricing remains favorable in most key markets. Moving to IET, the fourth quarter generated record orders driven by multiple awards in LNG and multiple awards in onshore/offshore production. Operationally, IET continues to navigate challenges in the Gastech services as well as challenges in different parts of the supply chain, ranging from chips and circuit boards to gas engines, castings and forgings. Orders during the fourth quarter for gas technology illustrates the breadth and depth of this portfolio. In LNG, we saw continued progress across our world class franchise. During the quarter, we were pleased to be awarded another major order to provide an LNG system for the second phase of Venture Global's Plaquemines project. This order builds on an award in the third quarter of 2022 for another Power Island system. Furthermore, this follows an award in the first quarter of 2022 for the first phase of Plaquemines and a similar contract for VG's CalcaShoePass terminal in 2019, which are all part of a 70 MTPA master supply agreement. In onshore/offshore production, IET booked contracts for five different projects in Latin America and Sub-Saharan Africa worth almost $900 million on a combined basis. With these awards, IET maintains its leadership in the FPSO market by providing power generation systems, compression trains and pumps that totals more than 30 aero-derivative gas turbines, two steam turbines and 20 compressors of various sizes. On the new energy front, we were pleased to book an order from Malaysia Marine and Heavy Engineering to supply CO2 compression equipment to PETRONAS' Carigali offshore carbon capture and sequestration project in Sarawak, Malaysia. The project is expected to be the world's largest offshore CCS facility with capacity to reduce CO2 emissions by 3.3 MTPA. Baker Hughes will deliver two trains of low pressure booster compressors to enable CO2 removal through membrane separation technology as well as two trains for reinjecting the separated CO2 into a dedicated storage site. Orders in our industrial technology business continued to perform well with strong traction this quarter across inspection and pumps, valves and gears. In our inspection business, we achieved significant commercial wins in the recovering aviation industry, including a record deal for visual inspection services in Latin America region as well as a number of orders for advanced ultrasonic testing systems with different customers in Asia Pacific. In addition to solid growth in orders, we were pleased to see some signs of operational improvement in our industrial tech businesses, led by volume and margin increases in condition monitoring and inspection. We expect this positive momentum to continue into 2023 as the chip shortage and supply chain issues start to abate and backlog convertibility recovers. As we enter 2023, IET has a record backlog of $25 billion and a robust pipeline of new order opportunities in LNG, onshore/offshore and new energy, and we now expect IET orders in 2023 between $10.5 billion to $11.5 billion. Despite the supply chain challenges, we are closely monitoring for both Gastech and industrial tech. We are well positioned to execute on this backlog to help drive significant revenue growth in 2023 and 2024. While 2022 presented some unique challenges to Baker Hughes, it was also a pivotal year for us strategically and accelerated a number of changes in the organization. As we look at 2023 and beyond, I feel confident in the structural changes we are executing and are positioning to capitalize on the multiyear upstream spending cycle, the unfolding wave of LNG investment and the acceleration in new energy opportunities. Across our entire enterprise, Baker Hughes is focused on significantly improving our margins and financial returns and meeting our customers' needs in a quickly changing energy landscape. Achieving these goals will require acute focus across the entire organization as well as the depth and scale of global resources and engineering talent. The culture of this company is unique in its diversity, its inclusiveness and its principles as well as its ability to adapt to change. Our team is focused on taking energy forward, transforming the way we operate and achieving the margin and return targets we have laid out to help drive best-in-class shareholder value and returns. Thanks, Lorenzo. I will begin on Slide 9 with an overview of total company results and then discuss our balance sheet, free cash flow and capital allocation before then moving into the business segment details and our forward outlook. Total company orders for the quarter were $8 billion, up 32% sequentially driven by industrial and energy technology, up 82% versus the prior quarter. Oilfield Services and Equipment orders were flat sequentially. Year-over-year, orders were up 20%, driven by an increase in both segments. We're extremely pleased with the orders performance at IET during the quarter, following strong orders throughout 2022. Total company orders for the full year were $26.8 billion, an increase of 24% versus 2021. Remaining performance obligation was $27.8 billion, up 13% sequentially. OFSE RPO ended at $2.6 billion, up 8% sequentially, while IET RPO ended at $25.3 billion, up 13% sequentially. Our total company book-to-bill ratio in the quarter was 1.4 and IET was 1.8. Total company book-to-bill for the year was 1.3 and IET was 1.6. Revenue for the quarter was $5.9 billion, up 10% sequentially and up 8% year-over-year, driven by increases in both segments. Operating income for the quarter was $663 million. Adjusted operating income was $692 million, which excludes $29 million of restructuring, impairment and other charges. Adjusted operating income was up 38% sequentially and up 21% year-over-year. Our adjusted operating income rate for the quarter was 11.7%, up 240 basis points sequentially. Year-over-year, our adjusted operating income rate was up 130 basis points. Adjusted EBITDA in the quarter was $947 million, up 25% sequentially and up 12% year-over-year. Adjusted EBITDA rate was 16%, up 190 basis points sequentially and up 70 basis points year-over-year. Corporate costs were $100 million in the quarter, driven by the realization of some of our corporate optimization efforts. For the first quarter, we expect corporate costs to be roughly flat compared to fourth quarter levels. Depreciation and amortization expense was $255 million in the quarter. For the first quarter, we expect D&A to remain flat with fourth quarter levels. Net interest expense was $64 million. Income tax expense in the quarter was $157 million. GAAP earnings per share was $0.18. Included in GAAP earnings per share were unrealized mark-to-market net losses and fair value for investments in ADNOC drilling and C3 AI of $89 million and $11 million, respectively. Also included were $81 million of charges related to the termination of the tax matters agreement with General Electric. These are all recorded in other nonoperating loss. Adjusted earnings per share was $0.38. Turning to Slide 10. We maintain a strong balance sheet with total debt of $6.7 billion and net debt of $4.2 billion, which is 1.4 times our trailing 12 months adjusted EBITDA. We generated free cash flow in the quarter of $657 million, up $239 million sequentially, driven by higher adjusted EBITDA and strong cash collections. For the first quarter, we expect free cash flow to decline sequentially, primarily driven by seasonality. We will continue to target 50% free cash flow conversion from adjusted EBITDA on a through cycle basis but expect 2023 to be in the low to mid 40% range. Turning to Slide 11 and capital allocation. We increased our quarterly dividend by $0.01 to $0.19 per share during the fourth quarter and also repurchased 4.2 million Class A shares for $101 million at an average price of $24 per share. For the full year 2022, we returned a total of $1.6 billion to shareholders. During the quarter, we closed the recently announced acquisition of Brush Power Generation, Quest Integrity and Access ESP. The total net cash paid for these three transactions was approximately $650 million. To fund these transactions, we took advantage of our strong balance sheet and used cash on hand. Baker Hughes remains committed to a flexible capital allocation policy that balances returning cash to shareholders and investing in growth opportunities. Our capital allocation philosophy starts with the priority of maintaining a strong balance sheet and targeting free cash flow conversion from adjusted EBITDA in excess of 50% on a through cycle basis. This framework will enable Baker Hughes to return 60% to 80% of our free cash flow back to shareholders. This will also allow us to invest in bolt-on M&A opportunities that can complement the current IET and OFSE portfolios as well as our efforts in new energy. As we look to return cash to shareholders, we will prioritize growing our regular dividend given the secular growth opportunities for IET and complementing this with opportunistic share repurchases. Now I will walk you through the business segment results in more detail and give you our thoughts on outlook going forward. Starting with Oilfield Services and Equipment on Slide 12. Orders in the quarter were $3.7 million, flat sequentially. Subsea and surface pressure system orders were $738 million, up 45% year-over-year, driven by an increase in subsea tree awards across multiple regions. OFSE revenue in the quarter was $3.6 billion, up 5% sequentially driven by increases across all product lines. International revenue was up 5% sequentially, driven by Latin America up 10% and Middle East, Asia up 7%, offset by Europe, CIS, SSA down 2%. North America revenue increased 5% sequentially. Excluding SSPS, both international and North America revenue were up 5%. OFSE operating income in the quarter was $416 million, up 28% sequentially. Operating income rate was 11.6% with margin rates increasing 210 basis points sequentially. OFSE EBITDA in the quarter was $614 million, up 16% sequentially. EBITDA margin rate was 17.1% with margins increasing 160 basis points sequentially, driven by increased volume and price improvements, partially offset by cost inflation. Year-over-year EBITDA margins were up 160 basis points. We are really pleased with the margin performance in OFSE, particularly in the legacy OFS segment which achieved a 19.6 EBITDA margin in the fourth quarter. Legacy OFS EBITDA margins were 20%, excluding under absorbed costs incurred prior to the completion of the sale of OFS Russia to local management in November. Turning to Slide 13. IET orders were $4.3 billion, up 20% year-over-year and a record orders quarter for IET. The strong fourth quarter orders performance closed out a great 2022 for IET with $12.7 billion of orders, up 28% year-over-year. Gas technology equipment orders in the quarter were up 36% year-over-year. Gastech equipment orders were supported by the LNG award for the second phase of Venture Global's Plaquemines project, a number of onshore/offshore production awards and the award for CO2 compression equipment for the Kasawari CCS project. Gastech services orders in the quarter were down 4% year-over-year, driven by lower contractual services orders, partially offset by an increase in upgrades. RPO for IET ended at $25.3 billion, up 13% sequentially. Within IET RPO, Gastech equipment RPO was $9.5 billion and Gastech services RPO was $13.6 billion. Industrial technology orders were up 6% year-over-year. Pumps, valves and gears, inspection and PSI and controls orders were up year-over-year, offset by condition monitoring orders, which were down year-over-year. Turning to Slide 14. Revenue for the quarter was $2.3 million, up 1% versus the prior year. Gastech equipment revenue was up 24% year-over-year, driven by the execution of project backlog. Gastech services revenue was down 17% year-over-year, driven by lower contractual services and upgrades. This was primarily related to the loss of service revenue from the discontinuation of our Russia operations, foreign exchange movements, supply chain delays and outage pushouts. As we've noted previously, the strength in commodity prices continues to shift maintenance schedules for some of our customers, a dynamic that we believe should normalize over time. Gastech services also continues to see supply chain delays, largely stemming from delivery delays in aero-derivative gas turbines and associated components. This is an area that we will continue to monitor and manage going forward. Industrial technology revenue was flat year-over-year. Conditions monitoring, inspection and PSI and controls revenue was up year-over-year while PBG was down year-over-year. Operating income for IET was $377 million, down 5% year-over-year. Operating margin was 16.2%, down 110 basis points year-over-year. IET EBITDA was $429 million, down 4% year-over-year. EBITDA margin rate was 18.4%, down 110 basis points year-over-year with higher equipment mix, cost inflation and higher R&D spending, partially offset by higher pricing and slightly higher volume. As we increasingly execute on our record Gastech equipment backlog, we are seeing a meaningful shift in the mix of our revenue profile with equipment revenue representing 55% of total revenue in the quarter versus 45% a year ago. Turning to Slide 15. I would like to update you on our outlook for the two business segments and our cost out program. With new reporting segments, we're providing a formal outlook in order to give another level of transparency for each business segment as well as further details around our forward looking expectations. As we transition to this new framework, we're providing a range of expectations and also highlight the variables that drive the different potential outcomes. Overall, we feel optimistic on the outlook for both OFSE and IET with solid growth tailwinds across our business as well as continued operational enhancements to help drive margin improvement. In addition to executing on the growing pipeline of commercial opportunities, a key focus for Baker Hughes in 2023 is transforming our organization through at least $150 million of annualized cost outs by the end of this year. All necessary actions to achieve this target should be completed by the end of the second quarter and the full impact will be realized by the end of the fourth quarter. For Baker Hughes, we expect first quarter revenue between $5.3 billion and $5.7 billion and adjusted EBITDA between $700 million and $760 million. For the full year, we expect revenue between $24 billion and $26 billion and adjusted EBITDA between $3.6 billion and $3.8 billion. For OFSE, we expect first quarter results to reflect usual seasonal declines in international activity as well as typical seasonality in North America. We, therefore, expect first quarter revenue for OFSE between $3.3 billion and $3.5 billion and EBITDA between $515 million and $585 million. Factors driving this range include the magnitude of seasonality in some international markets, timing of budget deployments in the US, backlog conversion in SSPS and the pace of our cost out initiatives. For the full year 2023, we expect another strong year of market growth internationally, spread across virtually all geographic regions, led by the Middle East, Latin America and West Africa. Overall, we expect international D&C spending to likely increase in the middle double digits on a year-over-year basis. In North America, we expect activity levels to likely remain range bound for the balance of the year depending on oil and natural gas prices and activity levels among private operators. However, we believe that this level of activity as well as cost inflation will still translate into North America D&C spending growth in the high double digits in 2023. Given this macro backdrop, we would expect OFSE revenue between $14.5 billion and $15.5 billion and EBITDA between $2.4 billion and $2.8 billion in 2023. Factors driving this range include the pace of growth in various international markets, a range of potential outcomes in North America activity, continued improvement in chemicals, the pace of backlog conversion and cost out initiatives in the SSPS segment and our broader cost out initiatives. For IET, we expect strong revenue growth on a year-over-year basis supported by backlog conversion at Gastech equipment and modest growth in industrial technology. We, therefore, expect first quarter IET revenue between $1.9 billion and $2.4 billion and EBITDA between $250 million and $300 million. The major factors driving this revenue range will be the pace of backlog conversion for Gastech equipment, growth in industrial tech driven by improving supply chain dynamics and the impact of any continued deferrals in maintenance activity or supply chain delays at Gastech services. For the full year, as Lorenzo mentioned, we now expect IET orders to be between $10.5 billion and $11.5 billion, driven by LNG and onshore/offshore production. We forecast full year IET revenue between $9.5 billion and $10.5 billion and EBITDA between $1.35 billion and $1.65 billion. The largest factor driving this range will be the pace of backlog conversion for Gastech equipment and any impacts associated with supply chain delays. Other factors that drive this range include foreign currency movements, the pace of improvement in supply chain impacts at industrial tech, the level of R&D spend related to our new energy investments and the timing of maintenance activity in Gastech services. Thank you, Nancy. Turning to Slide 16. Baker Hughes is committed to delivering for our customers and our shareholders. We remain focused on capitalizing on the growth opportunities across OFSE and IET, including LNG and new energy, where we are increasing R&D to develop our technology portfolio in hydrogen, carbon capture and clean power. We also remain committed to optimizing our corporate structure to enhance our margins and return profile where we are targeting EBITDA margins of 20% in OFSE and IET and increasing ROIC in both businesses to 15% and 20% respectively. And finally, we will continue to focus on generating strong free cash flow and returning 60% to 80% of this free cash flow to shareholders while also investing for growth across our world class business. So Lorenzo, maybe first one for you on the LNG side. When we were together in December, I know, as we were leaving, Jud was going to Houston, I was going to L.A., but you were going to a Middle Eastern country that has some huge gas reserves and huge plans for LNG. And I'd love to -- I know you made some comments in your prepared remarks, but Iâd love to get maybe some further comments on how you see kind of orders rolling in this year given your dominant position in LNG. And since that trip, I've also been back another 2 times, and I can tell you the customer discussions have been remaining, and there's a lot of positive momentum. And I think both as you look at the near term and also the long term prospects for natural gas and LNG, it's a positive investment cycle. In 2022, we did experience some cost inflation, some high interest rates, which slowed the pace of FIDs but conversations with customers definitely hasn't slowed down. And I think you've seen some of the announcements also within North America from Sempra related to Port Arthur, NextDecade, which has signed up a supply agreement. So importantly, I think the operators globally have recalibrated the project costs to the current environment, and they're actually starting to see success in securing some of the offtake agreements. So I think there's a realization out there as well that natural gas and LNG are going to play a key role, not just this transition but also destination as the world continues to need more energy. And so we see a number of projects that are getting close to FID. We feel comfortable with, at least 65 MTPA reaching FID this year and expect to see sanctioning activity actually exceed that. So it's not just about 2023. I think as we look at the environment right now, we're actually going beyond and seeing also 2024 and also 2025 with the portfolio we have of modular approaches and a good time to be in LNG. And then maybe for Nancy, given your new role as CFO here, how are you thinking about capital allocation and focusing on shareholder returns, et cetera, relative to -- maybe it's probably just the same, but relative to what the -- what Brian and Lorenzo were already focused on? Baker Hughes remains committed to a flexible capital allocation policy, and as Lorenzo already mentioned, balancing returns to shareholders and also continuing to invest in growth opportunities. Our philosophy starts really with the priority of maintaining a strong balance sheet and also targeting free cash flow conversion from adjusted EBITDA in excess of 50% on a through cycle basis. This framework will allow us to return 60% to 80% of our free cash flow back to shareholders. That also gives us the ability to invest in bolt-on M&A opportunities that will complement the current IET and OFSE portfolios as well as our efforts in new energy. So as we look to return cash to shareholders, we will prioritize growing our regular dividend given the secular growth opportunities for IET and also complementing this with opportunistic share repurchases. And just as a reminder, during 2022, we did return a total of $1.6 billion to shareholders through both dividends and buybacks. Nancy, I want to start on the free cash flow conversion rate from EBITDA this year. It does sound like working capital is probably a decent headwind this year. Is there more to working capital beyond just the top line growth? And I also noticed the adjusted tax rate forecast in the guidance, it looks like 35% to 40%. It sounds high. But can you also provide some comment on the cash tax rate? So just some additional color on that, that free cash conversion rate. And we do believe the free cash flow conversion potential should be around 50% through the cycle. And in â22, we saw conversion below this range for a handful of items primarily we had about $300 million to $400 million of cash generation that didn't materialize given the shutdown of the Russia operations. We also saw cash consumption from inventory build in OFSE and Gastech equipment as we prepare for growth in '23. We also had lower collections from some international customers during the year. And as we think about 2023, we believe we should be in the low to mid-40% range with higher EBITDA, higher CapEx, but still about 4% to 5% of revenue. And then cash taxes should be roughly the same as in '22, cash restructuring around $75 million to $100 million versus almost zero in '22. And then also for '23, working capital will be a use of cash versus a modest source of cash and that's another strong year of revenue growth in OFSE and Gastech equipment. So hopefully, that gives you a little bit of a picture. Yes, it does. And then just thinking about a couple unique items that impact EBITDA for the year. I think you mentioned that the restructuring benefit is really going to kind of build over the course of the year and hit more in late. So some additional color there and just how to think about how much of the $150 million cost out actually impact EBITDA this year? And then also, we've seen a big swing in the euro here and the dollar starting to weaken across a number of other currencies. Just thoughts on the FX that's built into the guidance. I know the euro weakness in the second half last year was impactful, but just how did you guys think about that in terms of putting together the guidance for this year? So on the cost out, we really put that program together last September and have identified a number of ways to remove cost from the organization and create a more efficient operating structure overall. I put the cost out efforts really in two categories. The first is cost reduction from structural changes in our organization identified around simplifying and streamline operations from four product companies to two business segments and the leaner HQ. That's about two thirds to three quarters of the $150 million in cost out we're targeting. These also include headcount reductions from removing layers and really thinking about implementing a strategically managed business structure where we can push some activities down into the business from HQ and then do it on a more cost efficient basis. The second bucket is really cost optimization or cost controls. So things -- headcount reductions to optimize our support functions and then also areas to optimize our cost in technology, third party services, external expenses, those sorts of things. And we should, in terms of timing, have all the process completed by the end of Q2 and all actions taken by the end of Q4 of this year. And then we should hit the annualized run rate sometime in the fourth quarter. So our plan today considers pretty conservative guides in terms of FX. And then the other piece on that is if the euro appreciates versus the USD, there could also be some upside to our revenue outlook for IET. And Scott, just to give some more color. I think on the cost out, we've been operationalizing a lot of the actions since we made the announcement in September. We've got a dedicated team that's set up to go and execute this. And you've seen some of the changes we've made within Baker Hughes. And I feel very good about the annualized run rate of the $150 million coming through and we'll see a lot of the actions in the first half of this year, which then will yield in the second half. I guess, first question, if we can come back to kind of the order outlook for '23 for the IET segment, it looks like you kind of bumped up your order outlook by about 5%. The new guidance is about $10.5 billion to $11.5 billion. And you bumped up the orders despite having a really strong fourth quarter order. So I would have thought you maybe pulled some orders into '22, but just given that you raised your order outlook probably means that you didn't really -- you don't think you kind of pulled any orders forward. So when we think about '23 and the bump like what was really driving the bump to orders in '23? And kind of when we think about that, obviously, LNG is a big driver, but kind of walk through some of the drivers as well. And really, as within a year, there's a lot of moving pieces when we think about the orders, particularly with some of the large projects that are still out there. '22, as you noted, was an exceptionally strong year for orders for IET at $12.7 billion and then a record 4Q at $4.2 billion. And so, broadly speaking, as we think about '23 Gastech equipment orders should be down versus 2022 primarily driven by onshore/offshore orders. And as you asked about the drivers, '22 was just a huge year for onshore/offshore and then LNG orders are likely to be down modestly. The biggest driver, though, will be the onshore/offshore. We do think Gastech services orders will be up modestly in '23 versus '22 with growth somewhat in line with '22. And then industrial tech orders will probably grow at a modestly slower pace than in 2022, and those were up about 6% in '22. So as you mentioned, overall, we now do expect IET orders to be in the $10.5 billion to $11.5 billion range for the year. And I think Chase [Multiple Speakers] as we go through it, again, activity right now is pretty strong out there internationally. And again, we think that $10.5 billion to $11.5 billion increase reflects the activity we're seeing. Lorenzo, maybe a quick follow-up here with new energy opportunities. Obviously, a lot of color on the conference call and in the press release around CCUS and hydrogen and clean power as well. So we obviously got some legislation that's helping accelerate some of these markets. So talk about the outlook that you have and the opportunity for Baker alongside some of these markets for '23 and beyond. And Chase, I firstly start by saying we're really pleased with the progress we made in 2022, which was a significant increase from 2021. And as we look at 2023, again, we believe we can achieve around $400 million of new energy orders. And we're seeing the early stages of development within CCUS, hydrogen. They are likely to be lumpy. But as you said, there's been legislation that has come into place. And the Inflation Reduction Act in the United States is helping to firm up that outlook, if anything starting to pull forward some projects. We do anticipate that Europe may bring in some legislation to help spur the energy transition as we go forward. So over the next three to four years, the new energy content should be around 10% of our Gastech orders. And as we stated previously, we believe by the end of the decade, new energy orders should be in the range of $6 billion to $7 billion. And if you think about the middle of the decade, new energy representing about 10% of our Gastech orders and then accelerate through the balance of the second half of the decade. So direction of trial is clear. We've got the investments in place into the new tech and feel good about the way in which the market segment is really creating on the back of some of the legislation. My first question is on your IET EBITDA margin guide for 2023. Nancy, you posted a 16.8% EBITDA margin in 2022. The midpoint of the guide is 15%. So I was wondering if you could walk through what's driving the margin change this year? And then how you see margins moving towards that 20% 2025-2026 guide over time? If we look at the full year IET guidance, it would apply about a 200 bps decline in margin rates from '22. And so, the real drivers are around the equipment mix is it continues to move up and the step-up in R&D around our new energy efforts. So on mix, you can see by our '22 results and our '23 guidance that equipment orders are going up. And in '22, Gastech revenue was 50% equipment and this year, it's likely to be 65% or higher. R&D, as we've been communicating, we're stepping up our effort there, about $50 million to $75 million as we look to commercialize some of the most promising technologies that include things like Met Power and Mosaic. And I think for the longer term, we would really reaffirm the margin levels that we previously indicated. And Arun, just to add, and I think we've maybe mentioned this before, as we go through a big equipment build, it's actually a good thing for our business. Our installed base is increasing close to 30%. And then in the later years, we'll get the service calories associated with that. So it's a factor of the longer cycle nature of this business, but we feel confident in the next two to three years to be able to take the margin rate back up to, as we said, to 20% EBITDA rate, and that's driven by the services starting to come through after the equipment flow through. And my follow-up is, Lorenzo, I believe you mentioned that the plan is to rationalize 40% or more of your subsea capacity. I was wondering if you could provide more details on this plan? And which markets do you plan -- or which markets will be focused markets on a go-forward basis for Baker? We did mention that we've been restructuring our SSPS business, and Maria Claudia and the team have been undergoing a strategic review. We are still in the early stages of that. But as we look at the subsea tree capacity, we're really going to be decreasing, rationalizing our production capacity by 40% to 50% and also outsource some of the basic machining. You can imagine from a cost perspective, we're in some relatively high cost countries. And so it's an opportunity for us to be able to rationalize capacity back to Asia, also Latin America and that machining was typically done in the UK. So we're continuing to look at how we go forward, and we feel good about the savings being achieved on top of the broader $150 million cost out effort that included about $60 million from OFSE. So still early days and we'll see this come through in 2024. But the team has got a good handle around how to take the strategy going forward for the SSPS business, and it's on the backdrop of an improving outlook for offshore. Lorenzo, just one question for me. You made a significant management change recently in the IET business. And I was wondering if you could just kind of talk about the management changes you made there. And you're bringing in somebody from the outside in [Ganesh] and just kind of what you're trying to achieve with this change? Are there certain KPI targets you're targeting, is there a new philosophy you're trying to instill in this part of the organization? It's obviously a big part of Baker Hughes and I'd just like to hear some more -- some of your thoughts on that. And I think as we continue to evolve Baker Hughes, and as you saw from the announcement we made in September and moving to the two business segments, we continue to look at the future of how the growth of both the IET segment and OFSE is going to take place. And in discussions with Rod and also how we are growing in the space of digital services, industrial and also climate technology solutions, it's not a one year journey, it's a multiple year journey. And bringing Ganesh was maybe sooner than anticipated, but we found a great talent that can help us drive the growth going forward, comes from an experienced background of having built digital solutions at an enterprise level. Also knows well the climate technology solutions space. And if we look at where the growth is in the second half of the decade, we said it's around the new energy and also the industrial asset management. So great candidate at the right time. And Rod is staying with us and helping with the transition and then he will be moving on. But very happy with the new structure. And as you look at the changes we've made overall, it's all with the contemplation of, again, how we're moving forward for the next three years, the plan that we laid out in September and achieving the 20% EBITDA across the two segments. I wanted to ask first about the guidance for first quarter in 2023. It seems to imply a steeper slope of improvement throughout the year than we typically see. I was curious if you could talk about your confidence in that progression and maybe how much traction we might see in the second quarter? Look, the confidence is there. And I think what we've mentioned before is we've got a large equipment mix that flows through in the first quarter. And so that's obviously impacting the EBITDA rate. But as we go forward, we've got the backlog at hand, so the visibility is there. Also, if you look at our IPO on the Gastech services at $13.6 billion, we've got how that rolls out as well. So I actually think this is pretty normal, the way in which we are seeing the profile of the year just based on the way in which the equipment and the longer cycle projects are converting. So we wanted to make sure that we gave that visibility but feel confident with the outlook for the year and then also the cost out that's going to be achieved with the $150 million transformation being annualized by the end of the year. And then following up on the prior discussion around orders for '23. Nancy, I think I heard you say that you expected LNG orders to be down year-over-year, but the macro outlook that you guys have has a near doubling of LNG FID at the low end. So maybe you could just kind of talk to that a little bit, if you could. Yes, maybe -- and again, it's an aspect of the lumpiness of the way some of the orders come through. I think as we go through this, again, the focus is on the total orders of the $10.5 billion and the $11.5 billion and the elements within there will shift. I think, again, as you look at LNG from the FIDs and the MTPA that's going to be sanctioned, probably will be up versus 2022 and 2023. I have sort of two related questions here, so I'll ask them at once. But basically, within the guidance for OFSE, you basically called out a couple of different swing factors that could affect the range or that are driving the range. I'm curious, on one hand, what are the big variables you're watching among the ones you called out? You call out pace of growth, you call out chemicals improvement, a few others. Could you just sort of specify for us what you think is the most important? And then, I guess, just in terms of the pace of growth, do you feel that third party service providers that you don't have control over, customer activity plans changing or maybe something else would be sort of the biggest risk to achieving that? Yes, I can kind of walk you through some of the variables. So the midpoint of the range assumes that the OFS business sees growth within the market fundamentals we've talked about with NAM, DMC growing to high double digits, international growing mid double digits and then adjusting for our portfolio, really high concentration of production related business lines in North America, higher concentration in the Middle East and also the sale of OFS Russia. We assume SSPS generates strong double digit revenue growth based on the backlog conversion. And then for margin rates, we assume 30-plus percentage incrementals as the chemical business continues to normalize and we see some benefits from our cost out efforts. The high point of that range assumes significantly stronger growth in North America driven by higher commodity prices and modestly stronger international growth. Also, SSPS backlog conversion remains the same as it's already locked in and then incremental margins in the high 30% range. So on the downside, I would say the low point assumes OFS North America revenue is essentially flat and international growth goes to low double digit growth, and then SSPS backlog conversion remains the same and then also really weaker incremental margins in the low 30% range. And then just in terms of where you see the largest potential bottlenecks, is that within Baker Hughes, is that third party service providers or is that just whether or not customers want to slow roll things based on the macro environment? As you look at some of the external factors that we're monitoring, it really comes down to the supply chain associated with the IET. And as you look at it, we mentioned that forgings, castings and some of the disruption you've heard about in the aerospace supply chain, we're managing. We think we've got that in check, but we're obviously monitoring the component flow very closely. We are starting to see some improvement in the electronic chips but monitoring that as well. So just something that we've got to keep our focus on and be aware that we're not the only users of some of these components. All right. Well, look, thank you very much to everyone for taking the time to join our earnings call today. I look forward to speaking to you all soon and seeing some of you also in Florence in the next week. Operator, you may now close out the call. Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.
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EarningCall_1249
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Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to today's Conference Call to discuss the Financial Results for Rocky Mountain Chocolate Factory's Fiscal Third Quarter Ended November 30, 2022. [Operator Instructions] As a reminder, this conference is being recorded. Joining us on the call today are the company's CEO, Rob Sarlls; and CFO, Allen Arroyo. Please be advised this conference call will contain statements that are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to certain known and unknown risks and uncertainties as well as assumptions that could cause actual results to differ materially from those reflected in these forward-looking statements. These forward-looking statements are also subject to other risks and uncertainties that are described from time to time in the company's filings with the SEC. Do not place undue reliance on any forward-looking statements, which are being made only as of the date of this call. Except as required by law, the company undertakes no obligation to revise or publicly release the results of any revision to any forward-looking statements. Our presentation also includes certain non-GAAP financial measures, including adjusted EBITDA as supplemental measures of performance of our business. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You will find reconciliation tables and other important information in the earnings press release and Form 8-K we furnished to the SEC earlier today, which will be available on the company's Investor Relations section of its website within approximately 24 hours after this call has ended. Well, thank you, and good afternoon, everyone. Our fiscal third quarter was highlighted by our strongest third quarter of sales since 2017, as well as our strongest third quarter of adjusted EBITDA since 2020. The groundwork our team has put in place since I arrived in May of last year has begun to generate strong momentum as evidenced in part by our flagship Durango store generating record sales in the fiscal third quarter, up 34% compared to the prior year. Although we are still early in the development and deployment of our strategic transformation, these initial wins are very encouraging. It may tell us that we're on the right path. The combination of our transformation plan and extensive dialogue with our franchisees will help us continue to foster growth at both the manufacturing and retail level. As we mentioned on our last earnings call, any business transformation starts with onboarding the right team. Earlier this fiscal year, we brought on a new Chief Financial Officer and Vice President, Sales and Marketing. And since our last conference call, we've made several key additional hires. In October, we announced the appointment of Scott Ouellet as our Senior Supply Chain Advisor. Scott brings more than two decades of supply chain and strategic planning experience to our team and over 10 years of which were with Hershey. His strong track record of identifying operating improvements and processes that expand margins and increase quality, flexibility and efficiency will serve us well and enable us to handle greater volumes in the future. Just this last week, we hired two additional operations experts who are in the process of relocating to Durango to enhance our business. For the first time ever, Rocky Mountain Chocolate Factory will have a resident, trained R&D expert who will help us not only with product formulation and new product development, but also with quality and regulatory compliance. Additionally, we hired a Senior Director of Manufacturing with extensive operational efficiency expertise with the financial background as a major plus. Both these new hires are critical to the first phase of our strategic plan, which includes the improvement of our operations in the factory and the enhancement of our end-to-end supply chain. Separately, in November, we announced the appointment of Kelsey Smith as Flagship Operations Manager to oversee the conversion of our Durango, Colorado store into our world-class operation and a reinvigorated beacon for the Durango community. She's been working closely with various colleagues representing all aspects of the business, including operations, marketing, business development, franchise support and training. We're excited to see the growth she will bring to our hometown of Durango in the year ahead and the potential scope of impact it could have throughout our network. Thinking about our franchise network. When I joined the company last May, I pledged to visit 50 franchisees in 50 weeks during my first year as CEO. I'm proud to say I'm well on the way to accomplishing my goal, having visited 27 stores so far. I can say confidently that our network feels more connected and energized with our team than they have in years. And the dialogue and feedback I have received during my business has already led to small but meaningful improvements. A small example of this is when I learned in our stores we're only getting one delivery by the company truck in December, one of our busiest months of the year. We added a second delivery by the company truck last month and store feedback on easing replenishment during this crucial selling season was well received. I look forward to completing the 50 visits in the spring, where I will go coast to coast visiting all our great airport locations. Furthering our commitment to our franchisee network, in December, we officially established our Franchisee Advisory Council and recently held our first meeting just this past Monday in Arizona. The council was formed to foster timely, consistent and transparent dialogue among franchisees at Rocky Mountain Chocolate Factory, which is critically important given the transformation underway. Our goal with the council is to more fully align Durango with the franchisee network to collaborate on the changes needed for gradual, mutual success and a superior experience for our customers. During the meeting this week, we previewed the working aspects of our developing strategic plan, which were well received. The council also agreed to meet every other month to weigh in and advise the company on significant transformation changes coming down the pipe over the next 12 to 24 months. We will be holding our next convention and the first annual convention in decades in San Antonio in late September. Planning is already underway on making this highly impactful and very well attended and the Franchisee Advisory Council is partnering with us on this. While our financial results this quarter were a strong step in the right direction, we're still facing some level of macroeconomic pressure resulting in labor and supply chain challenges, albeit not as bad as the pressure we faced earlier in calendar 2022. And as I mentioned in our last conference call, we were dealing with labor shortages at our Durango manufacturing facility, which impacted productivity. During our fiscal third quarter, however, we rolled out several new hiring and retention policies at the factory, which included enhanced new hire retention bonuses, resulting in a 150% increase in applications versus the third quarter last year. We have an active strategic planning committee wholly focused on rebuilding our culture, which we believe will improve the attractiveness to new potential hires while also improving retention. Outside of Durango, I'm happy to announce that we increased pay for our truck drivers, bringing them up to market to balance out the impact that inflation has had on so many Americans. Keeping our fleet of drivers happy has allowed us to deliver products on time and ensure an efficient cadence for our manufacturing facility to each of our franchisee stores. The benefit of this improved productivity far outweighs the cost of raising these truck driver wages. With respect to the supply chain, subsequent to the quarter, we met with our largest chocolate supplier to discuss opportunities for synergies and other process enhancements that can help us both reduce costs. They will be critical to our future growth, not only in terms of pound volume but in collaborating with our team and new R&D Head on innovation. It's worth noting, while we raised prices early in this fiscal year, which helped to offset inflationary cost pressure, our volumes have held up relatively well and are flat to slightly higher compared to the year ago quarter, which I believe speaks to the quality of our products and the loyalty of our customers. As another step in our business transformation, we have been actively identifying opportunities throughout the organization for margin and profitability improvements. Specifically, we've been working through an SKU rationalization to reduce our broad portfolio by at least 20%, removing products that account for an insignificant amount of revenue. Moving forward, our new R&D team will work to replace some of these SKUs with new innovative products throughout calendar 2023. We look forward to bringing exciting new products to the menu for our customers. While the transformation of the business is still in its infancy, a very solid third quarter and recent holiday season has proved us not only that we are on the right track with our plan, but that our commitment to extensive dialogue with the franchisee network and other stakeholders have begun to bear fruit. We look forward to sharing the exciting results from the holiday season on our next call as well as the full details of our new strategic transformation plan. Thank you, Rob. Jumping right into our financial results, please note that all variants commentary is on a year-over-year basis, unless stated otherwise. Total revenue increased 11% to $9.5 million for the three months ended November 30, 2022, compared to $8.5 million. Breaking down our revenue, total factory sales for the third quarter increased 14% to $7.3 million compared to $6.4 million, primarily due to higher shipments of product to our franchised and licensed retail stores as well as higher sales to customers outside of the Rocky Mountain franchisee network. Same-store sales at all domestic Rocky Mountain Chocolate Factory locations increased 3% during the three months ended November 30, 2022, and same-store sales at the company's domestic frozen yogurt cafes increased 14%. Retail sales increased 7% to approximately $679,000 compared to $636,000 in the fiscal third quarter of '23. Royalty and marketing revenue for the quarter was relatively flat at approximately $1.5 million. Franchise fee revenue was also relatively flat at approximately $60,000 compared to a year ago period. Total gross profit for the fiscal third quarter increased 17% to $2.1 million compared to $1.8 million. Total gross margin increased 50 basis points to 26.3% compared to 25.8% in the year ago period -- the year ago quarter, with the increase -- primarily due to increased pricing, which was partially offset by higher labor, material and inventory costs. Looking at our operating expenses for the quarter. Total OpEx decreased to $9.7 million compared to $10.5 million in the year ago period. Operating loss was reduced to $216,000 for the three months ended November 30, 2022 compared to a loss of $2 million in the year ago period. The decrease in OpEx and operating loss was primarily driven by lower costs associated with the contested solicitation of proxies as well as increased operational efficiencies. Net loss in the third -- in the fiscal third quarter improved significantly to $212,000 or $0.03 per share compared to a net loss of $1.5 million or $0.24 per share. Our adjusted EBITDA increased nearly 30% to $1.3 million for the three months ended November 30, 2022, compared to $1 million in the year ago quarter. Now turning to the balance sheet. We ended the quarter with a cash balance of $3.2 million compared to $7.6 million at the end of our last fiscal year, which was February 28, 2022. The decrease in our cash position was driven by an increase in inventory as we stockpiled finished goods to prepare for the seasonally strong demand in the holidays. As of November 30, 2022, the company continues to remain debt free. Thanks, Allen. Overall, we were pleased with our results this quarter. We've made great progress in improving company culture and round out our executive team, and we are nearly complete with the development of our strategic plan. We already have a few early wins under our belts, which is great to see and validates that we are on the right path. I firmly believe that the best phase for RMCF are ahead as we improve value to our customers, our franchisees, our employees and shareholders. This concludes our prepared remarks, and we will now open it up for questions from those participating in the call. Operator, back to you. Thank you, ladies and gentlemen. This concludes today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.
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EarningCall_1250
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Perfect. Hi, everyone. This is Rachel Vatnsdal with the Life Science Tools Diagnostics team. I'm joined by Udit Batra today, CEO of Waters. And so as a reminder, this will be a standard presentation. So we'll do a 20-minute presentation, followed by Q&A. You are able to submit questions via that conference portal if you are watching via webcast. Otherwise, if you are in person, feel free to raise your hand. We do have mic runners. We just ask that you wait to ask your question until you have the mic. Thank you, Rachel. Good afternoon, everyone, and thank you for braving the day and staying for one of the last presentations during the day. I hope to keep it entertaining for you. Roughly two years ago or so, we launched our transformation program, which we announced almost two years ago at this conference, and I hope to be able to provide you an update on where we are with that transformation. Nothing works if you don't have a great team, so I want to start by thanking the team that we have at Waters and the spirit that we have at the company that has led to quite a nice revival of growth, and nothing works if you don't have a supportive Board. So a big thanks to our Board as well. I have three messages today. Number one, we have executed consistently over the last couple of years. Number two, we've revitalized our innovation, and our pipeline is delivering very nice new products. And number three, I announced about a year ago that we were trying to get into a few faster growth adjacencies, and I want to present an update to you on that front, and we've had nice traction there as well. So before I get into where we are with our transformation, just a few words on the company itself. If you had a glass of water this morning, a cup of coffee, or if you enjoyed any lunch, chances are you've benefited from the products that we make. We are a leading analytical instruments company, and we work with some of the most innovative companies in the world to assure the safety and efficacy of the medicines that we take, the safety and cleanliness of the water that we drink and the durability of materials that we use day in, day out. Roughly US$3-ish billion in sales, roughly 8,000 of us around the globe. Industry-leading margins are around 30% in EBIT, and present in over 35 countries. We are consistently awarded for our efforts in sustainability. So a rather nice base. We apply a simple and repeatable business model, where we â on the left-hand side of this chart, you will see where we listen to our customers to understand the needs that they have. Using roughly 9% to 10% of our product sales and R&D to convert highly complex instruments to interrogate molecules and convert them into simple yet sophisticated systems. And on the right-hand side, you see the four parts of our portfolio that makes this simple model work. First, it's the instruments, right. We have roughly 150,000 of these instruments that are placed across our customers and in the industries that we serve. Second, the data that comes out of these instruments is fortified by an informatics system that is trusted by regulators and customers alike, so that nobody can adulterate the data that is submitted to these regulators. Empower, the system that we use for chromatography is used by the FDA and regulators to trust the data that is submitted to them. Roughly 50 or so pharmaceutical companies have used Empower over the last few years to submit data for pharmaceuticals. Number three, on the bottom right of this flywheel, you see our customized consumables. We are a leading player in that segment. As the complexity of the medicines that we develop increases, so does the ability to separate them with our customized consumables. And this flywheel works with this fourth arrow, which is our service team, which basically services â it consists of highly technical service representatives, which makes this flywheel work for our customers. So a simple and repeatable business model with these four portfolio elements. With this simple business model, we serve a highly resilient end market. So on the top left of this chart, you'll see our overall total accessible market, which is roughly around 12-ish billion, growing mid-single digits. The 2.95 billion that I showed to you on the previous chart is in the middle of the pie chart, roughly divided across these end markets. On the left, you see pharma, which is roughly 60% of our end market. Growing largely in â largely due to the volume of medicines that are being produced in the market. And with increasing concentration of biologics, this market is growing even faster. This market is, of course, quite resilient to ups and downs in economic changes in the macro environment. As you traverse to the right-hand side of this pie chart, you see our industrial and applied segment. Roughly 50% of this is food and environmental, which is also resilient to changes in the economy. So the need for food and environmental products goes in line with the population. And then finally, roughly 5% of the remaining industrial market serves life science material testing, serves semiconductor as well as electronics and battery testing, so also quite resilient to macroeconomic changes. So roughly 80% of our business is exposed to resilient end markets, which have durable drivers. So with a simple and repeatable business model, serving highly resilient markets, we have a portfolio that is leading in each and individual segment that we serve. So starting with the left-hand side of this chart, which is the instruments that we supply to the markets, liquid chromatography, with liquid â in liquid chromatography, we defined the QA/QC market way back when Jim Waters formed the company. We defined this market and has â we've established a leadership with our Alliance brand, which is now supplanted with the Arc HPLC brand that you see on the top of this chart. The ACQUITY line of products was developed to serve the ultra high-performance liquid chromatography market, and that remains a leader in separating larger molecules. As you move to the Mass Spec segment, we have one of the widest portfolio of mass spectrometry instruments in the industry, serving discovery applications with high-resolution mass spec and high-volume applications with our tandem quad portfolio. As you traverse to the middle of the chart, it's our TA business, which is a leader in thermal and mechanical analysis of materials as well as battery testing more recently. Moving to the right-hand side of the chart rather quickly is our precision chemistry portfolio. Some of our columns that we launched back in the 1970s are still in use for characterizing pharmaceuticals. So this part of our business has extreme longevity and the most recent products introduced are customized to separate biologicals and novel modalities. And finally, service and informatics. These are attached to our instruments to develop a flywheel that our customers have been quite used to. So a resilient, a stable business serving â a simple business model serving resilient end markets with a leading portfolio in each of the segments that we serve. This results in rather attractive financials, and I'll start on the right-hand side of this chart. Our return on invested capital, and this is from full-year 2019 to 2021, was roughly 40%. This is a market-leading number because it's not adulterated by any acquisitions or any sort of COVID tailwind. As you move to the middle of the chart, you see 30% in EBIT, which is, again, industry-leading, and you see the peer average at 23%. But what is most endearing about this performance is the return to growth, right. You see a 9-plus percent growth that we've shown on a three-year basis from 2019 to 2021. This, again, is a leading market performance. So in all, if you just look at Waters and why it is such a good investment, it's a simple business model with a leading portfolio, serving resilient end markets that have durable drivers and you can see the financials come as a consequence of this. So with that, let me provide you an update on how this has been possible to orchestrate over the last two and a half years or so. First, let me dive a bit deeper into why we think we have a consistently strong execution. Nothing speaks like numbers, right. So on the top of this chart, you see our Q3 year-to-date organic sales growth, roughly 14%. And as you traverse your eye through the portfolio, geography and end market columns, you see rather consistent numbers. From a portfolio perspective, the growth has been led by stellar instrument growth, roughly 19%. Our recurring revenues, both service and chemistry, also growing in the high-single digits, both much higher than previous years. If you look at it from a geographic perspective, you see double-digit growth across all geographies, with Americas and China in the mid to high-teens, and Europe and rest of Asia also in the low double-digit. And in the end markets, what is rather interesting is the industrial and academic segments, for a change, leading the charge and pharma is still being quite respectable at low double-digit. So very nice performance year-to-date. But again, what is more interesting is how this performance has developed over the last three years. So here, similar format. On the top of the chart, you see organic sales growth from 2019 to 2021. This is in excess of 9%. This is well above historical averages, which were roughly 4% to 6% in this industry as well as for Waters. And again, the same format on the left-hand side, you see the portfolio. Instruments growing double-digit, recurring revenues, 8%, both, again, ahead of industry as well as historical averages. Geography, consistent growth in the high-single digits, and in the end markets, pharma now driving over the longer term the growth. So consistently nice growth. And one of the questions we get from many of the people who cover the company is, please tell us what the sources of growth are for this sort of growth? And where do you see its sustainability? So what we try to do on this next chart is break it down a little bit, right. So let me walk through this chart from left to right. So the first column on the left-hand side is the historical long-term market growth rate. This has been 4% to 6% for a very long time, and what has commanded this growth rate as well in our heyday. As you traverse to the right-hand side, you'll see pricing. Pricing, especially last year was very good. This was about 350 basis points across the industry, which is about 300 basis points higher than overall historical averages. So in this market, roughly 50 basis points was the norm. So 300 basis points in excess of historical averages. So we amortize that over three years, that's 100 basis points a year, right. So that 4% to 6%, you add a 100 basis points, let's take the higher end of the 6% and add 100 basis points, and now you traverse your eye to the right-hand side of the chart, and you see 7%, which is the peer average in the industry, right. And the range of the peer group is between 6% and 9%. And you see Waters is at 9-plus percent, which is about a 200 basis points in excess of the overall market that we see growing, okay. So now what I'll try to do is explain this 200 basis points and the sustainability of it. There are three drivers of this 200 basis points of excess performance versus market. First, the success of our commercial initiatives, which I shared roughly two years ago right here. Second, our innovation has started to contribute rather handsomely, and I'll share with you some details of the products that we launched over the last two years and how they have gained traction. And number three, we are extremely excited to share that some of the adjacencies that we've talked about just last year have started to gain traction. So let me take each of these in turn. First, the commercial initiatives. What you'll recall is that we shared five of these initiatives. And in each of those areas, we've made solid progress, and we see a nice runway ahead of us as well. First, we said we are going to replace roughly 13,000 or so instruments that we had accumulated over the last few years as a backlog. We are roughly one third of the way through this journey. Number two, we said we will increase our service attachment rates, which is already industry-leading, by about 1,000 basis points. Over the last 2.5 years or so, we've increased that number by 250 basis points â sorry, 350 basis points, and there is another 650 basis points to go. Number three, we said we want to increase our penetration in serving contract manufacturers and contract research organizations. We've started off extremely well. In fact, the growth in that particular segment outpaces the overall growth of Waters' by 100%. So it's about 20% growth versus the 9-plus percent growth that I showed you earlier. Then we still see a nice runway ahead there. We are roughly half the way through the â increasing the penetration of that particular segment. Number four, when we started two years and change ago, the penetration of our consumables revenue across the e-commerce channel was less than 20%. Today, that number is at 35%, still far away from the 55%, we think, is industry average. So still some nice runway ahead on that initiative. And finally, we had said we were going to start doing justice to the new products that we launch, and we've already seen benefit on that front. So our product vitality index measured as the incremental revenue of products launched over the last three years. Instruments launched over the last three years and consumables launched over the last five years has increased from about 9% to 15%. So across all five initiatives, we've seen nice progress, but we also have a significant runway ahead of us. In summary, roughly 100 basis points of contribution that we should expect over the next couple of years from this initiative â in this initiative in the future. So nice commercial traction. Let me now switch and talk about how we've revitalized the innovation. Same format that I showed earlier. We are largely focused on products that solve critical unmet needs across the industry. And on the left-hand side, you see liquid chromatography. So for small molecules, we've introduced Arc HPLC, which now supplants the Alliance brand of instruments, which is the mainstay in high-volume, small molecule QA/QC testing. Second, our ACQUITY Premier UPLC, especially designed for testing biologics and has two orders of higher â 2 orders of higher sensitivity versus the leading instruments in the industry. So two products that meet unmet needs in the small molecule space and the large molecule space. Move to mass spectrometry, starting with high-resolution mass spec, our cyclic â SELECT SERIES Cyclic high-resolution mass spec is one of the only instrument in the industry that allows you to separate molecules based on their shape, in addition to their size. This is a significant advance that has led to increased traction of this particular product. As you move towards high-volume applications for biologics and small molecules, Xevo G3 QTof â bench top QTof, which is a workhorse instrument in late-stage development, can now seamlessly transfer methods from development into QA/QC with the waters_connect platform. And finally, the Xevo TQ Absolute, which I'll talk about in a bit more detail in a minute has the highest sensitivity in its class of high-resolution mass specs for high-volume applications. If I move now to the consumables segment, we launched the MaxPeak Premier Columns less than two years ago that has had the fastest uptake of any column in Waters' history. And this is largely because we have allowed customers to speed up their experiments between 15x to 20x and increase the sensitivity at the same time because this column was designed in particular for biologics characterization. Number four is informatics, where we introduced our waters_connect platform, which speeds up experimentation by 50% for people who are trying to test a large number of â are looking for large number of impurities in food and environmental samples. And finally, our TA business, not to be left behind has developed a powder rheometer that is extremely useful for characterizing precursors for development of lithium-ion batteries. So a renewal of the portfolio across the board and that bodes extremely well for future growth. As we move along, before we get into the adjacencies, I just wanted to spend a minute on the Xevo TQ Absolute. This is a mass spec that we've recently launched. It has 15x higher sensitivity than the leading instrument, with a much lower footprint, both environmentally as well as physically and reduces time of experimentation by 50%. It is largely applicable for anionic compounds like PFAS. And most of you would know that there are new regulatory requirements for increased surveillance of these forever chemicals across the globe. And there is significant global funding. We estimate this market to be roughly $200 million to $250 million, growing 20-ish percent. And with one of the best instruments in the industry, we expect to grow rather nicely in this space. So that's strong commercial execution leading to that additional growth versus the market. Second, innovation starting to contribute rather nicely, boding pretty well for the future. And then finally, I wanted to take a few minutes and talk a bit about the adjacencies that we had introduced about a year ago. So you'll recall, I talked about our simple business model with the four parts of the portfolio. We were rather careful about selecting adjacencies where we wanted to extend our business by looking at clear unmet needs in areas where we could apply this simple business model, and of course, we saw a commercial opportunity. And we identified these five, which are growing almost double the rate of our core business in terms of end market. The 4% to 6% now becomes high-single digits to low-double digits. Let me take each of these in turn. First is bioseparations. Basically, this is an area where we are introducing more and more sophisticated column chemistry to mimic the increasing complexity of molecules that are coming down the pipeline for medicines, right. So with increasing complexity of biologics and cell and gene therapy, it's no mystery that the demand for better separations is increasing quite rapidly. We estimate this market to be roughly $1.4 billion, growing 8% to 10%, and Waters has had a very strong position in the small molecule side of this business and we intend to establish something similar on the large molecule side. Second, bioanalytical characterization, and I'll do a double-click on this in a little bit. But there are unmet needs across the value chain to produce biologicals, from raw material testing to process development and in-process testing to QA/QC. And we believe with our capabilities, especially on the small molecule side, we can apply the same logic to large molecules and novel modalities, and we think this market is roughly 1.8 billion. If you include not just LC-MS and LC-UV, which are areas where we have strength, but also some of the other analytical techniques that are required to characterize bioprocessing much better, and this market is expected to grow roughly 10% to 12%. Number 3 is LC-MS in diagnostics. As the name suggests, this is specific application of LC-MS for high-volume testing of multiple biomarkers in areas such as oncology, endocrinology and drugs of abuse testing. Again, this market is $1.5 billion. It's already pretty well established, roughly 8% to 10% growth. Number 4 is battery testing, a highly exciting area. Battery testing is very similar to â is in a similar place as bioprocessing, where the full value chain of producing batteries from raw material testing to in-process testing to QA/QC is being established as we speak. And our products have been used for a long time already in characterizing different parts of the battery value chain. We are now trying to get them to become high volume and simple to use. And this market is rather attractive, growing the fastest amongst the adjacencies, 18% to 20% and roughly $1.5 billion or so in size. And sustainable polymers, the unmet need here, roughly â the unmet need here is driven by the fact that roughly 50% of the R&D in polymer development is now focused towards developing polymers that are sustainable and recyclable. And as you develop them, their physical and mechanical properties have to be measured using our products. So in all, it's roughly $7 billion in additional addressable market, growing almost double the rate of our core market, so rather attractive. As I said, let me double-click a little bit on the bioanalytical characterization space. There are three settings of use that we have uncovered with BioAccord, the simplified LC-MS system that we've talked about in the past. Raw material testing, process development and QA/QC for biologics. And you see names of customers on this slide. This is rather unusual. Customers gave us permission to share their names. There are several other customers who are using the same application. Starting with the fingerprinting of cell culture media, Janssen has been using our BioAccord to characterize all raw materials that go into development of their monoclonal antibodies and cell and gene therapies. In process development, we have a collaboration that's ongoing with Sartorius to speed up clone selection, which is a high-volume step in the early stages of process development. And we take a process that usually took six weeks, and we've narrowed it down to two days. And several customers have already bought the BioAccord to use it for that particular application. Recently, AstraZeneca presented a paper at BioProcess International using the BioAccord to do in-process characterization of their latest perfusion bioreactor. So you can see there are applications for our products in process development already. And then finally, QA/QC and biologics. A lot of customers have been striving to use mass spec in QA/QC, Regeneron is the furthest ahead. They've qualified not just the instrument, but the software for use in QA/QC, which is a significant step forward for the industry, and they have one of the largest pipelines of monoclonal antibodies in the industry. They have now qualified the BioAccord not just for identification of the molecule, but also quantitation of the molecule as well as glycans, which are chains that hang off monoclonal antibodies. So you can see not only are these interesting areas where there are unmet needs, there is traction with our technology, especially LC-MS across different settings of use and roughly a $1.8 billion market growing 10% to 12%. So I hope I've given you a flavor of how we've revitalized the business through commercial execution, through revitalization of our pipeline, through entering into adjacencies, but nothing would be possible if you were not leaving the world better than we found it. And I won't read through this chart, but across environmental, social and governance areas, we've received several accolades over the last year and change that verify that we have been working pretty hard on this front as well. Now as I put this all together, from a market opportunity perspective, we've gone from â we'll go from about a $12 billion or so accessible market to $18 billion. From a growth perspective, we are growing from mid single-digit end market to one that is growing high single-digit to double-digit. And from a margin perspective, I think we've spoken about this before, if our business grows in excess of 5%, we usually have 100 basis points that flows right to the bottom line. In the short term, we are investing 70 basis points to 80 basis points back into the business to build these high-growth adjacencies. And over the long term, if we have investment opportunities, we will continue to reinvest in the business. But if these faster growth areas pick up, there is a significant opportunity for margin expansion as well. So in all, I hope in this rather quick overview of our business, I've been able to give you some evidence why and how we are executing consistently, how we've revitalized our innovation and how adjacencies are gaining traction. Thank you. And so as a reminder, if you have a question, feel free to raise your hand and we'll have a mic runner bring you a microphone. So first off, you mentioned it, all the sell siders scratching their heads on what is going on with instrument growth. I think a lot of us in this room have seen the difficult comps off of last year. You guys continue to put up good numbers on the instrument front. So can you walk us through what do you think is happening there? Is it an acceleration of the market? Is it outperformance specifically for Waters? And then where are the strongest pockets of that instrument demand that you guys are seeing from your point of view? Thank you, Rachel. Not surprising that's the first question. I think you'll recall that I presented the waterfall for the full growth of the business. I mean a similar waterfall you can create for instruments, right. So instruments on a three-year basis have been growing roughly 10%, as I showed on one of the charts. If you decompose this over the long-term, instrument growth was roughly 3% to 4%, add-on 100 basis points or so for pricing, you get to 4% to 6%, or 4% to 5%. And you compare that now to the growth that Waters is seeing, you subtract it and you see a bit of outperformance, right. And it's the same levers. Basically commercial execution, the replacement cycle that we talked about. Second, introduction of new products, which have been gaining traction across the board in LC, in mass spec, in TA. And then finally, some of the adjacencies that we talked about, we are seeing nice traction of our instruments like the BioAccord. So when you look at it in aggregate, the 9% to 10% number, and you subtract the long-term growth rates and the pricing from it, it doesn't look so outstanding. I mean as much as it's doing pretty well, it's not the 19% to 20% that you see, right. So on a three-year basis, the instrument growth rate is 9% to 10% for Waters as well. Really 2% to 3% or so of that is outperformance, which is explained by the three initiatives that are actually on this slide. Perfect. And maybe just since you mentioned it, pricing. So pricing contributed 350 basis points this year. It's been outperformance across the board for tools players. So how should we think about that pricing lever playing into 2023? Can you guys sustain this level of pricing? Do you expect it to grow more? Or should we kind of fall back heading into next year? Yes. I mean it's difficult to tell, but I think I would break it down into three levers, right. The first is offsetting inflation. And we still expect this to continue, but not at the same rate as it had in 2022. Second is new products commanding a higher premium and now they are in the second and third year. So you'd see that flowing through. And third is a muscle that our teams have developed to pass on pricing when relevant, which is something that Waters was not doing in the past, right. So with all those three, we feel we can pass on more pricing than 50 basis points to 100 basis points. Now don't ask me if it's 350 basis points, or if it's somewhere in the middle, but we feel much more confident than we have in the past. Given the new product portfolio that we have, given the fact that the commercial execution, especially on the pricing side, is way better that we should be able to pass on more price than historical average. Got it. That's helpful. And then maybe looking at those high-growth adjacencies in the slide that you laid out. Looked a little bit different in the Analyst Day slide, specifically on some of the polymers and then the battery testing. It looks like battery testing used to be $0.8 billion market, growing double digits. Now today, that's $1.4 billion, growing 18% to 20%. And then on the polymer side of things, you used to kind of size the market at $3 billion. Now that's just under $1 billion, but growing a little bit faster. So can you walk us through what happened and what's the difference versus those Analyst Day numbers that you laid out? Sure. In all of those areas, we've learned a lot, right. And we have sort of become much more precise about what we think is our end market, the accessible market. So you didn't ask about bioanalytical characterization. There the numbers changed as well on the high side. What we've done there is included not just LC-UV and LC mass spec, which is what we did in the past, but also other instruments and techniques that are used to characterize raw materials, process development as well as QA/QC, right. So that's the explanation for that one. For battery testing, not only have we included our instruments, but we've also included some other instruments, same logic as bioanalytical characterization. And that market is growing really, really fast. Our part of the business is growing much faster than 18% to 20%, or that is the estimate for the market. And on sustainable polymers, we took it the other way, and we said, look, let's remove all polymers and materials that are not relevant to the exact end markets we're serving, right. So it's basically very specific reasons for each one of them, and that's in the footnote of the slide as well. So you don't have to memorize it. Perfect. Then maybe just looking at 2023, you've talked about your long-term outlook assumes that Waters will continue to grow above market. But the group is facing difficult comps heading into next year. Then also, we have some of this macro environment and concerns about that being pressures on the capital spending budgets. So can you just walk us through the puts and takes? I understand you're not giving formal guidance today, but how should we really think about that and growing above market into 2023? Yes. I mean, so first, again, let's just use that waterfall, right. So for the end markets, we are not seeing any meaningful signals of slowdown, right. So we are not seeing pharma changing dramatically. As I mentioned, it's a resilient end market, which is not sensitive to macro ups and downs. And over the long-term, this market grows high-single digits, maybe sometimes low double digits, right. We expect that to return. So nothing really changes there. Second, on the Industrial segment, we've seen a really nice growth over the last couple of years. That should come down just a little bit. We can't expect that to grow 15%, 16% over the long-term. And then finally, on the academic and government, we saw a nice revival, but that was due to sort of lower comps. And we still have at the Waters level a lot of work to do to gain traction in that segment. So that's the market commentary. From a Waters perspective, again, the three levers are on the slide. We still expect our commercial execution to continue to pay about 100 basis points or so. New products that I mentioned are contributing already and should continue to contribute over the next couple of years, and we are gaining traction in these adjacencies. So we feel rather confident that no matter where the market is, these three levers will allow us to outperform it. Helpful. Maybe just kind of going off of those industrial and applied comments. You flagged the PFAS testing market being $200 million to $250 million. Can you just dive a little bit deeper into that market? Are there any additional regulations that you see could be coming in the next year, to three to five years even that you think could accelerate that market even further and what we've seen today? Yes. I mean it's early days, right. But I've personally spoken to customers in Europe, in Asia, and public health authorities in the United States. Uniformly, people are expecting the regulations to get much more stringent. So let me give you an example. There is an expectation not only are we testing larger chain molecules or testing smaller chain molecules, and we are increasing the sensitivity to more than parts of $1 billion. And this is where our Xevo TQ Absolute is the best instrument in the industry to serve that need, right. So we are seeing it across the globe. So that's the regulatory side. We are also seeing companies respond. We are seeing large industrial companies, and there was one in the news recently, we are seeing large industrial companies respond in advance of the regulation. Some have committed that by 2025, they'll reduce PFAS in any of their affluence dramatically. And we've spoken to those companies and they are serious customers. So early days, but we see public health institutions and regulators increasing scrutiny. We are seeing companies that produce such products increasing scrutiny. And then finally, we are also seeing it not just relevant for PFAS in water, but also in food. For instance, in Asia, in some Southeast Asian countries, people are highly sensitive to what is present in baby food due to the baby food crisis a few years ago. And the regulations have increased quite dramatically there. So if anything, the regulations are going to get much more stringent. Since you mentioned Asia, I got to ask a China question. So you guys were able to grow 9% in China during 2Q despite those lockdowns. It sounds like we are going through another phase of a pretty meaningful outbreak. So can you just talk about how were you able to compete in that region during 2Q? Do you think that's replicable again heading into this year? And then just any commentary from boots on the ground, what has it been looking like the last few weeks there in the region? Look, I mean it's a different dynamic, right. It's not lockdowns. It's actually complete reopening. And yes, there is a wave of infections, no different than what you are seeing in the overall economy that's going through our workforce there as well. I am not worried at all about the long-term growth prospects of China for our business, not at all. But I am worried about the resilience of the teams on the ground who have been going through all these turbulence over the last few years. And my hope is that in the next few months that this wave of COVID goes through, people get vaccinated and we come out on the other side of this. So not worried about the long-term prospects, but you do see a bit of lumpiness, given which part of the country gets shutdown due to larger amount of infections. Helpful. While we're just talking on geographies here, can you just walk us through what you are seeing in Europe? Are there any capital budget constraints so far? Obviously, the energy crisis and how that's playing in as well. So what kind of conversations are you having with your customers in Europe there? Look, I mean, Europe has been one of our strongest performers, especially on a three-year basis. But even year-to-date, it's nice in the low to mid-double digits. Across the different segments in Europe, we are overweighted in pharma. So you don't see that slowing down at all. In fact, the food and environmental applications were led by Europe. Our mass spec headquarters is in the UK, so they benefit a lot as new mass spec products are launched. And then these mass spec products are custom designed and the software is custom designed first for food and environmental applications. So we've been seeing very nice growth there as well. From a macroeconomic perspective, we have seen really no signals of Europe slowing down. As I mentioned earlier, we are serving rather resilient end markets, right. 80% of our business is going to pharma or food and environmental applications, which see no real impact of the overall macroeconomic conditions that you are referring to. So no real signals that we see today. Helpful. Great to hear. And then maybe can you just talk about the onshoring opportunity. So we've been hearing this across pharma biotech, also with semiconductors in the CHIPS Act. But can you just walk us through how to think about this? Is it going to be really a one-time impact where it's just the instrument being placed in a different region? Or could we see some additional tailwinds, whether that's service attachment rates in different areas, some of the software selling as well? Yes, it's again quite early in the game. But I would have the same commentary I had on existing business. Now there are two pieces to the instrument. I think you were referring to the instrument replacement as far as onshoring is concerned, right. Classically, in the industrial segment, it's been a replacement business for instruments. Now we're seeing greenfield opportunities that are driven to some extent by the onshoring and to some extent by new segments like batteries. It's very difficult to deconvolute that. But in both of those areas, we think it's â once you've planted those â once you place those instruments, you'll have the same sort of replacement cycle that we see in pharma and the other areas. Helpful. And then last question, because we're kind of running out of time here, just on M&A. You've highlighted that you want to be inquisitive within some of these high growth adjacencies. Just with your refreshed view on some of the outlook for some of these adjacencies, where do you expect to do a deal? And then again, what size, just given the macro environment, what leverage are you willing to go to? I think you know that I won't be able to comment any more specifically than I have in the past on this topic. But that said, we are super excited about what we see in the bioseparations area. I mean we had â initially, when we launched the adjacency, we said we first want to make sure that we have organic traction in each of these. We feel very comfortable that in all five adjacencies we see organic traction, meaning we have people who understand these adjacencies. We are super excited about what we see in bioseparations. There are several interesting ideas. In bioanalytical characterization, we think we are in the very early innings of setting up that business rather nicely. And there's a significant opportunity and significant unmet need to speed up biologics processing to reduce the cost for cell and gene therapy, and analytical instruments have a strong role to play in that area. For battery testing, we've done really nicely with the portfolio we have, but we also see the ability to augment that particular segment. So especially on bioseparations and bioanalytical characterization, we are super excited about the organic development, but also what we see from an M&A perspective.
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EarningCall_1251
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Good afternoon. My name is John and I'll be your conference operator today. I would like to welcome everyone to the KB Home 2022 Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com through February 11. And now, I'd like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill, you may begin. Thank you, John. Good afternoon, everyone and thank you for joining us today to review our results for the fourth quarter of fiscal 2022. On the call, are Jeff Mezger, Chairman, President and Chief Executive Officer; Rob McGibney, Executive Vice President and Chief Operating Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer. During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results and the company does not undertake any obligation to update them. Due to various factors, including those detailed in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements. In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. Thank you, Jill. Good afternoon, everyone, and Happy New Year. We are pleased with our financial results in 2022, during which we produced revenues of $6.9 billion, a year-over-year increase of 21%; net income of $817 million, a rise of 45%; and diluted earnings per share of $9.09, up 51%. Our top line growth, together with the expansion of our operating margin to over 15%, drove our return on equity of 470 basis points to 24.6% and contributed to 27% growth in book value per share to over $43. I am proud of our team and their hard work in generating one of the strongest years of financial performance in our company's history. Although we acknowledge that the homes we delivered this year were sold under different market conditions than we are navigating today, we also recognize these remarkable results were accomplished despite numerous obstacles, including supply chain issues and municipal delays that significantly extended our construction times, as well as persistent inflation and rising interest rates. Given the current market environment, we are providing guidance today for our 2023 first quarter and for the full year we are only giving a range of expected housing revenues. As we begin 2023, we do so with a significant backlog of over 7,600 homes, valued at roughly $3.7 billion, supporting our revenue projection for the year. While our backlog has become overextended relative to historical levels due to longer build times, we are committed to reducing our cycle times to achieve deliveries within a more traditional timeframe of between six months and seven months from sale to close. With our Built-to-Order model, our buyers tend to have an emotional attachment to the homes they select, choosing their floor plan on their lot and personalizing the home with their preferred features and finishes. For the most part, buyers are closing when their homes are completed and roughly 90% of our deliverable universe did close during the quarter. Although the cancellation rate on our beginning backlog increased sequentially, it was still below our historical average, and after peaking in November, cancellations declined in December and we anticipate a further moderation in January and February. A significantly higher percentage of our buyers are locked on their mortgage rates as compared to our 2022 third quarter. These buyers, together with our buyers who are paying in cash, which is also increased slightly sequentially, represent close to 80% of our backlog, giving us confidence in our ability to convert our backlog to closings. With respect to the fourth quarter, we generated total revenues of $1.9 billion and diluted-earnings per share of $2.47, representing a year-over-year increase of nearly 30% in earnings. We achieved an operating income margin of 15.8%, up 290 basis points year-over-year, excluding inventory related charges, driven by both a higher gross margin and lower SG&A ratio as we focused on effectively managing costs. We remain committed to balancing our overhead with our revenues as we continue to open new communities and navigate current market conditions. I acknowledge that we missed deliveries relative to what was implied in our guidance, stemming from a combination of cycle time extensions at the latter stages of construction, higher cancellations on homes that were close to or at completion and ongoing challenges with utility companies in getting communities and homes energized. We continue to believe that the long-term outlook for the housing market remains favorable. The demographics of the millennials and Gen Zs are advantageous for our business as we primarily serve the first time and affordable first move up buyers, market segments traditionally comprised of these large and growing cohorts. Although existing home inventory has risen recently, there remains an under-supply of resale homes, particularly at our price points. And with housing starts now down roughly 40% on an annualized basis, the industry is falling further behind in serving the underlying demographic demand. That said, the current housing market continues to be weak in the face of higher mortgage rates, persistent inflationary pressures and an uncertain economic outlook, which have made buyers more cautious since the middle of last year. Our net orders were 692 as compared to 3,529 in the year-ago fourth quarter, stemming from a low level of gross orders and an increase in cancellations. Let me discuss each of these components separately. Given the size of our backlog at the start of the fourth quarter, and with only 210 finished homes available for sale, we prioritized delivering our backlog and protecting our margins rather than pursuing incremental sales in a softer demand quarter. To frame this another way, entering the quarter, we had an average of nearly 50 homes in backlog per community at very solid margins and we elected to discount our pricing to a level similar to other new homebuilders to get more sales, we estimate that the impact to our backlog value would have been in the hundreds of millions of dollars. On our last earnings call in September, we shared that with the rise in interest rates to above 6%, we had seen a softening gross orders trend sequentially. As rates continued higher in October, hitting 7% late in the month, our orders declined further. Then, with rates moving slightly lower in November, gross orders stabilized roughly at October's level. For the quarter, our gross orders were 2,169 a year-over-year decline of 47%. On a per community basis, our gross absorption pace was 3.1 orders per month. With respect to cancellations, due to the unusually low level of gross orders and our large beginning backlog, we believe looking at cancellations relative to backlog is a good way to understand the dynamics during the quarter. At 14%, our cancellation rate on the 10,756 homes we had in backlog at the start of the fourth quarter represented a sequential increase, although it was still slightly below our historical mid-teens average. The primary reason for cancellations continue to be buyersâ lack of confidence to move forward in these uncertain times, even though they qualified for their home purchases and many were locked on their loans. For the quarter, we continued to align starts with our gross sales pace starting roughly 2,000 homes and ended the quarter with about 8,800 homes in production, of which 80% were sold. Average [ph] return of this 80:20 split on sold and unsold production, the strategic range we have historically targeted, we expect to continue to manage our business to these levels. Our priority has been and remains selling Built-to-Order homes, but we have always offered quick move-in homes in each of our communities. We are monitoring local market dynamics and individual community performance, while we continue to emphasize delivering our still large backlog, we are also selectively getting more aggressive on pricing reductions and other concessions on a community-by-community basis ahead of the spring selling season. By the end of the first quarter, we expect to be taking steps in most of our communities, as we will have delivered more of our existing backlog. Through the first five weeks of our '23 first quarter, a slower demand period, our net orders are down 72% relative to the comparable prior year period. To support our '23 projected revenue range and given the actions we are taking, we are targeting net orders in the first quarter to be down 50% -- between 50% and 60% year-over-year versus an incredibly strong comparison in the prior period. This translates into net orders of approximately 1,900 at the midpoint of this range. Concurrent with the pricing and concession moves, we are pursuing significant reductions in our construction costs and cycle times. This will enable us to start homes at lower cost, to help offset the steps we are taking to work with buyers and achieve our sales and delivery targets. With that, let me pause for a moment and ask Rob to provide some color with respect to our sales approach, as well as an operational update. Rob? Thank you, Jeff. Let me start by reiterating our focus on protecting our backlog and generating new orders to rebuild our backlog as it delivers out. This effort requires a deep understanding of the competitive dynamics of each submarket with respect to product, price, concessions and finished inventory in both the new and resale markets, which our sales teams and division leadership are continuously analyzing. I have also been heavily engaged with the teams on this effort. We are utilizing two different sales strategies depending on how many homes we have in the backlog in a community. For communities that have large backlogs, particularly those with far more in backlog than remaining to sell, you're are placing more emphasis on our temporary interest rate by down and lock programs to help produce sales and de-emphasizing price reductions until more of our backlog is delivered. While we recognize that price is the most effective sales lever to generate new orders, we also know that if we lower the base price in a community on new sales, many buyers in backlog would expect to receive a similar reduction regardless of the rate in which they may have locked their loan. As a result, it is typically not advantageous for us to lower the base price to a market clearing point in our high backlog communities as the impact to the prices of homes that are resold could be significant, particularly in what is traditionally a slower time of year for sales. That said, we have adjusted pricing in communities with smaller backlogs, where only a small percentage of that backlog will be impacted. The market turned very quickly in the 2022 second half as interest rates rose, and in certain instances, we were able to pull back the most recent price increases without a significant impact to backlog values. Let me share some examples. We have a community in Austin with over 100 in backlog -- 100 homes in backlog at mid 30% margins. Competitors in the submarket are discounting or incentivizing their speculative inventory by $60,000 to $70,000. We are electing to deliver more of the backlog before adjusting price. In Orlando, we have multiple with over 50 homes in backlog and margins approaching 30%. As in Austin, other builders in the submarket are discounting their specs significantly. We are focused on delivering more of our backlog and allowing the market to stabilize before we consider lowering base pricing. In each of these examples, we expect a far better financial result by delivering the homes in backlog to buyers that are awaiting completion of their personalized homes instead of chasing the speculative inventory pricing reductions that are occurring in these markets. Our strategy with respect to communities with smaller backlogs has defined the market by making the product more affordable through base price reductions in combination with our interest rate buy down and lock programs. For example, we have a community in Phoenix with 18 homes in backlog and 175 remaining to sell. This community opened in May of this year at or near peak pricing. We found the market by lowering the price by $30,000 and our pace has improved as a result. Another example is a community in Raleigh, with about 50 homes in backlog and an equal amount remaining to sell. We had aggressively increased prices in this community prior to the market slowing, so we were able to implement a $30,000 price reduction and only impact a few homes in backlog that were purchased at the higher price. One of the best illustration where our divisions are heading is our Inland Empire division which benefits from the fastest cycle time in our company. The division has been able to rotate through its backlog more quickly and delivered a higher percentage of its backlog in the fourth quarter. As a result, the Inland Empire division was able to be more aggressive in adjusting prices late in the fourth quarter, defined the market and has achieved the best sales result in all of our divisions quarter-to-date in the 2023 first quarter, still with solid margins. With the strength in sales the IE division is now lifting prices in some communities. Our sales process remains rooted in executing on the fundamentals, ensuring that the community looks pristine from the signage to the models, making certain that we have the right sales staff in place and conducting targeted and thoughtful outreach to our interest list and brokers in the submarket. Beyond these basics, we're doing what we think is necessary to generate sales to support our revenue range target for the year. That said, we made each community individually and the examples I shared with you illustrate that every community has its own story. What remains consistent across all our communities is our ongoing rotation into offering smaller more affordable product to expand the qualified buyer pool. While the average footage of homes we delivered in the fourth quarter and those in backlog remained consistent at about 2,100 feet, 70% of our communities offer floor plans at or below 1,600 square feet. We are also value engineering our elevations and interiors along with other cost reduction initiatives to ultimately offer a lower base price to our customers. Our initiatives are driving our direct costs down and we've achieved a $10,000 reduction in the average cost of a homes started in November relative to one started in August. Our teams are currently negotiating more significant cost reductions, particularly in the front end of the construction stages. Build times are coming down in addition to costs. Overall build times improved sequentially by 14 days, and it was bifurcated between the front end and back-end, we experienced a 21 day improvement from sales to frame, but extensions of two days from frame to drywall and five days from drywall to final. While supply chain issues persisted in certain areas, which I will address in a moment, the five day extension from the drywall stage to completion was less about the chronic supply chain issues that have plagued our industry and more about the overall volume of production in our markets combined with ongoing municipal delays and issues related to the availability of electrical infrastructure material as all builders push to complete homes by year-end. The 21 day improvement from sale to frame is a better reflection of the current market, given the lower volume of homes in production at this stage. The slower sales pace across our industry in the second half of 2022 has resulted in reduced starts and we expect these build time improvements to waterfall through the construction schedule as we move into the first half of 2023. As to building materials, availability is improving for some products that had been long standing issues, such as garage doors and windows, while other areas are still of concern, including electrical components, HVAC equipment and flooring products. Our teams continue to work tirelessly on behalf of our customers to move homes as efficiently as possible through the construction cycle, despite the supply chain issues and trade labor shortages. We are encouraged by the significant improvement in the front end of our build times and with industry starts lower into the new year, we believe we can gradually return to our historical build times. Each of our divisions has an action plan in place to significantly reduce build times by the end of 2023. Thanks, Rob. The credit profile of buyers that use our mortgage joint venture KBHS Home Loans remain strong. For loans we funded during the fourth quarter, 66% of these customers qualified for a conventional mortgage. And while the vast majority of KBHS customers use fixed rate products, we saw an uptick in the use of adjustable rate products, as buyers took advantage of the lower interest rates these products offer. The average cash down payment was 17%, which equates to nearly $87,000. As to income levels, the average household income of these buyers was over $130,000 and their FICO score was 734. While we target immediate household income in our submarkets, we continue to attract buyers above that income level with healthy credit that are able to qualify at higher mortgage rates and make a significant down payment. In the fourth quarter, we again reduced our land acquisition spend, with investments heavily skewed toward development and related fees. We have also been renegotiating land contracts to reduce purchase prices and extend closing timelines. In certain cases, where we are no longer comfortable that we can achieve our required returns on the investment, we have terminated the contract. We canceled contracts to purchase about 6,900 lots during the quarter, walking away from deposits and due diligence expenses. For the year, we remain balanced in our capital approach, investing $2.4 billion in land acquisition and development and returning over $200 million of cash to stockholders through share repurchases and dividends. Our land spend was lower by about $100 million year-over-year and our investments were heavily weighted towards the first half of the year. With the anticipation that both our land spend will be materially lower in '23 and our build times will improve, which will reduce our investment in homes under production, we expect to generate a healthy level of cash flow. This positions us to continue to return a portion of our excess cash to stockholders and it also enabled us to opportunistically resume investing in land once market conditions improve and at a more attractive cost basis. Our lot position stands at roughly 69,000 lots owned or controlled, a reduction of over 20% year-over-year. Of these, 48,000 are owned and only about 17,300 are finished, with 9,400 having a house under construction, including models. We continue to balance our development phasing with our start space to limit building up a large inventory of finished lots. Our focus is on developing lots on adjusted time basis, creating smaller phases and reducing our cash outlay. We are also pursuing savings on development costs, as development slows across the industry. Relative to the vintage of our own lots, we contracted approximately 80% of these lots in 2020 or prior before the run-up in both land and average selling prices. We have a solid lot position with a favorable cost basis and good distribution across our markets. We opened 28 new communities in the fourth quarter and we anticipate that the lots we own or control should provide us with growth in community count in 2023. Our most recent grand openings have performed well out of the gate, priced appropriately for current market conditions. As we continue to open more communities, we expect this growth will help to support our net orders even at lower absorption rates. Before I wrap up, I'd like to recognize and thank our entire KB Home team for their incredible resilience throughout the year, never wavering from their commitment to serving our homebuyers. As a result of our team's hard work, KB Home was honored to be included into recent rankings. The company was recognized as one of the 250 most effectively managed companies in the U.S., a ranking that was developed by the Drucker Institute in conjunction with The Wall Street Journal. In addition, we were named to Newsweek's 2023 list of America's Most Responsible Companies in recognition of our results related to our ESG initiatives. In both cases, our company was the only national homebuilder to receive these distinctions for multiple years in a row. While we don't manage our business with the goal of winning awards, these honors provide third-party recognition that we're doing the right things. In closing, although we expect to have less visibility and greater uncertainty in 2023, we are confident in our ability to navigate these more challenging conditions with a solid balance sheet, along with a long-tenured and experienced team that has successfully steered our company through multiple market cycles. We look forward to continuing to update you on the progress of our business as we move through the year. Thank you, Jeff and good afternoon, everyone. I will now cover highlights of our financial performance for the 2022 fourth quarter and full year, as well as commentary on our outlook for 2023. In the quarter, we produced solid financial results, including significant year-over-year growth in revenues and an expansion in our operating margin that drove a 29% increase in our diluted earnings per share. In addition, while we experienced persistent supply chain and inflationary challenges throughout the year, and softening demand in the second half, our exceptional portfolio of communities and solid operational execution enabled us to generate strong full year financial results. These results included meaningful revenue growth, considerable operating margin expansion, higher diluted earnings per share and robust returns. In the fourth quarter, our housing revenues of $1.93 billion were up 16% from a year ago, reflecting a 3% increase in homes delivered and a 13% rise in their overall average selling price. Housing revenues were up in all four of our regions, with increases ranging from 5% in the Southwest region to 51% in the Southeast. Looking ahead to the 2023 first quarter, as we anticipate housing market conditions will continue to be challenging, we will focus on delivering our large backlog of sold homes and navigating ongoing though improving supply chain constraints. For the quarter, we expect to generate housing revenues in a range of $1.25 billion to $1.4 billion. For the 2023 full year, we are forecasting housing revenues in a range of $5 billion to $6 billion, supported by our backlog and growing portfolio of open selling communities. As Jeff mentioned, given the uncertain economic and housing market outlooks for 2023, we are providing full year guidance only for revenues. In the fourth quarter, our overall average selling price of homes delivered increased to approximately $510,000. We are projecting an average selling price of approximately $490,000 to $500,000 for the 2023 first quarter, up 2% year-over-year at the midpoint. Sequentially, this represents a 3% reduction in average selling price reflecting geographic and community mix shifts and challenging housing market conditions prevailing when the home is expected to be delivered or sold. Homebuilding operating income for the 2022 fourth quarter totaled $278.2 million, up 30% as compared to $214.4 million for the year-earlier quarter. Our homebuilding operating income margin was 14.4% compared to 12.8% in the 2021 fourth quarter. Excluding inventory related charges of approximately $27.9 million in this 2022 period versus approximately $0.7 million a year ago, our operating margin was 15.8%, up 290 basis points, mainly reflecting improvements in both our gross profit margin and SG&A expense ratio. The current quarter inventory related charges included $6.4 million of abandonments relating to 36 projects and $21.5 million of impairments relating to three communities out of our year end portfolio of 246 active selling communities. We anticipate our 2023 first quarter homebuilding operating income margin, excluding the impact of any inventory related charges will be approximately 9.5% to 10.5%. Our 2022 fourth quarter housing gross profit margin improved 10 basis points from the year earlier quarter to 22.4%. Excluding inventory related charges, our gross margin for the quarter expanded 150 basis points year-over-year, to 23.9%. This improvement primarily reflected the impact of higher average selling prices, partly offset by increased construction costs and the impacts of selective price adjustments and other concessions in response to softer demand conditions. We are forecasting a housing gross profit margin for the 2023 first quarter in the range of 20% to 21%. The sequential decrease mainly reflects the expected lower average selling price, impacts from concessions such as mortgage rate buy-downs, higher construction costs during the 2022 first-half, when the majority of the homes are expected to be delivered were started, mix shifts and lower operating leverage. Our selling, general and administrative expense ratio of 8.0% for the 2022 fourth quarter improved 180 basis points from a year ago, mainly reflecting a decrease in external sales commissions, lower costs associated with certain performance-based employee compensation plans and enhanced operating leverage due to higher revenues. In 2023, we will continue to focus on aligning our overhead expenditures with revenue levels we are forecasting our 2023 first quarter SG&A expense ratio to be approximately 10.3% to 10.8% as compared to 10.2% in the prior-year period, primarily reflecting reduced leverage on fixed costs from the lower level of expected revenues, along with costs associated with the higher community count in the current year. Our income tax expense is $68.5 million for the fourth quarter, represented an effective tax rate of approximately 24% and was favorably impacted by $6.5 million of Federal energy tax credits, reflecting the benefit of our industry-leading sustainability initiatives. We expect our effective tax rate for the 2023 first quarter to be approximately 23%. Overall, we reported net income of $216.4 million or $2.47 per diluted share for the 2022 fourth quarter, up 24% and 29% respectively as compared to the prior year period. Reflecting on the full year, we are very pleased with our strong 2022 financial performance. Compared to our robust 2021 results, we increased our housing revenues by 21%, to nearly $6.9 billion, expanded our operating margin by 350 basis points to 15.1%, measurable improvements in both our gross margin and SG&A expense ratio and reported $9.09 of diluted earnings per share, an increase of 51%. Turning now to community count, our fourth quarter average of 237 was up 11% from 214 in the corresponding 2021 quarter. We ended the year with 246 active communities, up 13% from a year ago. We expect our 2023 first quarter average community count to be up in the range of 15% to 20% year-over-year, with increases in all four of our regions. Having pivoted our land strategy earlier in the year in response to softening housing market demand, during the 2022 fourth quarter, we continue to moderate our investments in land acquisitions and development, with expenditures down 29% to $443 million compared to the year-earlier quarter. Land acquisitions represented only $68 million of the total fourth quarter investment, a decrease of 74% from the same quarter a year ago. We also evaluated our transaction pipeline and move to renegotiate pricing and terms for many deals while abandoning others that no longer met our return thresholds. In the 2022 second half, our new land acquisition investments declined to $203 million as compared to $624 million during the first half. We have also modified our land development strategy, electing to build smaller phases and in some cases, to further start of next phases to align with expected demand in certain local areas. During the year, we generated $183 million of cash from operations and completed several initiatives to improve our balance sheet and liquidity, including upsizing our unsecured -- secured revolving credit facility to $1.09 billion in the first quarter. We also refinanced $700 million of our senior notes by issuing $350 million of eight-year senior notes in the third quarter and borrowing $360 million under a senior unsecured term loan in the fourth quarter. At year-end, our total liquidity was approximately $1.26 billion, with $329 million of cash and $933 million of available capacity under our revolving credit facility. Our debt to capital ratio improved to 33.4% at year-end 2022, compared to 35.8% for the previous year. We have no debt maturities until the term loan's 2026 expiration, with our next senior note maturity in June 2027. In addition, we returned over $200 million of cash to our stockholders by paying dividends of $52 million and repurchasing $4.93 million shares or about 6% of our outstanding shares at an average price of $30.44 per share, a significant discount to our book value. We ended the year with stockholders' equity of $3.66 billion, up 21% as compared to $3.02 billion a year ago and a book value per share of $43.59, which increased 27%. Finally, one of the most notable 2022 achievements with a significant improvement in return on equity to 24.6%, a year-over-year expansion of 470 basis points. In conclusion, we are very pleased with our strong 2022 financial performance. Though we expect to face a challenging business environment in 2023, we remain optimistic about the long-term outlook for the housing market, given the favorable fundamental demographic trends and continued under production of new homes. In addition, we believe our strong financial position, including our liquidity profile and long runway for debt maturities, will allow us to continue to be opportunistic with capital deployment in 2023 and beyond. In 2023, we plan to execute on our durable principles of our returns-focused growth strategy and unique build-to-order business model through the evolving market conditions, while carefully allocating capital with a focus on enhancing long-term stockholder value. Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Matthew Bouley with Barclays. Please proceed with your question. Hey, good afternoon, everyone. Thanks for taking the questions and for all the very helpful detail you gave there at the top. So first question just to understand the margin outlook, you saw the sequential margin or gross margin decline in Q4 and guiding to further decline in Q1 there, but it seems to be this is sort of before you've made the more aggressive price adjustments, if I'm hearing you correctly? So, yeah, I know you're holding off on giving hard 2023 margin guidance, but is the implication therefore, that we should think about sort of another reset to gross margins beyond Q1 as you do start to get more aggressive on the price side? Matthew, I think the implication really is that there's just a fair amount of uncertainty out there right now, which is why we didn't guide beyond the first quarter. A lot of the remainder of the year just depend on what the Spring selling season holds, both in terms of new sales and what it takes to close out our current backlog. And we have a lot of offsets we're working on as well. We're looking to pull a lot of levers to potentially offset any further market price decline. We expect to achieve construction cost decreases. We'll see a lot of the lumber price decreases, mainly reflecting in our gross margin starting next -- in the second quarter. There's fluctuations that could happen based on, related to rate buy-downs, depending on where the mortgage interest rates move. Cancellation activity as well is one where we are looking for some mitigation. We expect to see some mitigation and that removes a little bit of pressure on having the resell those homes into a weaker market. And then finally, we see some levers that we can pull on the cost side in terms of lowering our spec levels and continued value engineering and initiatives of that nature. So it's just uncertain right now which is why we didn't guide and just prefer to keep it that way until we see what the Spring holds for us in the market. Got it. No, that's helpful there, Jeff. Thank you for that. Second one, I mean, you talked about sort of careful capital deployment in 2023. So as you do reduce land spend build times, I mean, it does sound like there is an expectation for more meaningful cash generation this year. So can you just sort of expand on that just on the capital deployment side and sort of share repurchase in that scenario? Right. I think what you should expect to see from us is a continuation of a balanced approach. We've always talked about focus on growing the business in the future of the base business, we're very confident, very optimistic about the base business. In the past, we used to focus in order of priority on land investments and then dividends and quite a few years ago now, on debt reduction. And now, we've been able to pivot those three priorities to land, dividends and share buybacks. We do expect to see strong cash generation in 2023 and all I can say right now, we'll continue to be measured and thoughtful on deployment of capital. We consider ourselves to be good stewards of capital and see opportunities out there to deploy it. My view right now is that the buyback strategy has been a real winner for us, especially given the current market value, which has been so much under our book value per share. And with each buyback we've initiated, we've been able to increase future earnings per share, increase future returns and amazingly at the same time increase our book value per share with every buyback. So we really like that strategy. But we will maintain, like I said, a balanced approach and be measured and thoughtful as we move forward. Thank you. And our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question. Yeah, thanks very much, guys. Appreciate it. And wanted to just sort of follow-up, Jeff, on the construction cost side of the equation. We've been starting to hear that builders are actually getting real reductions, not just sort of stabilization in price. And I guess we're certainly hearing it on the labor side. So I'm curious what you're actually seeing, can you quantify maybe some of the success you're having around cost reductions? Is it just labor? Are you seeing it on products, too? Is it spreading to sort of late-stage type of trades as well? And you talked about the lumber benefit, but I would love it if you could give us a little quantification on what is reasonable to expect given the implosion in the lumber prices? Sure, Jeff. Steve, on the construction cost side, it's -- I mentioned, we were down $10,000 a house from our August starts to our November starts. So that's not just lumber, there's other costs in there, too. But I would say, we're still in the early innings of the cost reduction effort and it's, we're getting more traction on the front end trades, where there's less -- those trade partners are feeling the impact of lower starts across our markets more so than the back half of it is. So I'd say, early innings of the cost reduction work that we're doing on the front end, it's really just getting started on the back end, as a lot of those trades haven't felt it yet. And this isn't just renegotiating and allowing the market and the cost reductions to come to us, and we have a lot of initiatives in play right now through value engineering, simplification, lowering our spec levels, adjusting elevations to drive cost out and it'll likely pass those savings onto our customers. Yeah, that's really, helpful. And it's going to be something that we're going to be looking for, I'm sure, in the communities you're opening up next year. In that vein, I wanted to ask a little bit about the balance sheet and your, in particular, land spend. I think you talked, Jeff, about owned lots. Well, I think, I observed that your own lots, owned lots, not including the options, but your own lots were down a little over 3,000 this quarter, but obviously, things are sort of -- continue to be sort of tough out there. I'm curious whether it's reasonable to think we might see another reduction of that magnitude as we get into the first quarter in terms of owned lots, that would take you to somewhere in the 45,000 on lots. And overall, is it reasonable, Jeff, to think that total inventory dollars could be down about $500 million by year-end? I'll leave the dollar value, Steve, to Jeff to talk about. But if you look at our fourth quarter, I don't know the exact number, but itâs like 700 lots we purchased total. And so you know our delivery numbers, so therefore, your lot count went down, I would expect that it will go down further in Q1. I don't know that we've looked at it, but we're being pretty tight right now with any land spend and at the same time, we're continuing to deliver on our backlog and our WIP. So I do think you'll see our lot count go down. We own lots that support growth right now for '23, '24, '25, so we're in a good spot, with good basis on our lot portfolio, so we don't feel the pressure to have to buy anything to grow and we'd rather hold our cash and wait for the right time to go back and redeploy. So we could, we will see a lot count down in Q1. It could continue for a little while. Jeff, you want to talk dollars? Yeah. As far as dollars go, Steve, I mean, we generally don't forecast, things like that on the balance sheet. But I think it is a reasonable expectation to assume that our inventory investment would be lower at the end of the year and generate some operating cash flow for the company that we could redeploy into other uses as we move through 2023. Thank you. Our next question will come from the line of Michael Rehaut, with J.P. Morgan. Please proceed with your question. Thanks, good afternoon, everyone. I appreciate you taking my questions. I wanted to circle back first to the gross margins and the guidance for the first quarter. Help me reconcile the statements that you're protecting your backlog and not getting as aggressive or getting a least aggressive as you can on the backlog, maybe I guess you said in some instances where they're smaller backlogs in certain communities maybe incentivizing a little bit but broadly, trying to maintain the gross margin of let's say three or six months ago, and help me reconcile that statement with the first quarter guidance of 20% to 21%, which is several hundred basis points lower than a couple of quarters ago. I know you mentioned as part of the drivers there, mix and a lower amount of operating leverage, so it does sound like some of the delta is in that, I guess that's my first question, I'll go onto the second one. Right. As we talked about in the prepared remarks, it really, it's our outlook on the homes that are going to close, we have most of them in backlog right now, what those margins look like, we have an offering certain concessions pretty close to closing a lot of homes in order to basically convince buyers are closing their homes, and there's a little bit of set aside for continued activity in that area. Higher construction costs are hitting in the first quarter, just based on when homes are started and keeping in mind that our lumber lags a little bit because of the way we lock lumber prices, so that trough that hit starting to go down about mid-year last year is more or less going to hit us more like the second quarter as opposed to the first quarter. The lower pricing obviously, has been the main driver on the quarter-over-quarter decline in margin and we're just basically call it like we see it right now and what's expected to close in the first quarter. Well, I appreciate that. I guess maybe just as a follow on around that, it would be really helpful to kind of get a sense of, to the extent that again, you've tried to keep it to a minimum but what amount of incremental incentive on average is in the backlog today versus six months ago? And more importantly, you highlighted in your prepared remarks, the Inland Empire, where you're starting to kind of work through the backlog more quickly and you said that in the last few weeks, you've generated better sales growth -- sorry, better sales pace with what you said were solid margins, I'm kind of curious what solid margins mean there and perhaps that's kind of a clue in terms of how we should think about margins going forward for the broader company? Right. I'll just reiterate my comments from earlier, Mike, I mean there's a lot of uncertainty in the back half of the year and I think it's too early to call a lot on very much on what could happen in Q2 through Q4 on margins. Well, there's a lot of initiatives underway in the Company right now. We expect to see a lot of offset to whatever negative they come out of the general market. The largest difference between the margin in the first quarter and the expected margin in the first quarter and what we saw in the first half of last year, was the rate environment and the necessity to offer some concessions related to mortgage rate buy-downs to our buyers that we didn't have at all in the first half of 2022. So that's a pretty significant gating factor, very dependent on what happens with mortgage rates. And if we see those coming back in, there is significant margin pickup from that type of activity that we might see in the general market. So that's I guess that if you're trying to really dial-in on back half and what could happen in second quarter and everything else, and we're trying to provide as much information as we know today without seemingly having a crystal ball and what could happen, especially in the macro environment. So we're just trying to call like we see it right now, Mike. Hi guys. Thank you for taking my questions. The first one is, rates have certainly come down in December and January, I mean, call it 100 basis points plus from the highs. I mean what are you seeing from an order pace, cancellation pace and is the volume, is the quality of traffic improving at all? Different topics, John, it's the time of year when traffic improves anyway. So we are seeing a pickup in traffic certainly, after the first half of the year. But the summer was okay, I'll call it with traffic, we shared in our prepared comments that cancellations are actually moderate, that's a good thing. The wildcard is what do rates do versus how strong is the spring selling season? And rates have come down and the consumer is starting to digest the higher rate. So I think that's a positive for the consumer, and then we'll see how the spring selling season evolves, but so far so good. Okay, next question is, you know, just trying to better understand the sales approach heading into the spring selling season here, not lowering prices in the high backlog communities because the backlog would expect concessions. I mean intuitively that makes sense. But I guess the question is, what stops that backlog from going next door to a competitor if you're not at the market price, I mean, does it make sense to define the market price in order to get closer to in each community. John, that's a good question, one of the things that we all have to be mindful of is that a house isn't a commodity. It's somebody's home, that's where they live and it's where they make memory. So there's a lot that goes into the home besides x square feet for this price, and our buyers that, as I said in my comments, our buyers picked their floor plan, pick their lot, personalize their home, finish their home and they're waiting for us to complete and so they can close it, and for the most part, they're closing it. It isn't a 100%. If some other builders out there with a crazy discount that they can't ignore, they may move, but for the most part, they're -- they appreciate the process, the value proposition, the high levels of customer satisfaction. The leading industry energy efficiency, the smart home technology, all those things that we put into our product over the years are meaningful to the buyer, and it's more than just a price for footage. And if you couple that with what Jeff was talking about before, we went through pretty significant period of turbulence when rates moved up as fast as they did. And we had a lot of buyers that weren't locked, that we had to work with the keep in the backlog because they were scared to death of 6%, when they bought it at 3.5% or 4%, and a lot of what's coming through here in the first quarter, hitting margins as we did more than we normally do on financing concession to keep the backlog, but if you spend 2 points or 3 points on loan as opposed to a broad-based price discount, as a Company, financially, we're far better off. So as this backlog rotates through, that's when we'll go back out and evaluate what's the right price for the community, and you get out of the financing concessions and you go to a better price proposition for the consumer. We won't do both, we'll go back to price, which is what we always do and we're far better off letting the backlog turnover and clear than we would be -- the example Rob gave is, it'd be bloody if you just cut your prices when you got 50, 60, 70 backlog in a community. So we think our approach is the right one. Thank you. And our next question comes from the line of Alan Ratner with Zelman and Associates. Please proceed with your question. Hey, guys, Happy New Year, good afternoon, thanks for all the detail. I found the -- kind of walking through the examples of the community is helpful that you gave as far as ones where backlog might be a bit larger and taking a different price action there versus the smaller one, do you have any sense, if you look at your kind of 240 or so communities active today, what percentage would fit the bill of a community where the backlog is still quite large and you're focusing maybe a little bit more on delivering that backlog as opposed to generating improved order activity versus communities where you've kind of made the progress working through the backlog or maybe it's a newer community and you are kind of more pedal-to-the-metal trying to generate activity. I'm just curious what that share looks like today versus maybe three months ago when you started this quarter? Simple math using averages, Alan, is our backlog per community is still more than 30-per-community on average, so some are 50, some are 15, and it's all over the place. So each community rotates through. We'll take the steps at the right time. This isn't a problem, by the way, it's a good thing. If the backlog is solid and at decent margins. But Rob, I don't know if you were looking at it, what was the range on communities where we had taken steps. It wasn't that big in the fourth quarter at all? No, especially not at the start of the fourth quarter. So start the fourth quarter, the kind of filter the main filter, we're using CFO community as a candidate for a price reduction or not is whether it has more in backlog than remaining to sell. So in those cases, with more backlog than remaining to sell, we take a really hard look at those before we decide to pull the pricing lever because of the impact on backlog. When we started the fourth quarter, about 70% of our communities were not a candidate for a pricing change based on that criteria. But today, that's shifted more to mid-to-high 30% range. So that caused us to be more defensive, I would say, in most of Q4, but with some of our communities now with lower backlog and more remaining to sell, we've got more communities that we're looking at price adjustments to drive additional net sales. Thank you. And our next question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question. Thank you. Good afternoon. My first question is talking a little bit about the design centers and are you seeing any change there in what people are choosing to put in their homes or any other sort of adjustments in order to reach that affordability? Well, it's interesting, Susan, you've tracked us for a while, you know, the design center, it's a great consumer laboratory every day for what the consumer values and what they choosing because they are voting with their checkbook and our studio revenue in the fourth quarter deliveries was actually the highest it has been in many years. Not by a big number, it's tweaked up a couple of grand a unit from Q1 to Q4 but it cleared 40,000 a unit. And for the most part, it continues to be value type items. It's not the seasonal items but it's the value items, I need more cabinets, I need this converted to a den or an office, as opposed to a bedroom, I want a bigger covered patio because of the climate where this community is, it's not giving a seventh level of granite, not the second level because I want nicer granite in my home. But the consumer is continuing to spend in the studio. Okay. Thank you. And then the follow-up question is, thinking about the financing piece of it, I think that you said that the down payments on average are 17% and that you actually saw more cash buyers on a sequential basis in the quarter. Are you seeing that people are preferring to either use cash or just have bigger down payments as opposed to say using floating rate or other sort of alternatives? Well, I think it's interesting that the down payment, our pricing has been moving up a little bit and the down payment percent has been moving up a little bit as '22 unfolded. I think people like to put more down in order to avoid the mortgage insurance. And if you think about the conventional percentage, we had at 66% and then they put down that much, they can have a much lower mortgage insurance and it helps their -- with their monthly out of pocket. I also mentioned that adjustable rate ticked up, which they did, but it was like from 1% to 6%. So the vast majority of buyers are still taking a fixed rate. Thank you. And the last question we have time for comes from Jay McCanless from Wedbush. Please proceed with your question. Hey, Good afternoon and thanks for taking my questions. Could you talk about what your spec count was at the end of the quarter and maybe some notion of where you want to run that in the first quarter? Well, Jay, I shared in the prepared comments, we're, our WIP right now is about 80% sold and it's at 8,800, so that's roughly 1,700 inventory spread across various stages and that's about where we've always run it historically. So depending on how our sales track and our built-to-order sales and our starts will try to target the 80, 20 going into Q2 and Q3 deliveries. The other question I had, just thinking about the cadence of quarterly closings for '23, with the orders being down so much this quarter, should we expect some type of gap out in 2Q or 3Q or is there enough homes in backlog to make up for that? Actually, Jay, I think what we're falling back into a more normal seasonal cycle. We entered the year with a nice backlog that sets us up first half of the year and then the spring selling season will deliver out in second part of Q3 and in Q4, which is what we've typically done around here. Normally, a backlog of 7600 would be a much higher delivery count than we're guiding to, because we still have to get our build times back but as Rob shared, we're starting to see that compress. And ladies and gentlemen, this does conclude today's question and answer session. And this also concludes today's teleconference. Thank you for your participation, you may now disconnect your lines. Have a great rest of the day.
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EarningCall_1252
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Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Loop Industries [Second] Quarter 2023 Corporate Update Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. This conference is being recorded today, [October 13, 2022], and the press release accompanying this conference call was issued after market close yesterday, [October 12, 2022]. On our call today is Loop Industries Chief Executive Officer, Daniel Solomita, Kevin OâDowd, VP, Communications, Investor Relations. I'd now like to turn the conference over to Kevin to read a disclaimer about forward-looking statements. Thank you, operator. Before we get started, let me remind you that today's meeting will include forward-looking statements within the meaning of the securities laws. These forward-looking statements relate to among other things, current plans, expectations, events and industry trends that may affect the Company's future operating results and financial position. Such statements include risks and uncertainties and future activities and results may differ materially from these expectations. Additional information concerning these statements and related risks and uncertainties is contained in Risk Factors and Forward-Looking Statements section of our latest annual report on Form 10-K, our quarterly report on Form 10-Q filed with the SEC yesterday, in yesterday's press release. Copies of these documents are available at the sec.gov or from our Investor Relations department. At this time, I'd like to turn the call over to Daniel Solomita, Chief Executive Officer of Loop Industries. Daniel, please go ahead. Thanks, Kevin. Hi, everyone. Welcome to our Q3 earnings call. I'll just start with the main headlines of what has gone down in the last quarter. First, the sale of the land in Bécancour. It's just a really solid business decision. The value of that land has increased over 500% in the two years since we bought the land, so that the value of the land has exploded, and there was a lot of people that were looking for land in Bécancour and that was the main motivation behind selling the land. The value had increased significantly. And for us, that was just a really solid business decision, selling the land plus our cost reduction initiative gives us three years of cash on hand. That's without having any â raising capital and dilution, and that is more than enough to get us through this current global slowdown that we're experiencing. The Quebec and the Canadian project is still really important for us. It's an important project for Loop. It's important for Canada to be able to get to their 2030 goals of eliminating plastic waste. We're continuing to be engaged with the Canadian government and the Quebec government. We've already looked for other land available in Quebec and outside of Quebec and other parts of Canada. So there's plenty of land available that's much cheaper than the land that we had at Bécancour. And so when the macro environment improves, we'll be ready to begin that project. So it's still a very important project for us, and it definitely still in our cards for the future projects that we're going to develop. With these uncertain macroeconomic times, it's important for us to make sure that the projects that we do focus on and that we do build are the ones that have the least amount of risk and the highest amount of success. And that's what leads us to the projects that we're working with our partners at SK Global Chemical. SK Global Chemical is a large petrochemical company with very deep resources. Our project in Ulsan, South Korea has been going on for quite a while. It's not like it's a new project that we're just starting. We've been working with SK hand-in-hand. Teams from Loop and SK are working on a daily basis together to execute on the Ulsan project since we announced our partnership when SK became a 10% owner â equity ownership stake in Loop in 2021. So the companies have been working really closely together and we have multiple projects with SK that we're working on. First one being the project in Ulsan, South Korea that is scheduled to break ground in this year in 2023. Really important project for us, having that foothold in Asia is hugely important for some of our customers, especially on the fiber side. So all of the polyester fiber supply chains for the clothing and textile industry. So that's a really important area for us. SKGC brings in a wealth of experience. Obviously, they do all of the operation of the plant. So they have an experienced operations team. We're building the plant on one of their existing petrochemical sites. So they already have a lot of the infrastructure for the site available. We're working together with SKEE, ecoengineering, who is the SK division of their in-house EPC contractor, very large organization. They built petrochemical plants all around the world, and they have a huge wealth of knowledge in this experience and building not only on the engineering but on the construction of these facilities. So they'll be providing all of the construction and engineering services for the projects. SKGC also provides the majority of the capital for the projects, which is obviously very important for Loop. I said they're an experienced operator. SKGC also is in charge of all of the feedstock sourcing. Loop and SKGC working together on the customers. So Loop brings in the global customers that we have for other projects and SKGC works mainly on the local customers. So it's really a tremendous partnership between both companies. These are projects are really the ones that are the easiest to execute the least amount of risk because of having a partner such as SKGC. And so in these more uncertain economic times and the macro environment out there, we think it's best decision for Loop to be executing on the projects with the least amount of risk and the easiest to execute on. We have plenty of projects in the pipeline. There's tons of interest for the technology in other parts of the world. I mean, Asia as well. Asia, obviously, with SKGC. We have a plan to build multiple plants with them over the coming years. We also have multiple projects in Europe. We have our project in France, but we are also looking at other projects in Europe as well with the same consortium of partners and we have other projects in other parts of the world. So there's no shortage of demand for the technology or for the final product. But in today's world, we have to be looking at which projects are the easiest to execute on with the least amount of risk and the highest return on capital. And so that's where we see huge benefits in working with our partners at SKGC. That's all I have. So we can open the call up for questions now. Thank you. [Operator Instructions] Our first question comes from Gerry Sweeney of ROTH Capital. Gerry your line is open. Please go ahead. I was hoping that maybe you could discuss maybe the best that you're permitted to maybe some of the critical next steps with SK. I believe you're looking at â there's a bunch of scenarios, I think, maybe determining structure of the JV as well as the financing of the project on a go-forward basis and maybe any other items? And secondarily, maybe timing or target timing on sort of hitting these milestones. I know things are in flux, but I want to get an understanding of what big steps are out there and potentially when we can see some resolution on those steps? Yes. Thanks for the question, Gerry. So with SKGC things are not in flux. It's been very organized and structured work that we're working with them. So there's the finalization of all of the joint venture agreements. That's something that we are at the6 final stages of completing with them. So that's one part of it. And then our engineering teams are already working together on the final engineering and construction. Like I said, we've engaged with SKEE, the ecoengineering, which is a division of SK Inc., the broader company. So SKEE will be providing all of the engineering and construction for the facility. We're scheduled to break ground on the facility in Q3 of 2023. So that's the goal. SKGC has been very vocal about the project and their intentions. Most of that is in the Korean and Asian media. So it doesn't really come to the Canadian or the U.S. media very much, but you can look through at the Korea Times and things like that. So they're very vocal about the project and the timing and the importance of this. Because SKGC really wants to be seen as the largest recycling company in the world and really moving sustainability to the front of their agenda. So I would say, signing up the joint venture, which we're at the final stages of and then breaking ground in Q3 of this year. As far as the financing, we're discussing SKGC in the partnership. SKGC provides 80% of the capital for the project. Loop is responsible for the 20% of the capital for our equity portion. And that's the portion that we're discussing with SKGC on providing the capital that Loop needs for our equity positioning in the project. Thank you. [Operator Instructions] Our next question comes from David Quezada of Raymond James. David, your line is open. Please proceed. Thanks. Good morning, everyone. Daniel, my first question here, just kind of a follow-up on what's happening with the Ulsan project. Could â like are you able to comment on whether or not the long lead time pieces of equipment have been ordered and any thoughts or context around how those time lines are shaping up relative to expectations? And if costs for that facility overall are still shaping up in line with your expectations? Yes. Thanks, David. Nice to hear from you. Thanks for the question. So long lead time equipment, so the two reactors, the polymerization reactors that Loop had ordered for the Bécancour project will be transferred over to this project. So that long lead time equipment will just be shifted over because those are standard pieces of equipment, so they can â they can go to any of our projects. As far as long lead time equipment for this project, right now, like I said, we're scheduled to break ground in Q3 of 2023. So the long lead time order equipment needs to be ordered later on during the year. So there's nothing that needs to be ordered today. Costs are in line with expectations. We already have our first cost estimates internally for the project. They've been approved. So we're in line. We don't see â we've built all of this through this crazy inflationary environment. So we don't see â foresee any changes coming up in the cost of the facilities going forward. Hopefully, we'll start seeing some reduction in cost as we start seeing the world's economy is cooling off a little bit and supply chains easing up, hopefully with China's decision to forgo their zero COVID policy. So the project is in a really great space right now and both parties are very dedicated and very motivated to get this project built as soon as possible. Excellent. Excellent. Thanks for that, Daniel. And then maybe on feedstock for this facility is are there agreements in place for a certain volume of feedstock? And are you able to â do you have any color you can provide on if any of it has been sourced so far? Yes. So there's quite a bit of feedstock that's been we're starting like Loop has been testing the feedstock from different Korea suppliers. So we were doing a lot of that work together with SKGC. So there's a lot of typical feedstocks that we use in our process, which is the waste PET finds from the mechanical recycling industry, PET trays. A big thing in Asia is going to be the polyester fiber waste coming from all of the polyester fiber clothing supply chains. So that's going to be a feedstock that's important for the Asian expansion. So SKGC is primarily responsible for the feedstock. We do â we support them with all of the testing and all of the qualification, but it's really SKGC's role in the joint venture to be able to source the local feedstock. Okay. Perfect. That's great. And then maybe on the sales side of things, I guess, you and SK are kind of working together on lining up new customers. Is there a target that you guys have in terms of the proportion of volumes from the Ulsan facility that you like to have contracted? And do you anticipate those contracts happening or closing prior to groundbreaking? Or would you break around and then look to contract whatever volumes you would â you're targeting? No, we always look to have certain volume or capacities of the volume sold or reserved in some type of [indiscernible] contract or an LOI with customers before the breaking ground of the facility. So yes, we're definitely â we're starting to engage with the customers on which customers will be taking volumes from the Asian facility focusing on some Asian customers. But we can also ship material from Korea anywhere in the world. But the Asian supply chain, like I said, in the polyester fiber space are extremely interesting because a lot of the polyester fiber clothing companies need more sustainability. They need more recycled content into their fibers, into their clothing and into their products. And today, the mechanical recycling industry is the only way for them to do that. So taking water bottles and turning that into fibers. So the ability to get fibers back into fibers is something of huge interest to them, and that's obviously Loop's technology can provide that to them. So there's a strong interest there not only to sell them the final material but also to be able to recycle the waste that's generated at their facilities. So we anticipate to have quite a few fiber customers from the facility, but then there's also the bottle grade customers that we work with around the world that all have needs in Asia as well. So â but we do anticipate having I would say, majority of the volume already contracted before breaking ground. Okay. Excellent. And maybe just one more for me, if I could. Your R&D expenses were down in the quarter, which I think is consistent with your plan to reduce the burn rate. But could you comment on just â are most of the R&D activities that you that you need to undertake for your upcoming projects? Are you mostly complete at this point? Or I think you mentioned you're still doing some R&D or some testing for feedstock in Korea. Just wondering how you expect that R&D expense to trend going forward? So the biggest â in our cost cutting and our cost reduction, the biggest thing that we've done is we just reduced the hours of operation for â from the production facility in Terrebonne. The production facility in Terrebonne, the nameplate capacity is 1,000 tons a year, roughly 2.2 million pounds a year of capacity is what we can produce at the Terrebonne facility. The facility was never built to generate profits, but it's built to be able to showcase the technology at a commercial scale and supply customers with commercial volumes. And we've been successful in doing that. So the plant worked well. We built it out to a scale that anybody can come and see and our partners can do due diligence or customers or companies like SK Global Chemical, can do full due diligence on the technology. And so that's been completed. So by reducing the hours of operation, instead of running the facility 24/7 slowing down, having full night shift, having four shifts of workers. I mean that's a very big expense, and you can't generate a profit because the volumes are too small. And so really, it's just about reducing the hours of operations. So we're still producing material. We're honoring all of our existing customer contracts with on shoes, and we had some material with other brand owners, and we have some upcoming events as well with other brand owners coming up. So we still have the operation and know that R&D expense is really the operations running at the plant. So we'll always keep the facility open to be able to test feedstocks as that's always really important. That's an important part of the business. So being able to qualify any feedstocks that come in from Korea or any other part of the world that needs to be characterized. So we do it first at our lab scale and then we do it at the production facility in a few tons at a time. So the R&D and production expenses kind of mix together in there. But you need to keep this facility open to be able to produce material for the customer. So you mix in the customers with R&D because we're testing feedstock. So it all blends in really well together. But there is no need for us to be running this facility at full capacity producing 1,000 tons and trying to get it out there. Today â in the world we live in today, it's â cost cutting is an important measure. And I think it makes a better â the customer â the company leaner and keeps people motivated. So I think it's been a bit overall, it's been a success. Thank you. At this time, this concludes our Q&A session. I'd now like to turn the call back over to Mr. Daniel Solomita for his closing remarks. Thank you very much, operator. So I guess this concludes our Q3 earnings call. Like I said, the company has made really smart business decisions. Selling the land in Bécancour was a really smart business decision as it had appreciated over 500% in two years, focusing on the projects that are the easiest to execute on with the least amount of risk with SKGC is obviously in my mind and in management's mind with the best course of action. So really excited about 2023 breaking ground on our first facility and then many more to come. So thank you very much for your time.
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EarningCall_1253
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Welcome to Metropolitan Commercial Bank's Fourth Quarter and Full Year 2022 Earnings Call. Hosting the call today from Metropolitan Commercial Bank are Mark DeFazio, President and Chief Executive Officer; and Greg Sigrist, Executive Vice President and Chief Financial Officer. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the prepared remarks. [Operator Instructions] During today's presentation, reference will be made to the company's earnings release and investor presentation, copies of which are available at mcbankny.com. Today's presentation may include forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to the company's notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer. You may begin. On an operating basis, MCB had a record year with adjusted net income of $94.4 million, up from $38.4 million in 2021, and adjusted efficiency ratio of 44.5% versus 48.2% in 2021. Our fourth quarter net interest margin of 4.05% versus 2.59% in the prior year quarter. The commercial bank along with our banking-as-a-service initiatives saw growth along all lines of business contributing to our operating results. While 2022 was a challenging year for our industry, we worked through rising interest rates, increased cost of funds, fierce competition for deposit, a material correction in the digital asset industry and, with that, increased regulatory scrutiny. Our early intuition that we should pivot away from crypto -- the crypto industry has served us well. Our minimum exposure coming into 2022 allowed us to efficiently replace the deposits we have foregone to-date, along with generate efficient liquidity to sustain loan growth. As we previously announced, we will fully exit the industry in 2023 with minimal impact to earnings and liquidity. We are also very close to bringing closure to ongoing investigation from the DFS and the New York Fed regarding a fintech client MCB banked in 2020. As a result of the investigation, MCB has reserved $35 million toward a joint settlement. MCB's decision to settle was a conscious effort to move forward with the business of MCB and reduce our professional fees to a more normalized run rate. There were lessons learned here throughout the experience and we have implemented improved oversight of consumer compliance for our banking-as-a-service business. This was an unfortunate situation that occurred during an unprecedented time. On balance, we successfully covered tremendous ground in 2022 and are entering 2023 in a strong position to support our clients with enhanced resilience and strong capital levels. Our operating performance in 2022 continues to demonstrate the strength and sustainability of our business along with the dedication and execution of the MCB's employees and clients. We have effectively managed through the challenging environment [indiscernible] are in a good position to support our clients with enhanced resilience and strong capital levels. Now, for a few financial highlights for 2022. Loans increased $1.1 billion or 30%. Net interest income of $229.2 million was up 46%. Total revenues were up 42% to $255.8 million. Net interest margin improved to 3.49% from 2.77% in '21. And return on tangible common equity from operations remained very strong at 16.6%. And our efficiency ratio improved to 44.5% from 48.3%. MCB's core business continued to scale as it reported adjusted fourth quarter net income of $27.3 million or diluted EPS of $2.44. Reported net income inclusive of the regulatory settlement was a $7.7 million loss with a $0.71 loss per common share. Turning to key drivers in the quarter. The Commercial Bank posted a strong quarter with net loan growth of $223.2 million or 4.8% on loan originations of $411 million. We saw growth across all loan verticals. Loan yields increased to 5.98% from 5.3% in the prior linked quarter. The credit environment remains benign with no charge-offs in 2022, and non-performing loans effectively at zero. The provision in the quarter was in line with loan growth. I do want to spend a moment on deposits. We have successfully managed the transition to a leaner, more efficient balance sheet. As certain core deposit clients looking for higher yields have moved into treasuries or other money market investments, we have onboarded efficient, lower cost deposits. This is evidenced in the fourth quarter with outflows from bankruptcy trustees and property managers being offset by strong inflows from retail deposits, up $178 million in the quarter, and fintech banking-as-a-service deposits, which were up $40 million in the quarter. As expected, digital asset related deposits were down in the quarter by $268 million to $494 million at year-end. Of that remaining $494 million deposit balance, $326 million or 6% of total deposits are related to MCB's four active institutional crypto asset related clients, which are subject to wind down in 2023. To support a more efficient balance sheet, particularly as deposits related to these active crypto clients wind down, we may, at times, utilize FHLB advances for other funding sources in advance of executing on strategic core deposit initiatives. We did have $250 million of FHLB advances and Fed funds purchased at year-end, which in part reflects the strategy, but it's also reflective of the timing of normal client cash flows around year-end. While deposit competition has increased, we remain thoughtful and patient both on pricing of existing deposits as well on execution on funding alternatives. Our pricing discipline is evident in the success we have had in moving our new production loan yields up, raising loan floors and in our net interest margin of 4.05% in the fourth quarter, which is up from 3.85% in the prior linked quarter. The interest-earning asset yield increased 86 basis points to 5.12% in the quarter. Asset yields benefited from the impact of rising rates on floating rate loans and overnight deposits as well as increasing new production loan yields. Given the extent of rate increases since late September and as a result of our active management, total cost of funds has increased by 72 basis points, but remains at a low 1.17%, which is particularly notable in light of our branch-light model. We have also moved for much more neutral stance from an NII perspective, which will allow stability to the extent rates do continue to rise this year, but we are also well positioned for eventual rate cuts. For our Global Payments business, revenues were up $244,000 in the quarter to $4.3 million. To give you more color, fintech banking-as-a-service revenues were up $569,000 to $3.1 million, while crypto-related revenues were down $324,000 to $1.2 million in the quarter. We're very pleased to see the continued scaling of our banking-as-a-service revenues. Turning to operating expenses. Compensation and benefits were up modestly in the quarter, reflecting our continued investment in human capital, particularly into risk and infrastructure teams. Legal fees remained elevated by approximately $2.4 million in the quarter and $6.2 million for the full year, with outside counsel engagement focused on the regulatory matter as well as carry over on Voyager's bankruptcy proceedings. We do expect legal fees to moderate back to historic levels during the fourth quarter -- sorry, first quarter. Despite the elevated legal fees, our adjusted efficiency ratio remained low at 45.1%. The effective tax rate was impacted by the regulatory settlement reserve as well as discrete tax items that came through in the quarter. This includes the impact of vesting date fair values of employee stock-based compensation and refined state apportionment rates. Going forward, we would expect the effective tax rate to be in the range of 31% to 32% excluding discrete items. I wanted to start off with the regulatory settlement reserve. Can you provide some additional color on that reserve? And can you just confirm that it was a fintech client and not a crypto-related client? And how does this change how you approach the business going forward? And as a follow-up, how do you think about the risk of needing additional regulatory reserves on top of that $35 million? Thanks. Okay. So, there was a lot there, so if I miss anything, just follow-up with that. So, working backwards, this is a specific fintech client. It was not a crypto client. We will announce the name of the client at some point. But this particular banking-as-a-service client is no longer and hasn't been a client of the bank since the summer, I believe, of 2020. I think this made us a better bank. I think the regulators are good partners of ours, and I think they pointed out. You got to remember when this occurred -- this occurred in March of 2020 as I reported, it was an extraordinary time under extraordinary circumstances, and we were trying to manage through an extraordinary initiative from the federal government as part of the CARES Act with unemployment benefits. And this was a small amount of the level of fraud that actually took place regarding the $1 trillion that the government put out there regarding unemployment benefits. This was a virtually a rounding error; however, it did occur. Working with the regulators over the last several months, actually over the last two-and-a-half years on and off talking about this, I think they brought some really good insight and gave us some really good suggestions on how to improve our oversight. I think the regulators and MCB clearly realize that banking-as-a-service is going to stay and the way in which a retail banking is being done today is digitized, it is inclusive, and it's very scalable. And I think working alongside the regulators going forward would only add to our ability to grow the business efficiently, and in a way that speaks to very safe and sound banking practices. So, I don't think it's a headwind at all. I think it's a positive, although painful, it's a positive. Thanks, Mark. And moving on to the crypto business exit, can you talk about the sense of timing of the rundown of the crypto-related deposits for the four accounts? And could that come with potential security sales? Thanks. One, it will not come with any -- we've not planned on any security sales at all, there should be no reason for that. And we are anticipating over the course of 2023 that these four clients will be off our balance sheet. Now, our -- we'll wind down relationship with them and the agreement we have in place. They seem to be making a lot of progress in talking to other banks. So, it could accelerate, but we're planning that will be a smooth transition over the next two, two-and-a-half quarters. Thanks, Mark. And what about outside of those four relationships in terms of crypto-related clients? I think there's about 3% of total deposits. How do you think about those balances moving forward with those exchange clients moving out? They're not exchange, they're corporate funds, they're operating accounts. We just have operating accounts for, let's say, a hedge fund who has raised some equity and they're running their business payroll, etcetera. So, these are just real operating accounts that they don't touch crypto in any way. Thanks, Mark. And one more before I step in the queue. On loan growth, when you exclude the crypto-related deposits, your loan to deposit ratio is approaching 100%. Can you talk about your expectations for loan growth in 2023? And if we should expect the pullback of growth relative to that historical growth level given a more challenging deposit environment? Thanks. I have probably a much clear line of sight in '24 and beyond. I'm very confident that we will go back to normal -- a lower loan to deposit ratios. We have a lot of optionality on that side of the balance sheet, and we're bringing in new initiatives, which the market will hear about in the upcoming quarters. So, for '23, we could be a bit higher, a bit lower, but I think on balance, we will come into '24 and continue to be a very efficiently-funded bank and core-funded. So, I'm very optimistic that, that loan to deposit ratio will come back down significantly in '24 and beyond. I just wanted to circle back quickly to the regulatory settlement reserve. And if you guys could comment on how confident you are that, that reserve is adequate and I guess how close to kind of final settlement you might be? Yes. I think, I'm very, very confident that this is the high watermark on the $35 million [Technical Difficulty] in settling with both regulatory agencies. Both of us are working and I have to say that the regulators are working in really good faith to finalize this settlement, and I think we're really close. Again, it's [Technical Difficulty] contentious situation at all. We're working with them. We always had great relationships with regulators my entire career, never mind the 23 years here at MCB. So, we kind of put the fine point on some enhancements and some changes that they would like, which we are in agreement with. And we'll get this behind us, but that's why we fully reserved for this. Is there a chance that it could be slightly lower? Yes, it's possible. We all are working in good faith, as are the regulators. But I wanted to fully reserve for an amount that I think is absolutely the high watermark. Okay, great. As far as the expenses and once this falls out of the expense run rate going forward, how -- I think the regular professional -- sorry, professional and legal line is also still a bit elevated in this quarter as well relative to where it's been in the past. Can you just talk about kind of where the [indiscernible] expense run rate might drop down to once this behind you? Yes, sure, Chris. I mean, you touched on the professional fees. I really think that we're going to moderate back to the level we saw late in '21 through probably the first half of '22, maybe split the difference between when you take the legal fees out versus where we were then. We've worked with a lot of initiatives over the last year, year-and-a-half. So, I do expect that line to kind of moderate a little bit. As you know, we're still a growth company though. So, comp and benefits, we are -- we will still continue to invest in human capital. I think we've brought on and onboarded a very substantial team over the last year or two. You're going to continue to see expansion in that line. We're going to continue to invest in human capital. I think it might moderate a little bit from the level you saw in 2022 in terms of growth. I think the other key thing is it's really just the efficiency ratio, as we always talk about. We are going to be very focused on continuing to work that ratio down from current levels. So, it's as much about getting the leverage out of what we're bringing on those investments -- on the investments, the return on the investments we're making and making sure we keep an eye on overall expense growth. Okay. Got it. All right. And then, as far as what you guys have been -- you mentioned a few things on the deposit side some initiatives kind of as you head into the front end of this year. I guess, how are you thinking about deposit growth if you exclude the crypto -- the expected crypto runoff for the next quarter or two? I think, it will be robust. I think if you remove the crypto, we would be very pleased if all crypto ran off in the first quarter, just so we don't have to talk about it again. And then, obviously, I have to fill that bucket up, if you will. But I'm feeling really comfortable with the initiatives we have. Everybody in the company whose client-facing is working really hard. And as I think we will always be a core-funded institution. We always have been. We will continue to be a core-funded institution. And this is the first time in, I think, 15 or 16 years that we dipped into the Federal Home Loan Bank. So, this is not something that we tend to want to rely on long-term. It's good bridge funding, but it will not be a core strategy of what's going forward. Yes. And just to add to that, Chris, I mean, around year-end, we have a very active successful client base. So, we also saw just some normal flows around year-end. I think the important takeaway is we've really hit business as usual in terms of managing a leaner, more efficient balance sheet. We could always bring on more deposits to manage the loan to deposit ratio or other metrics. We're staying focused on our pricing discipline and our margin management. And we have the options to bring funding on. And we have a lot of strategic initiatives that are above and beyond our existing deposit verticals that are actionable, they're in the queue, and I think Mark kind of touched on this that we're going to be executing on over the balance of the year. So, I think we're all very confident and comfortable with our ability to continue supporting high-quality, prudent loan growth with low quality -- or low cost deposits. And Chris, I should -- I really should point down and should not go unnoticed, two deposit verticals that we developed internally and the property management business, which is a nationwide business, and the U.S. Trustee business, and there's only a handful of banks that actually could hold U.S. Trustee's deposits on balance sheet. You got to keep in mind, we chose to let those deposits runoff. We replaced them. We decided to be a much leaner, operate as a much-leaner balance sheet. We can dial that up anytime we want. We can bring those deposits back. We have wonderful relationships with these companies. When we find that that's an efficient source of liquidity for us to maintain the discipline we have toward knowledge and management, we'll bring it back. So, it's not like it's an investment. There's no capital investment to bring on and replace those deposits. And we're working really hard to add to our supply of deposit verticals. And by the way, this rate cycle will pass. Those rates will [Technical Difficulty] and they'll find their sweet spot. We have a significant advantage as being one of the few banks in the country that actually can hold U.S. Trustee deposits on balance sheet based on the investment [go] (ph). So, those are just deposit verticals we can fill up anytime we want, so we can bring that loan to deposit ratio down anytime we want. But we are a bank that likes mid-teens and higher return on tangible common equity. We think that's our mandate and that's where we've been historically and that's where we're going to stay. Got it. Circling back to one of the earlier questions on the crypto runoff over -- in the next couple of quarters, and whether the offset of that is coming from cash or securities. Can you just walk me through what the decision-making process is, and how you guys landed on the decision to do solely cash, given where the securities yields are on the [AFS] (ph) book? Yes, we -- I think in part, Chris, it goes back to just the opportunity we see in the deposit side. I mean, we obviously have $7 million or $8 million a month of principal cash flows coming off the securities portfolio that's available to us. We're still generating a tremendous level of cash just on an operating basis, it will be part of the mix. GPG, if you're looking at the banking-as-a-service deposits, those have continued to tick up quarter-on-quarter and we still see a lot of runway for growth in that vertical. And we feel that we don't have to rush out to fill the bucket, right? We are targeting between $200 million and $250 million of on-balance sheet cash at any moment in time, such as part of using the FHLB advances, as an example, to fill that bucket. But we are thinking over the balance of the year that we're going to be able to continue to support loan growth and replace crypto deposits with existing verticals and initiatives we've touched on. Okay, understood. Thank you. And then, last two quick ones from me. One, is there any discussions internally, or have you guys thought about the potential for a buyback authorization? And then, two, I believe that the office book for you guys is around 8% of total CRE. But maybe if you could just walk us through some of the characteristics of that book and where it's located, et cetera, that'd be great. All right. I'll start with the buyback, and then Mark, I think, can pick up the composition on the CRE side. Obviously, we evaluate a lot of capital alternatives, including dividends and a lot of things. I think anytime you trade close to book value -- your tangible book value in this sort of the market, you really have to think hard about it. All I can say is, yes, we're absolutely having the conversations. And if anything becomes actionable or reportable, we'll let you know about it. But it's certainly been on our mind. As far as the office building market, as you said, we have small exposure, but most of it is the suburban office building market in different geographies, strong sponsorships, strong cash flows, low LTVs. We're not in those Class A office building markets -- office building assets here in New York City with low occupancies. But keep in mind, the occupancy level, the actual people coming into the buildings is rising every single month. It's around 50% or so, but the default rate is still very low in the industry. However, we don't really play in that space. So, we're very comfortable with the ownership, the sponsorship and the position of our office building portfolio. This concludes the allotted time for questions. I would like to turn the call over to Mark DeFazio for any additional or closing remarks. Just really quickly, I know a lot of people were a bit taken back by the regulatory settlement, but looking forward, I do want to stress that, this is behind us. We're a better bank today, and we're positioned well to continue doing what we've done in the past. And I look forward to a continued good working relationship with the regulators as we move forward, become best in practice when it comes to banking-as-a-service. This does conclude today's conference and webcast. A webcast archive of this call can be found at www.mcbankny.com. Please disconnect your line at this time, and have a wonderful day.
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EarningCall_1254
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Good morning, everyone, and welcome to the Pinnacle Financial Partners' Fourth Quarter 2022 Earnings Conference Call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer; and Mr. Harold Carpenter, Chief Financial Officer. Please note, Pinnacle's earnings release and this morning's presentation are available on the Investor Relations page of their website at www.pnfp.com. Today's call is being recorded and will be available for replay on Pinnacle's website for the next 90 days. At this time, all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation. [Operator Instructions] During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other facts that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's Annual Report on Form 10-K for the year ended December 31, 2021, and its subsequently filed quarterly reports. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events, or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by the SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com. Looking at the performance in the fourth quarter, key success measures like net interest income growth, tangible book value accretion, core loan growth, core deposit growth, asset quality, all continue to be strong. There is a fair amount of noise in our fourth quarter numbers. So, we're going to move quickly to the performance detail for the fourth quarter to try to create clarity there, then to the outlook for 2023 to help with model builders, and finally, I'll spend some time detailing why I believe we have a unique ability to continue producing outsized shareholder value. As you likely know, we believe asset quality, revenue growth, earnings per share growth and tangible book value accretion result in long-term shareholder returns. That's why our incentives are linked to them, and that's why we show this dashboard every single quarter where you can see the relentless upward flow for those metrics, most closely tied to the shareholder returns. GAAP measures first, followed by the non-GAAP measures, which I'm personally most focused on. And if you believe that asset quality, revenue growth, earnings per share growth and tangible book value accretion mostly influent shareholder returns, which I do, then you have to appreciate the persistent excellent performance against those variables year in and year out. As I mentioned a minute ago, there is considerable noise in our fourth quarter financials, so we're anxious to get on details. The most impact of those items with BHG's election to fund roughly $500 million in originations on their balance sheet, thereby deferring the income on those loans over the life of loans as opposed to directing them into their auction platform, which would have resulted in taking the gain on sale upfront, significantly increasing their and our earnings during the fourth quarter. Nevertheless, I believe you should be able to look through to see that the core banking business continues to have great momentum. As usual, we'll start with loans. The fourth quarter was another strong loan growth quarter for us, and we believe annualized mid-teens loan growth going into 2023 is reasonable for us, as we anticipate loan yield growth in the fourth quarter, and we anticipate further escalation in loan yields in the first quarter. Along with that, we are forecasting Fed increases of 25 basis points in February and 25 basis points in March. Our modeling indicates that loan yields will be up 40 basis points to 50 basis points or so in the first quarter. The talent we've added over the last several years results in extraordinary balance sheet momentum, as we've done over the past few quarters, we're again dissecting net loan growth based on the categories noted on the slide to help everyone better understand the source of our growth. It's been a huge year for us as far as loan growth is concerned, and it works out with the new markets and our new hires contributed to more than half of our growth. That said, that represents more than just an annuity stream for interest income, those are new clients with now new opportunities for our firm [from] (ph) all types of financial products. We are definitely in a broader footprint with new markets, but also a much deeper footprint given our model. Now deposits, really pleased to report the growth in deposits for the fourth quarter. Growing deposits at a reasonable price in 2023 is a key focus for our current environment. We are actively building out deposit gathering franchise around HSA, community housing associations, non-profits and others, and we believe we are making headway with these and other special deposit initiatives. Our average deposit cost came in heavier at 74 basis point increase over the third quarter. Although we believe we remain inside of our total deposit beta guidance of 40% through the end of 2022, we experienced an acceleration in deposit cost in the fourth quarter above our expectations by about 15 basis points. Competitive pressure around deposit costs are significant. So, we fully anticipate that increases in Fed rates will continue to add a tailwind for increased deposit costs in 2023. Average deposit cost, we believe, may approach 1.5% to 2% in the first quarter of this year. As for mix, we are seeing deposit move more noninterest-bearing and lower-yielding interest accounts with the higher interest products and current deposits. Our average noninterest-bearing deposits were down approximately $440 million in the quarter from 3Q averages and even more based on end-of-period balances. Our plan will contemplate this decrease to continue at a lesser pace in the first half of '23. About 90% of our noninterest-bearing balances are commercial, with approximately 25% of that number being annualized. Over the last year, annualized commercial has dropped from around $425,000 per account to around $350,000, while non-annualized commercial has dropped from $35,000 to $30,000. Pre-COVID levels will be around $300,000 per annualized and a little less than $25,000 for non-annualized. So, average account size is still 10% or so higher than pre-COVID levels. Our number one objective remains developing strategies and tactics around funding our growth. We continue to like our chances given the significant investment we've made in both relationship managers and new markets over the last few years. Hopefully, you'll not hear this bank's leadership ever talk about having too many deposits. Our belief is that we have and will fund our deposit growth effectively and prudently maintain the appropriate balance between profitability and growth. Now, liquidity. We believe we have ample liquidity to fund our near-term growth. As investment securities, our allocation to bonds was flattish in the quarter. We don't anticipate any significant growth in bonds this year. As the top left chart reflects, our GAAP NIM increased by 13 basis points compared to 28 basis points to 30 basis points in the previous two quarters. As we mentioned last time, a decrease in our NIM expansion was not unexpected, although we felt like the NIM would expand in the fourth quarter by a few more basis points than it did. Our planning assumption is our NIM will likely to be flat to down next year and likely down in the first quarter, given the first quarter is burdened by fewer days. That said, our growth model should provide for increases in net interest income. As we enter 2023, we believe net interest income guidance of the high-teens percentage growth for 2023 over 2022 is reasonable at this time. As for credit, we're again presenting our traditional credit metrics, Pinnacle's loan portfolio continues to perform very well. Our current ACL is 1.04%, while -- which again compares the pre-CECL, pre-COVID reserves of 48 basis points at the end of 2019. We did modify our CECL modeling this quarter with a more pessimistic assumption set with a baseline at 20% stagflation at 30% and with pessimistic scenario at 50%. We continue to have conversations with borrowers about supply chain, inflation and how it's impacting our businesses. We've been all about sustainable credit diligence efforts with the intent to actively identify any weaknesses in our borrowings. We continue to have a very limited appetite of new construction, whether it be residential or commercial. Thus, the growth of our construction portfolio is limited to funding previously approved commitments with no new projects being added at least through the first quarter of 2023. We also remain attentive to our concentration limits in all areas of our portfolio, particularly in CRE and the table on the bottom right of the slide details. No changes regarding our CRE appetite from last quarter. In summary, our outlook for credit remains strong as we entered 2023 from a position of strength. So, if negative trends begin to develop, we believe we're advantaged. Now, on the fees, and as always, I'll speak to BHG in a few minutes. Excluding BHG, fee revenues were flattish for the third quarter. All that said, we're pleased with the effort of our free-generating units [indiscernible] that several units are negatively impacted by the current operating environment in a meaningful way. Obviously, residential mortgage volumes were down this year. Mortgage does see their pipelines building back modestly in the first quarter as rates hopefully will be less volatile when the spring home buying season begin. Gains on SBA loan sales are also down significantly from the third quarter, as their business was impacted by the elimination of incentive from the CARES Act, which drove more business to SBA lenders in the previous quarter. We've gotten a few questions on earnings credit rates and the impact on deposit fees. So, here's a stab at that. We have approximately $2.5 billion in annualized commercial noninterest-bearing accounts. Our current ECR is around 35 basis points [indiscernible] is competitive. At the moment, our run rate on analysis fee with labors is about $4.5 million per quarter. For every 25 basis points, we raised the ECR that reduces our analysis fee by $400,000 to $500,000 each quarter. Our goal is to stay in the middle of our competition peer group on earnings credit rates, so we have to release some lift in the ECR that's coming, but it will come in small bites. We had anticipated 2022 to return a high single-digit growth in fees over 2021. Excluding BHG and other non-equity investments, we believe 5% growth, and we achieved 5% growth for the year. We think mortgage should recover modestly in 2023, and we've also added some strong revenue producers in Wealth Management late in 2022. Excluding BHG and the impact of other equity investments, we believe that high single-digit to low-teens growth in '23 over '22 in the region. Expenses came in about where we thought for the quarter. We did see non-compensation expense decline from 4Q -- in 4Q from 3Q, but attributable to the reversal of franchise tax accruals with some of that being added to the tax line, so it was a reclassification between franchise tax expense and income tax expense. All in, we are anticipating an effective tax rate of approximately 20% in 2023. Our incentive costs also decreased in 4Q from 3Q. This was primarily the result of the impact of 4Q '22 PPNR results on a cash plan, which came in below target, and overall performance metrics on the performance-based equity incentive awards, which came in below our expectations. All of this is a segue into a few comments about variable cost nature of our expense base. We feel like our expense base should result in mid-teens growth for '23 over '22. As to how we can manage expenses? As I mentioned, we've reduced our '22 payouts due for not achieving selected incentive targets, particularly on our quarterly PPNR targets and various other measurements when it comes to equity compensation, which is, by the way, primarily impacts senior leadership. That's how it works. Our cash incentive plans always tied to EPS growth targets and, for 2022, it was also tied to PPNR target for each quarter. We missed our fourth quarter PPNR target, thus incentives were reduced. Our leadership equity plans were tied to results in relation to our peers, some are returnable tangible common equity, some are tangible book value accretion, some are PE and tangible book value and [all that] (ph). So, it's all based on ranking in relation to our peers [indiscernible] that we think are directly linked to shareholder value, the higher the peer ranking, the better we do. We believe we have a very shareholder-friendly compensation system that is objective, not subjective, which is a meaningful variable cost component. The other element that brings the variable cost attribute to our expense growth is our hiring level. We can always back down or overrecruiting and have done that a few times in our history. I can recall once during the financial crisis and the other is during COVID. Both times, we slowed recruiting until we better understood the depth of the macro environment. Lastly, and as we mentioned in the press release, we've got the ability to modify, cancel and postpone various events and projects with [indiscernible] and we will do should our targets be in jeopardy and not being achieved. On the capital, tangible book value per common share increased to $44.74 at quarter-end, up slightly from last quarter. Our capital ratios remain above well-capitalized levels. We like our tangible common equity ratio, which was stands at 8.5% currently. We are mindful of our Tier 2 capital levels, particularly at Pinnacle Bank. We'll be monitoring our capital levels as we get into '23. We believe the action we've taken to preserve tangible book value and our tangible capital ratio have served us well and have no plans currently to alter our PNFP Tier 1 capital stack via any sort of common or preferred offering. Now, a few comments about BHG before we look at the outlook for the rest of the year. As slide indicates, BHG had another great quarter on originations, second best in its history. Originations did decrease from the prior quarter with BHG's implementation of a tighter credit mark, so fewer of the lower credit score loans, which are typically more profitable, were funded in the fourth quarter. As a result, spreads did come down from the last quarter from 9.7% to 8.9% as the chart on the bottom left indicates. That's more spread shrinking than originally planned, but as the chart indicate, for several quarters in 2020, current spreads remained above or near historical norms. The accrual for loan substitutions and prepayments increased to 5.66% and 5.28% last quarter as a result of a more precautionary posture on BHG management. BHG accrual for loan substitutions and prepayments for sole loan portfolio increased from $270 million at September 30 to $314 million at December 31. As the blue bars in the bottom right chart show, recourse losses fell slightly from 4% to 3.96% at year-end. Additionally, given the macro environment and as we mentioned last quarter, BHG also increased on-balance sheet reserve for loan losses to $147 million or 4.59% of its on-balance sheet loans from 3.53% last quarter. Of course, CECL is still on the radar for adoption on October 1, 2023. We continue to anticipate the CECL reserve to be 8% to 9%, but that certainly is an estimate at this point. The quality of BHG's borrowing base, in our opinion, remains impressive. As mentioned earlier, BHG has modified its credit mark, particularly with respect to lower tranches of its borrowing base. This will have an impact on both production and spreads going forward. BHG refreshes its credit score monthly, always looking for indications on weakness in its borrowing base. Credit scores were at a consistent level with the previous quarters, so their borrowers have remained resilient during the cycle thus far. In comparison to other consumer lenders, we believe BHG remains well -- BHG borrowers remain well compensated with average borrower earnings being around $293,000 annually. BHG's trailing 12-month charge-off ratio has increased from 1.98% to 2.94%. Similarly, its delinquency ratio has increased from 1.22% to 1.78%. Although these ratios are in line with early 2021 ratios, BHG recognizes the macro environment to lead to further deterioration of similar credits. In an effort to keep performance to near historical levels, BHG has made a number of credit cuts to both their marketing and underwriting models. We believe that BHG's management team has taken a proactive approach to managing credit as they've entered 2023. Lastly, BHG had another great year in 2022. As I mentioned during our earnings calls this year, we have always believed BHG's earnings in the first half of 2022 would likely be stronger than the second half, as they set more loans to the bank auction platform in the first half of the year rather than whole loans on their balance sheet. As you know, the bank auction platform delivers an immediate gain on sale, while loans that they retain on the balance sheet and fund through various funding options deliver interest income over the life of the loan. BHG accomplished three securitization this year, aggregated almost $1.3 billion in volume. During the last part of December, they added $550 million in new facilities with Goldman and Truist. This represents incremental funding available to BHG in 2023. A third facility for $500 million was closed in late December as well. Closing on this facility required more loans to remain on balance sheet than which otherwise had been expected. This facility was fully funded at year-end 2022. So, here's a simple example. $100 million issuance through the bank auction platform could generate anywhere from $30 million to $40 million in gains immediately, while going through the securitization platform at an 8% spread would yield approximately $7 million to $8 million in interest income annually. In the fourth quarter, BHG set more of the balance sheet than originally anticipated with [indiscernible] sold through the GMS model. Again, looking forward, some key points I'd like to reemphasize which are basically the same comments I mentioned for three year -- three months ago. BHG management has responded to the macro environment in a very real way. BHG is and will be increasing reserves based on macroeconomic data at least over the next few quarters. BHG has been modifying their credit model scores [originally in] (ph) less risky assets with that spread shrinkage may occur as we head in 2013. Production volumes are strong, and we believe they will maintain production levels going into 2023. BHG's new funding alternatives will broaden their already strong liquidity platform, which we also believe is unmatched by their peers. Lastly, a few weeks ago, BHG took steps to limit its headcount with job eliminations and elimination of most open positions, as well as other expense reductions, which shield -- which should yield a 10% reduction in its expense burn in 2023 from 2022. For all those reasons, we have great confidence in our partners at Bankers Healthcare Group to deliver strong results over the long term. Quickly, here's our final initial outlook for 2023, along with a comparison of our comments on 2022, the third quarter conference call in October. We expect mid-teens growth in loans, low to mid-teens growth in deposits. This correlates to a similar outlook for net interest income, which should result, we believe, in high-teens growth in net interest income. Our plan to 2023 contemplates our NIM being flat to down for the year, which will obviously be a challenge and we need to be nimble with respect to product, especially on the cards. Fee revenues may be our biggest challenge as many fee units are facing more than their fair share of economic headwind, but we've had some key hires in several of these areas and are optimistic that we should see a lift from those new associates. We believe BHG's [target] (ph) will be flat to slightly up for 2023. We've reduced our expense growth outlook to mid-teens. Our senior leaders are still committed to a strong recruiting year, especially as it pertains to revenue hires. Asset quality, we believe, is in great shape currently, and we believe we are entering the year from a position of strength, which should be a great thing should negative trends begin to develop. We are putting the final touches on our strategic and financial plans for 2023 with just as many unknowns now as they were last year, but our goal remains the same; top quartile earnings performance no matter what gets thrown at us. There're two things that I hate, and I know most of you do as well. One is noise in the numbers. In my opinion, no one just forces discussion to be around trying to create clarity about the noise and take focus off the underlying ability to produce outsized shareholder returns, which, of course, where I think the focus should be. The second thing I hate is economic uncertainty. So, frequently it forces investors to the sidelines regardless of the potential for shareholder value creation. And so, I will take just a minute to ensure understanding how we intend to produce outsized shareholder returns regardless of whether BHG [elected] (ph) balance sheet more loans regardless of the economic uncertainties that persist, come what may. It's not lost on anyone on this call that there's a broad sentiment that we're headed into a difficult economic landscape. Greenwich's long survey commercial executives as to their view of the direction of the economy going forward. Their optimism index is simply a net score of deposit less or negative. And as you can see here, commercial executive has not been so pessimistic since the great recession. The economic headwinds bearing on commercial banks are widely known and include shrinking money supply, which means a shrinking deposit pool, increased rate-based competition for deposits and inverted yield curve, inflation and, ultimately, a recession, just to name a few. And there's no doubt that the banking business is subject to the economic environment. But our growth model is more a function of our ability to take both talent and market share, and therefore, is substantially less dependent on short-term interest rate movements, inflation ups and downs and those kinds of things. And we literally have been pursuing this model for 23 years. So, frankly, it's just hard for me to understand our competitors who've not been building this differentiation can either catch up or defend against it, it is the classic sustainable advantage. Beginning with the far right, objecting is total shareholder returns. Here you can see the dramatic outperformance over the last 10 years. Generally, that would be true if you look at our first 10 years of existence; true, if you looked at our 10 years of existence; true, if you looked at our first 20 years of existence. And while past results are no guarantee of future performance, I believe it will be true over the next 10 years, because this model is intended to produce value through thick and thin over the long term. The reason I say that is because we built a demonstrably different client experience. Every banks say they give great service. In our case, it's our clients who say that. And they tell that to the independent researchers that prepares the data not only for Pinnacle, but for virtually all of our competitors. You can see in the center of the chart that our clients' engagement with this firm is literally unparalleled. And at the risk of oversimplifying, that differentiated service is largely contingent on our ability to excite and engage our associates. I'm not going to read you the list, but to say it simply, in 2022, we've been rated as the best place to work in virtually every market we operate in; and on a national scale, we've been ranked as the second-best workplace for women and the seventh best workplace for millennials in the country. We excite and engage our associates. So, it's just hard for me to imagine that competitors who've not been building this over an extended period of time will be very successful, either taking our associates and clients or stopping us from taking theirs. Moving on to the advantaged markets. Using the United Van Lines' Movers Study, the Southeast continues to attract people from all over the country. Our challenge is to find a bank with a more advantaged footprint than ours in terms of population migration and growth. And then as it relates to our chosen footprint, we operate in the vast, vast majority of the large high-growth urban markets. So, we're located in the most advantaged region of the country. And within that region, we're generally located in the largest and fastest-growing cities. Moving beyond incredibly attractive size and growth dynamics of our markets, frankly, the more important attraction is the competitive landscape. Given the Net Promoter Score is the best indicator of a bank's ability to protect or expand market share, beginning on the left, according to Greenwich's national study, despite all their investments in technology, you can see scores are horribly low for the national franchises, slightly better while defining at super regionals, and not surprisingly better while defining the community banks. Moving to the right, you can see the Pinnacle stores are unmatched and getting better. I fully expect that gap to widen as the industry adopts a work-from-home platform, while we operate a work-from-office platform primarily for the purpose of further differentiating our service level. [More women] (ph), that's what we'll do. Keep in mind that Net Promoter Score measured clients' willingness to recommend. So that's how you continue to grow safely in the face of a declining economy. And speaking of the competitive vulnerability, never in our existence, I remember a time when the banks that have the bulk of the share in our markets were more likely to give it up than now. Here's a smattering of recent headlines in our markets regarding our competitors. My goal here is not to spare them, but simply to crystallize the sustainability of our ongoing market share taking for both associates and clients. And here's further demonstration of our winning war for talent. I believe we've become the employer of choice for bankers that are frustrated with the large bank employers in our markets. It seems like every year, we set a new record for hiring many of the most experienced and successful revenue producers in our markets from those banks that still have the largest market shares. And when they work in a company that despite of bureaucracy and is universally focused on wining clients, these revenue producers create literally the best experience in the market. Now to the label point, but the three banks on the left of that chart are the market share leaders. So, I could expect anything from us but rapid growth over the long term, complete [diagnostic] (ph) to economic conditions when you recognize that those banks are where most of our revenue producers come from, and you see the differentiated service that they're now able to provide. Here's another way to visualize that opportunity. Banks above the crosshairs have share dominance. Banks to the left of the crosshairs are least successful engaging their clients, they're vulnerable. Of course, banks to the right of the crosshairs are most successful in engaging their clients and best positioned to capitalize on those competitive vulnerabilities, PNFP being the most advantage against the market share leaders, all of them look vulnerable. Most has been written about the competitive advantage is being created by the tech spend at the nation's largest banks. And in Greenwich's study of the national franchise, you can see sure enough, there is a strong correlation between clients' perceptions of a bank's digital capabilities and a client's willingness to add them as a bank provider. But according to Greenwich, in our markets, the best overall digital experience is being provided by Pinnacle, the best product capabilities, the best service professional, the best overall experience. Thinking about long-term shareholder value creation, Greenwich research is long isolated the three pillars on which client loyalty is built: number one, value in long-term relationship; number two, ease of doing business; number three, a bank you can trust. Over the last couple of years, they've actually expanded to a fourth pillar, which is data and analytics-driven insights, a key area of investment, again, for those largest competitors. But again, in our markets, we dominate all four of those metrics, further indication that our net growth of clients is likely to continue. And now I'm trying to connect the dots. I recognize many, associate engagement, client service, they have little or no bearing on earnings and shareholder returns. Some [indiscernible] things is expenses to be cut, but hopefully, this slide can connect the dots for you on why we believe our growth should be insulated from economic conditions, because the people we hire and the service we give, very few clients would consider leaving and a great many intend to add us as a provider on their next product [need] (ph). As you scan up and down those net momentum percentages for the banks in our market, irrespective of economic conditions, our net momentum is huge. In the case of small businesses, more than twice as much as the next best competitor. And in the case of the middle market, total dominance, particularly when you compare it to the market share leaders, the top three banks on both of those charts. Without understanding our unique approach to penetrating the market, largely by hiring experienced bankers, enabling them to be easy to do business with, [indiscernible] draw a completion that if it's growing like a weed, it is one. So, many of our competitors are out prospecting for new clients by circulating ton of brand list or some other prospect list, trying to be the prospect to borrow money. I would say, even slow growers, that's typically how it is done, and you can see here, according to Greenwich, we're dead last in prospect calling. As previously discussed, we're not out trying to meet clients loan money to, we're simply supporting our relationship managers and calling on the clients that they've known them by many times for decades. We believe that strategy provides us with better protection than our peers in the event of credit terms. So, Q4 was a noisy quarter. Economic uncertainties are bound. My encouragement is to keep the imposes on the right to level. As it relates to BHG, the fundamentals remain strong. Originations were the second highest in their history. They've restored their loan book and score has not deteriorated again, and gaining strength in the loan book. They continue to add liquidity sources and utilized those liquidity sources many -- from some of the most sophisticated investors in the market. And at the end of the day, nearly $300 million in pre-tax earnings, 22% growth over prior year, it's an incredible story and continues to be a handsome asset. Beyond that, and I think this is most important to me, we run a core banking franchise that continues to dominate and continues to have momentum regardless of what the circumstances are. We compete in the advantaged Southeastern footprint. We have a cultural focus that results in a differentiated client experience, and there is no more sustainable advantage than that. Our organic growth model, we're having proven successes that resonate throughout our markets. One of the best loan growth stories in the U.S., one of the best tangible book value growers in the country. From a credit perspective, we're top quartile in terms of NPAs, the loans and OREO, clearly, the place you want to start, if credit does turn. And then, lastly, I'll just hit on the slide there. Harold has talked about it a little bit, but I think an important consideration as people begin to focus on how we get to 2023 estimate set, has to do with our compensation systems, high those goals are set, particularly as it relates to the leadership compensation. Specifically, those incentive plans focused on tangible book value generation, making some insight to why our tangible book value grew at the pace it did versus peers in '22. We do a peer relative target setting, so we have to outrun the peers. As Harold has indicated, we're looking for top quartile performance on things like EPS and revenue growth in 2023. As many of you trying to develop those 2023 estimates, maybe you can go to still a little bit on 2022. And all I mean by that is, if you think back to 2022, generally, the outlook for the industry as a whole was that there would be negative earnings -- negative earnings growth in 2022. It was because most believe that the industry didn't have sufficient momentum to outrun the loss of PPP income. But I will say this, obviously, this information ends up in our proxy, but regardless of what those industry expectation are, we still targeted top quartile growth, which was not negative, and we bet mine's and Harold's incentive and the incentives of the roughly 3,000 salary-based employees of this company on that idea. That's been our methodology from the start that continues to be our methodology. And so, if you think through that, you get some insight into our belief about the momentum in the core banking franchise in order to get that done. Thank you, Mr. Turner. The floor is now open for your questions. [Operator Instructions] And the first question is coming from Jared Shaw from Wells Fargo Securities. Jared, your line is live. Good morning, guys. Thank you. Maybe just starting on margin and the guidance. Harold, when you're saying it's down, should we assume it's down from fourth quarter's 3.60% or the full-year-over-full-year should be slightly down? Yes. We believe that it will be flat to down from the fourth quarter. We think the first quarter is going to be probably penalized more because it just has fewer number of days. But we believe it could be 3 basis points to 5 basis points, something like that. Okay. And then, when we look at the asset sensitivity disclosure, it looks like you became more asset sensitive in the fourth quarter. So, is this just you anticipate increased acceleration of deposit funding pressure I'm assuming here? Yes. I mean, we are planning to still see rates increase here in the near term. We think our deposit beta might level off at somewhere around 45% by mid-year, maybe a little more than that by mid-year. Yes. Okay. All right. Thanks for that. And then, on BHG, what are some of the assumptions you have for provision in '23 with the weakening credit backdrop? And how sensitive is your BHG outlook to the provision? Yes, that's a great question. They plan on not nearly as significant of increases in their provisioning or their reserves going forward. So, I think they've gotten the bulk of it done here this quarter, but they'll just have to monitor what past dues are looking like, what charge-offs are looking like to see if they can stay within that guidance. Okay. And then, just can you give us an update on the estimate for that Tier 1 -- I'm sorry, that Day 1 CECL impact in October for Pinnacle? Well, the number I've seen from BHG would be about $190 million. So, we'd be 49% of that, that would run through our equity. Thanks. Good morning, guys. I think, Terry and Harold, you guys have said, you spend NII, you don't spend the NIM, but, obviously, some of the optics around the deposit betas can be tough. You guys laid out a really good slide, I think, in second quarter kind of showing you guys have traditionally had higher betas, but also higher NII growth. Is there anything today within the balance sheet that makes you think moving forward will be any different, whether that be funding mix, the reduction in noninterest-bearing deposits, the scale of funding pressures? Or do you think that the story that will continue to play out that, "Yes, we'll have higher betas, but we'll also have this better NII growth resulting in better earnings over time?" Yes, for sure. We're talking about high-teens growth in net interest income this year, and with a margin that could be flat to down. So that thesis is how we operate. So, several years ago, I remember on a call somebody asked a question about "How we're going to deal with this thrift-like margin?" And that was back when it was down around [2.50%] (ph) or so. So, there is a point where our pricing and our margins get too low for us to live with and we have to adjust. But as we sit right now, our growth engine appears more than capable of providing significant net interest income growth with this, somebody say, higher deposit beta. Okay, great. And within that composition, Harold, you mentioned some other niche kind of verticals and I noticed it appeared in the slide deck that indexed deposits jumped maybe to 17.2% of deposits from like 11.3%. Was there any meaningful changes there in terms of product or verticals there that drove that increase? Yes, I think most of that would be public funds. We've attracted some public fund clients here locally as well as in Washington. And I think some -- most of those are tied to some kind of index. Okay. And then just last thing for me. Just on that share repurchase, the $125 million plan, as well as you noted a potential sub debt raise, can you give us an idea about how you're thinking about that into '23? How aggressive you might plan to be? And what the size of a potential sub-debt raise might look like? Yes. We modeled out $200 million to $300 million. Right now, we think we can step through it -- step through the year without any kind of need to go out raise sub-debt. But we'll just have to see how that pans out, how loan growth performs, all that. I want to start on expenses. So, if the revenue environment proves to be worse than expected, could you walk us through which levers would you expect to pull early on, right? What's like first to go, last to go? And how quickly could you throttle down expense levels, if needed? Yes. There are several things that we can respond to fairly quickly. One is that if Terry believes the -- kind of the revenue number appears to be kind of -- will be consistent for the year, then, like we've done in the past, we can always reduce our hiring profile or hiring plans for the year. We also anticipate what the payout is going to be on the incentive plan, so those accruals would also come down. And then, we've got plans for various events throughout the year that could get on the table for complete elimination or reduction or whatever. So, this year, I think, given what's going on here today and what we reported in earnings, I think there's going to be an intense focus on not only expenses, but revenue growth, pricing, all of that by this management group to make sure that we achieve our targets this year. Terry has allocated time in his senior level meeting to review those kind of things. And so, I think, our firm, our particular senior leadership, is committed to hitting our targets and doing whatever we need to do to accomplish that. Hey, Steven, I might just tag on there a little bit, maybe not exactly what you asked, but I think some color related to that topic. As you know, in terms of annual cash incentive plan, generally we have clear sound and threshold, we can't make bad loans and win. So, we clear that, most of our existence, the two variables that determine to payout were earnings per share growth and revenue growth that was required to hit that earnings per share growth. And last year, we looked at PPNR and I guess for a year or two during a difficult period where allowances are being build and those kinds of things, we relied on PPNR more than revenue. Our Board has not technically approved the comp plan. They'll do that here in the next few weeks, in February meeting. But the anticipation is that they'll go back to the two performance variables being earnings per share growth and revenue growth. And so, anyway, I'm just putting that in perspective. I get it, you're asking about expenses, but it does create a great focus on getting the revenue generated, which drives up the odds of success there. And secondarily, the earnings, if we're not hitting that revenue growth, there's plenty of focus on it. We will get in here and start working in a different way on the expenses. Got it. Okay. That's helpful. If I could change to the margin, to follow-up on your answer to Jared's question, and all the commentary you gave about the competitive environment for deposits, Harold, how should we think about the trajectory for NIM? How are you thinking about it here? I think you said down 3 basis points to 5 basis points in the first quarter, but do you think it's slow and steady declines through the year? Or do you think we bottom out in the first half, recover in the second half? How are you thinking about that? Yes. As far as the rate increases and impact on our margin, we think they will have kind of -- that'll drive some of the reduction in our margins. So, in all the likelihood we'd see -- margin is probably going to just kind of rotate around this 3.55% to, call it, 3.60% number, we believe, all year long. If funding pressures -- and we're not able to hit our deposit targets, then obviously, that's going to impact that assertion. But as it sits right now, we believe we're just going to be -- kind of be in that 3.55% to 3.60% range. Okay. That's helpful. And then, finally, on BHG, if we look at the prior expectations for 2023 versus what you're coming out with now, right, through reduced outlook for the contribution, it doesn't sound like that's related to you anticipating higher provisions at BHG. Is this all related to them just holding more production in portfolio? Is that really what's driving this, or is there something else? So, I think there will be year-over-year more credit costs related to provisioning of some, call it, 10% to 20%. But they intend to probably back off some of their balance sheeting and send more money through the auction platform this year. They think they're going to have to do that with the elimination of these lower tiers, these higher credits -- I mean, lower credit score accounts in order to hit their revenue numbers for this year. So, I think they'll send more to the auction platform, and I think they'll also be still adding more money to the reserves, but not at the same pace that they did in the fourth quarter. Hey, good morning. Thanks for taking my questions. Harold, I think last quarter you talked about a cumulative deposit beta somewhere in the 60% range and you kind of estimated 40% by the end of this year, which you kind of had. Any changes to that just given the competitive pressure for that longer-term cumulative beta? And if the Fed does stay higher for longer, does that impact that? Thanks. Yes, I don't know. I've not really thought about or put any kind of math to what deposit costs could look like at the end of '23 as far as beta calculations and into 2024. We've kind of talked about beta through the middle of the year of somewhere between 45% and 50% given the two rate hikes here in the near-term. So, I'm not really going out and kind of looked at what the longer-term deposit beta, but we fully expect that once the Fed stops raising rates that you're likely to see deposit rate creep just due to competitive pressure. So, I don't know how long we will talk about deposit rates, but I think when you get into the latter part of the year and, like you said, Mike, well, assuming the Fed, we're in a higher rate environment for a longer period of time, that we fully anticipate that deposit ratio will continue to improve north in kind of a flat rate environment. Okay. Thanks for the color. Maybe just one separate follow-up question. Just wanted to kind of revisit where you guys are in terms of the BHG investment. Obviously, it's done a lot of great things for you all over the years. I know you've kind of maybe hinted at maybe reducing the stake at some point in the future. But just want to -- just given where the earnings contribution is and expected to be over the next years, it's obviously going to be lower than it has in the past, any sort of strategic thought as we kind of move over the next short to intermediate term? And how you guys view that business? And what the longer-term strategic rationale of the investment is for you? Thanks. Yes. I'll start and Terry can add his comments. First of all, I want to say that the partnership between us and BHG is strong. Matter of fact, I'll have a Board meeting with the BHG folks here in about a couple of hours. But the valuation of Bankers Healthcare Group, we understand, we realize, we believe is kind of part of the bear case on our shares and trying to figure out what that number is, is important, but absent an arms link transaction is difficult to discern. That said, I think, we and BHG are on the same page. There are -- there have been opportunities to reduce our stake, but right now the pricing is just not, we believe, at a point to where that makes it worthwhile for us. We think it's a valuable asset. We think it has created quite a bit of earnings momentum for us. We think BHG on another day could be worth quite a bit of money. All that said, the -- our opinion about BHG is that a lesser ownership interest by ourselves probably wouldn't be that bad. And we should consider any kind of worthwhile transaction that does that carefully. Yes. I think, Michael, maybe just to echo Harold's comments, you started with the right assumption. I think what I'll try to say is that if nobody had to be happy, we would like to reduce our dependence on BHG as a function of our earnings stream, not because we're not bullish on the company and not because of any reason other than, it just has become [indiscernible] investor conversations, investor outlooks, and so forth, it's just hard to keep telling a story that so many people even disagree with or don't understand. And so, again, at least for me from a strategic standpoint, I'd like to have less dependence on BHG as a function of my earnings stream. I think, to Harold's point, I think, we've been good with that. I think BHG will be good with that. I think there are -- there always -- almost always are a number of people who have interest, they pursue ownership interest in BHG. And so, then, the question just comes down to what's the price. And so, if we find the right price in there, I think, we would have expressed preference to lighten our load some, if you don't find the right price. We continue to love the invest and what it does for our company and how it fuels our ongoing growth. And so, again, it's -- the worst case is a good case. But again, just to be clear, at the right price, we would certainly lighten our exposure to BHG as a function of our earnings stream. Yes, thanks. Good morning, guys. Question on the fee guide ex BHG. I was just wondering, what are the drivers, because to get to the low end of the guide implies kind of a mid-teens growth from the current run rate on average to hit the low end of that guide in 2023. Just wondering what the drivers are. Yes. I think mortgage is going to be impactful. They had a big hit in the fourth quarter, because of valuation of the hedge. Their pipeline is down to the lowest level it's been at in, I don't know, seven or eight years, Casey. So, the size -- the absolute size of the pipeline drives the valuation of that hedge. And so, we think we're going to get -- we're going to at least have that tailwind going into the, call it, the early part of 2023 into the spring. We've also hired a meaningful number of wealth management people. And we're particularly interested in a few that have been at this for decades. Their client base is broad, well supported, so we anticipate some pretty significant revenue bumps from that. As we've also mentioned, we are targeting quite a bit of commercial accounts. And so, with that, we believe we've got both annualized fees and unannualized fees -- non-annualized fees that would be coming to us. So that's kind of where that high single digit number comes from, primarily in those areas. Okay, understood. And then, just digging in a little more on BHG. Just wondering what kind of spread you guys are assuming just given the bank buy rate has increased and that spread has kind of come in? Does the guide for '23 assume that, that spread holds, or is there a little bit of deterioration in that? Okay, very good. And then, just last one for me. I know it's tricky, but the noninterest-bearing deposits settling down to 28%, any sense as to how much more attrition is possible before you start getting into like core working capital and you hit a floor there? Yes, that's a great question. And you need kind of a crystal ball to figure it out. But the best data that we have that we've looked at is when we start looking at average account sizes and what they were pre-COVID and what they are now, and so, it could be anywhere from, call it, 5% or so to may be something north of that, but our planning assumption is somewhere around that. Hi, thanks. Good morning. First question for Harold. With Michael Rose's earlier question, you mentioned a flat rate environment and what this means for the margin. But what if the Fed starts to cut its fed funds rate? What are some incremental levers you guys could pull to help protect the margin in the NII? Yes. When we have entered into a couple of swap transactions for about -- well, there's actually four of them that we've entered into for about $2 billion in coverage on the loan book at somewhere around, call it, [4.25] (ph). So, we do have that. I think the biggest thing we've got is, first of all, we've mentioned we've got an increase in indexed accounts, so those will come down. But the other thing we've got is a relationship-based business where we think we've been pretty strong -- pretty good at being fair with clients. And so, what happened last time in a rate-down environment is we were also pretty fair on the way down. So that takes a lot of communication with clients, but that's -- we've been doing that now for all of 2022. And if we get into a rate-down environment, we fully anticipate our relationship manager will begin to pull those deposit prices down quickly. Matt, I might add to Harold's comments. There is a lot of energy in the company on loan floors. And if you know, going into this cycle, we had a lot of protection from the loan floors that we were able to successfully negotiate with our relationship. So that's also [indiscernible]. Yes. Okay. Good points. And I guess, shifting over towards the loan growth, the mid-teens guidance, just trying to get better idea of assumptions behind this. I know the bank always does kind of a bottoms-up analysis for each of its producers. Any other commentary you can share with us about the process for 2023, especially in light of the slide in the deck you guys put out there on 2023 where you include that the optimism index of commercial executives is at very low levels? Thanks. Yes. If I understand the question, Matt, you're trying to get at what's our assumption on how we grow in the face of declining economy? Is that -- am I getting? Yeah, that's it, Terry. I guess -- I know, you did do the bottoms-up analysis with each producer, but I'm trying to appreciate if there were any more adjustments at the end of that than you typically do each year with your preliminary guidance? Well, I guess if I -- and given what you're looking for, we went through the same process this year that we always do, which is both the top-down and the bottoms-up deal. So, again, we -- if you would expect, I think, we go through every relationship manager where they are, what their expected production is, their targets, as you would guess, add up to meaningfully more than what our target at the top of the house is. And so many of those targets are large because of the hiring ladder that we have where we've hired so many people over the last three years, so many people over the last two years, so many people over the last one year, that still owe us the bulk of their book movement and so forth. So, there is a level of detail that will be done to the relationship manager and those expectations would exceed what we believe will do or what we're communicating will do at the top of the house. Thanks. Good morning, everybody. Just one small question kind of following up on BHG and expenses. So, if I just think back to the past few years, BHG has been really instrumental in really paying for the build that you've had in the hiring process and building the core bank. So, at a point in time, we're seeing the BHG contribution stabilizing, maybe at risk of pulling back a little bit. I guess, what does it take for you to feel the need to adjust the expense outlook a little bit more than this mid-15% range? Is it -- is there a level of profitability that you feel like you shouldn't go below and that might trigger more expense initiatives? Or, is it all just about making sure revenue growth is higher than expense growth and kind of growing EPS that way, but less about maybe what the ROA is? Any kind of just color on that would be super helpful. Thanks. Yes. The ROA probably not at the top of our list. We do have ROTCE and all that. But at the end of the day, Catherine, what we've got are earnings targets, revenue targets per share. And BHG is a component in that. And so, we're going to try to get to that bottom-line number in the most effective way that we can. If that means we need to cut costs, we'll cut costs. If that means we need to go try to figure out how to grow revenues in some way, that's not in the plan, we'll do that. BHG, in the past, has provided us some tailwind with respect to growth. And so, they typically outgrown our number year in and year out, and that's provided us a little extra resource to go after and support our hiring platform. This year, it looks like their growth is going to be fairly flat to slightly up. And so that may -- you might imply from that, that we may need to back off on hiring in order to kind of meet our EPS targets. So, I don't know if I'm getting at all your questions, Catherine, but we're going to eventually nail down what we think top quartile growth needs to be for this firm, and a simple plan that is the most likely to achieve it. And that would include Bankers Healthcare Group in that, and we'll use the latest and greatest information we have for them to do it. Hi, Catherine, let me -- if I can just maybe make a slightly different point. I don't know if it'll be helpful to you or not, it's intended to at least give you some insight into what our mindset is, what we're trying to do here. I made a comment during the presentation about how the incentive plans work here, and really just trying to clarify for people that I don't think anybody thought that banks were going to grow earnings in 2022, given the loss of PPP income, but we believe that we had momentum in the core banking franchise and ability to do that and our incentives were bet on that, and we did that. In fact, we outperformed the number. Of course, we got the benefit of rate increases that were beyond expectation, all those kinds of things. But I guess I just want to be clear, we believe that [the bet] (ph) going in that we had more momentum in the banking franchise, which would carry today and outrun the loss of PPP income. I think that's different than what I hear when I talk to most of my peers. That same phenomenon exists this year. For me, one of the reasons I want to go through the momentum, the core momentum, just how are you get clients, how much business momentum exists, and it's going to occur regardless of economic conditions and so forth, is to try to help people get that even in a year when we're projecting BHG to not being a major part of the earnings growth story that we believe we have such momentum in the core banking franchise, which just goes back to the story that we've been talking about for a long, long time, all the people that we've hired, all the businesses that they're moving, all the success they're having penetrating these large banks that are giving up share that we can outrun them. So, again, I'm going to guess that's a different story. And so, I know it's frustrating because most people will easily go to, "Hey, it looks difficulty. Why don't we cut expenses?" We'll do that if that's what's required, but it's just not Game Plan A. We believe we have momentum that's going to produce outsized revenue growth and that's the play that we want to make. And as I say, that are not only mine and Harold's, but really all the associates to this firm on that idea. Got it. That makes sense. So, you're saying in a moment where BHG revenue is less than expected, the core bank is better, and so that's why you don't have to tap into expenses. But if from here, revenue becomes more challenging or BHG falls more than expected, that's when you can start to flex the expense lever? That's exactly. Catherine, I've got about $125 million in cash bonuses in this point. So that's all subject for hitting EPS growth targets. Great. Okay. That's super helpful. And then, this is really a small knit, but just wanted to do it for modeling purposes. The FTE adjustment typically -- and I've looked historically, typically pops up a little bit in the fourth quarter then normalize. So, should we expect -- you saw that linked quarter increase this quarter again. Should we expect to see that kind of normalize back down in the first quarter like we've seen historically? Harold, let's beat a dead horse a little more. You gave a pretty tight net interest margin guidance. Would you -- would it be fair to say that the margin is probably the most at risk element of the fundamental guidance that you guys laid out for 2023? Yes, I think so. Deposit pricing will be key to it. We feel pretty good about where loan pricing is. We feel pretty good about that. Our fixed rate loan pricing is definitely improving. And we've been beating on that drum for several quarters now and I think it's finally getting some traction. So, the loan yields we think will hang in there. And I think we've got support from Rob and Rick and Rob around the franchise on that. It's -- the competition for deposit pricing for us extends beyond what Truist is paying, what Regions is paying, what some of these other franchises paying around our competitive peers. It extends as what the money market accounts are doing, what the high yield savings accounts are doing, what the brokers are trying to do with folks, all that as well. And so, that point is that there is a limit to how much these deposit cost will go. We don't think we have to go all the way up to those levels for sure. But we have told our salesforce that we will not lose a deposit because of price. And so, their marching orders are to go out there and make sure that whenever they got a chance to defend their deposit portfolio, they do it, and we're not letting those deposits [for them] (ph). Secondly, there was an earlier question about DDAs and where those are headed. There's also a strong emphasis on that and protecting those deposits best we can. We did see kind of an initial thrust during the quarter that a lot of that DDA movement occurred around November and the November rate increases. We didn't see nearly that kind of reduction in December. So, we're hopeful that a lot of that, although we anticipate will occur, we just -- we are hopeful that it won't occur at the same kind of levels that has occurred here in the fourth quarter. So, the second -- one more thing as far as margin protection that we're doing tactically, Jennifer, as far as the loan guidance and all of that, we are actively selling to our salesforce the notion of prepayment penalties on all fixed rate credits. And I think we've been working on that too for the last two or three quarters and we're getting traction there. So, we're hopeful that if rates do come down on us at least in the near-term, we've got some or at least in the longer-term, we've got some protection there. Okay. And the deposit growth that you're projecting for this year would be very strong. Is this a permanent shift for Pinnacle in terms of just focus -- putting a more intense focus on deposit growth overall? Jennifer, I think the answer to that question is yes. And all I mean by I think that yes is, I think we have, since the founding of the company, had an intense focus on deposit acquisition. As you know, if you have a mature company, you got a mature retail deposit book and you can sort of milk and ride that. In our case, we got to fund it as we go, and so there's a different energy and emphasis around that always and has been there since the beginning. But clearly, during the pandemic and all the inflows and liquidity, we didn't concentrate so much on the defense by our deposits. We didn't have to do that, and those kinds of things. So, it is a different day as the money supply [is less] (ph) and deposit book [is less] (ph), it does require a different level of energy. Happily during that pandemic period, we built three or four specialty deposit businesses that all have some level of traction in them. I'm going to guess, Jennifer, that in 2022, those four specialties probably produced, I don't know, $800 million to $900 million in deposits for us. We expect that growth to be still bigger as we go forward. We're in the early stages with still positive momentum in all four of those specialty. And so, that's the reasons I say, okay, yes, I think there is a structural difference in our ability to do it, which in addition to all the energy and emphasis of the relationship managers, we do have some product specialties that are pretty meaningful in terms of how they're bolstered on our deposit growth. Hey, guys. Good morning. I'll be brief. Just, Harold, Terry, just the hiring outlook for this year. I mean, I think, you talked last quarter about where you thought it might be, but given fourth quarter is wrapped up and some of the commentary earlier, how are you thinking about hiring in '23 relative to '22? Yes. I think one of the things that's important, Brian, when we talk about hiring most of the time when we're talking with investors, we really talk primarily about hiring revenue producers, because that's really the thrust of our company, has been all along. What we're trying to do is grow our revenues, grow our top-line in order to grow our bottom-line, all that sort of stuff. But again, just a sort of maybe make a point that's obvious that sometimes forgotten, those revenue producers are generally going to be supportive 2:1 by non-revenue producers. And so, the total number of people that have to be hired in a year, I think, that increases were in the 400-person range. Don't know what the exact number, it'd be in that range for total associates hired whereas the revenue producers were down closer to 125, I think, for the year. So, what -- the point I'm really trying to get to with you is, I think we'll expect a similar year on revenue producers. We'll expect a less -- where we would expect hire less is support personnel in 2023 than in 2022, primarily because a lot of that support personnel been in controlled infrastructure and so forth, which generally, in my view, a stair step kind of expense, you got to build the capacity for -- as you pick compliance monitoring, BSA risk, long review, all those kinds of things, you invest in people in a stair step mode. I think we've made significant investments in the controlled infrastructure. So, it's a long way to say, look, I think revenue hires might be a little less in 2023 than 2022, but it ought to be comparable. Total number of hires ought to be less in 2023 than 2022, because of the stair step nature of some of those control expenditure. Got you. No, that's helpful. And maybe one for Harold. Just on the reserve level, Harold, you talked about maybe being a little bit more pessimistic on -- or Terry did on the kind of the outlook. Just how should we think about the reserve level as you kind of go through the next several quarters given your outlook? Yes. I made with the credit officers quite a bit. Right now, they are still having the same posture that our credit book is strong. We're not seeing any kind of systemic kind of weakness in it. And so, our planning assumption today is that our reserves probably will be fairly flat here on out. We'll, obviously, monitor that. So, if we start seeing some weakness and adjust accordingly. But right now, we think credit is in check as best we know today. Got you. Okay. And then, just going back to your comment, Harold, about the fee income, I mean, I guess, the -- you highlighted the wealth. I mean, when you think about the mortgage and the SBA piece in there, are those expected, I guess, kind of your big picture planning to rebound a fair amount? I guess, just kind of getting to this number you talked about on the fee income side, the high single digit or low double digit growth in fee income ex those kind of more volatile numbers, it just seems like there's more to it, I guess, on some of those other items that you're not calling out. So, like the -- for instance, the mortgage and SBA. Do you expect -- I know SBA was down this quarter, same with the mortgage, a pretty meaningful rebound in those coming in the next couple of quarters? Yes, for sure, in mortgage, I don't know about SBA. SBA has got some other headwinds. But no -- mortgage should have a better year this year than last year, and this whole wealth management investment that we've made should produce tangible results. We've also hired some very capable individuals in our capital markets area that all will help us. They have a long resume of success. So, we're planning on that being influential as well. Got you. Okay. And last one, Harold, and I'll let you go, is the margin outlook you talked about, that kind of assumes your two rate hikes. If you see a -- the Fed lower rates at all, does that -- how does that change the margin outlook, I guess, particularly as you get later in the year into next year? I guess, does that -- if it's not material declines, is it not much change from what your forecast is today or kind of your outlook? Yes, we actually have some rate decreases in November and December in our forecast right now, but they're pretty much in consequent. Thank you. And that does conclude today's conference. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.
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EarningCall_1255
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All right. Good morning, everyone. Welcome to day three of the JPMorgan Healthcare Conference. I'm Julia Qin, lead analyst covering life science tools and diagnostics at JPMorgan, and it's my great pleasure to introduce you to our next company presentation by Invitae. Thank you, Julia, and I appreciate the opportunity to join everyone today, and thanks to you and your team, by the way. I think you're putting together another great conference. Good morning, everyone, and thank you for joining us. With me today is Dr. Bob Nussbaum, our Chief Medical Officer; and Roxi Wen, our Chief Financial Officer. They're excited to be here, as you can tell by looking at them. Looking back to 2022, it was a year of significant changes in foundational progress at Invitae. And I appreciate the opportunity to update the investment community on our story as we begin a new year. Before I start, though, please note that we will be making forward-looking statements about our business. And as such, please refer to the safe harbor statement here for more details. As a reminder, our mission is to bring comprehensive genomic genetic testing information into mainstream medicine to improve health care for billions of people. That mission is bold and has long been our purpose. It's our why, and we remain very much committed to it. Now looking at the industry today, I think it's hard to overstate just how impactful genetic information has been in multiple clinical areas with oncology and rare disease as prime examples of benefactors. Our work is already led to improve health care and improve outcomes for millions of patients, which is why the Invitae team and our partners are working tirelessly to deliver that information every day. What we've been building for more than a decade is nothing short of the future of health care, a future that focuses on prevention, better outcomes and the potential for disease eradication. Now all of these are fueled by knowing more about the patient at the individual and genomic level than we knew before. And tomorrow's discoveries will require, knowing even more. Invitae is poised and determined to architect that future. So yes, we're still early on this journey, but I'm so proud of our team for what we've accomplished in leading this shift because it takes courage to grab the tip of that spear. I'm also excited about where we are headed. For years, we've talked about the idea of genomics-based solutions delivering the fundamental knowledge of the human genome into healthcare throughout life from inception to new birth through the golden years of old age. We still have our eyes on the value of genetic information at each step of human development. And today, we provide that information at many points, including our products and services and support of hereditary cancer, rare disease and pediatrics, pharmacogenomics and women's health before and food pregnancy. And we're super excited about our recent entrant into personalized cancer monitoring and surveillance. Each engagement generates data and insights at different stages of life and by way of different patient needs. Aggregating these data and insights into solutions for providers, patients, policymakers and other partners is where the next phase of transformation will occur. Our plan to lead and guide this transformation has not changed as we have realigned our company. What has changed is how we will converge our focus and strategy to deliver sustainable growth as we go about reaching our goals. Invitae has been a pioneer and leader in genetic testing at scale, and we aim to maintain that leadership position going forward. Now looking at our track record, what has been built over the last 10 years is really impressive. Invitae has become a trusted and reliable provider in genetic testing. We've served over 3 million patients. And over 2 million of those patients have entrusted us to responsibly share their information, enabling additional research. The depth of our genetic data, along with the longitudinal focus of our patient network, are leading to insights, which could provide further benefit to the lives of those patients, their families and the healthcare ecosystem. So yes, volume growth for Invitae has been impressive and has come organically as well as through acquisition. The mechanism to guide and inform our approach to growth has historically been highlighted by our growth flywheel. But you know a flywheel is a dynamic system with reinforcing nodes or levers, like the number of patients served and the impact of insights and solutions, which drive momentum and acceleration. And just as importantly, flywheels need balancing nodes, like adoption and customer experience, to provide feedback and protect against unintended side effects. Now our prior version of the flywheel was built to drive volume growth. And this, our updated version is built to drive profitable growth. So Invitae is evolving from a company with an almost singular focus on volume growth to an organization driven to continue to use science and technology to deliver clinical genetics alongside a unique customer experience that leverages a more connected portfolio of products. The experience for patients, customers and partners are keys to accelerating the momentum needed to transform the adoption and utility of our integrated solutions -- excuse me just a second, and we are driven to scale our growth in a profitable manner with operational excellence and cash generation to fuel our future. So let's dive into a key few elements of the renewed flywheel. We see customer experience as an integral and long-term growth strategy as an underutilized catalyst to move genetics in the mainstream medicine. Great service, ease of use, such as efficient ordering, comprehensive choices and reliable turnaround time are important for physicians. This is particularly true in encouraging adoption for the non-genetic expert, who like all of us, are time constrained and likely to benefit from others' learning and expertise. We need to help them keep up with the rapidly expanding best practices and treatment options. Expanding adoption is not a hope. It is actionable. And there are new levers for us to discover that will move the needle such building a more connected customer experience will be a focus of investment for us. Now make no mistake, the upper node of the flywheel creates positive and reinforcing momentum, resulting in high growth in the number of tests performed. As our network continues to scale, we will lower our operating costs and increase our margins while continuing our pursuit of low prices to drive accessibility and affordability of genetic information; high volumes, good margins, low prices is a winning combination, when executed well. However, our ability to sustainably lower our prices will also be balanced by our success in improving reimbursements and cash collection. This balancing node simply demands that we are unapologetic and our expectation to be fairly compensated for the tremendous value we deliver. To achieve this, our team is focusing on generating scientific evidence and proactively engaging with stakeholders to prompt better payment and additional coverage. The final component of the flywheel that I want to highlight is our insights and solutions in parallel with our internal R&D spending to bring new tools and products to market. We know that our unique and deep combination of genotypic and phenotypic insights also makes our partners more nimble and precise as they bring their own insights and solutions forward. I think of it like this, we can solve more puzzles together than any of us can do alone. More solutions feed improve customer experiences, which in turn, feed more answers per patient, which feed greater adoption, which brings on more partners and the flywheel spends on. So if there are three things I would want you to take away from today, they would be the following: First, Invitae is moving from a broad, somewhat disconnected, portfolio of individual test to an integrated and connected portfolio of solutions. In that regard, patient service valuable and rich data, sales and marketing synergies are how we are building our competitive advantage. Secondly, our business model is evolving to unlock profitable growth. With customer experience adoption, partnership value and clinical insights and solutions as growth levers, balanced against reimbursement cash flow and affordability. What's great is our team is up to the challenge and early results are demonstrating that we are all in and making great progress. Finally, we have an incredibly talented group of engineers and scientists at Invitae, who, when focused, have shown they can do big things. Moving forward, our innovation efforts will focus on offering integrated solutions for our customers in addition to going after big bed opportunities with the potential for long-term growth and healthy margin profile for the Company. So strategically, this probably makes sense. But a question might be, how are you executing against your road map? Well, we rolled out our realignment plan in July 2022, and we continue to be on track for the cash burn reduction and gross margin objectives we laid out. Our portfolio is stabilizing. And we're moving on from the business lines that we had planned to exit. Profitable growth is the foundation on which we built our plans for 2023 and beyond. Next, we're doubling down on our oncology franchise, combining our industry-leading genetic hereditary cancer testing with our recently launched personalized cancer monitoring product. We're expanding call points and will enable broader adoption. And by the way, we also like the growth opportunities of our data and patient network for long-term value generation. And then lastly, when we enter our acceleration phase, we will have implemented the differentiated technology and service elements needed to fully enable our major growth opportunities. We will be valued for our ability to help put the puzzle pieces together for the patient journey, and we also expect to be generating positive cash flow. Now here you can see our current and upcoming core products within each of our business areas, which showcase the versatility of our pipeline to fuel long-term growth, along with the importance we're placing on our customer workflow and tools. So let's drill down into a couple of product areas. One of the prime examples of a connected portfolio will be found within our oncology franchise. We will have one of the most comprehensive offerings for a physician who is considering options for an individual at risk or diagnosed with cancer. Our portfolio will uniquely deliver the ability to determine individual's comprehensive genomic risk of cancer and serve as a prognosis. It will inform options for personalized therapy selection based on both germline and somatic profiles and will detect therapy responses and recurrence well before the current modes of imaging through our proprietary patient-specific MRD assay, and we all know that early detection saves lives. Additionally, we plan to overlay our pharmacogenomics offering to inform clinicians and patients of potentially dangerous drug-drug and drug-gene interactions, which can send many cancer patients to the ER unnecessarily. An example of this is the use of 5-FU, which is an often used therapy for colorectal cancer. Patients with certain variants in the DPYD gene can carry a 25x greater risk for 5-FU related mortality when these variants are present. To drive this connectivity, we are introducing additional digital tools to help walk both clinicians and patients through the journey of diagnosis and treatment of the disease. And at every step, we are able to collect the most enriched data, fueling our data and patient network value proposition with multiple partners, including academic medical centers. Now as shown on our flywheel, the effort at improving accessibility to genetics is a reinforcing mechanism in support of our goal to serve more patients. While many talk a lot about the healthcare disparities among underrepresented groups, we are taking intentional action through various programs. And one of those programs is a unique partnership with the Morehouse School of Medicine, where Dr. Valerie Montgomery Rice is the President and CEO; and Dr. Montgomery Rice has been kind enough to join us today. She's in the audience, thank you, Valerie. The initial phase of this partnership will provide Invitae hereditary cancer testing to both patients with cancer and to healthy individuals. Participants will also be enlisted in the Invitae data platform for real-world monitoring of outcomes. And over time, the program is also expected to expand and utilize the full power of our portfolio. And we look forward to providing more details in the near future. This is a meaningful step toward delivering precision medicine to historically underrepresented communities and populations. And I would also point out that this work may also bring much-needed patient diversity into the drug discovery and development ecosystem. As we move on to women's health since early 2022, we made dramatic improvement in transforming this business from negative gross margins into a solidly contributing area. We've worked to improve performance at the account level and have enacted better reimbursement practices. In the U.S., things like average risk coverage of our non-invasive prenatal screening test by major payers Things like better product positioning for different customers and improvement in COGS have all helped us to achieve better gross margins, and we're just getting started. We expect those margins will improve even further going forward. And last but not least, in light of recent market consolidation, we have won new business. And I'm confident that we have a good shot at winning additional healthy volume. And I say healthy because that's the approach for this business for us. In our data segment, our success goes beyond just the number of tests performed. We find that our unique capability to both provide genetic testing and third-party patient data produces a uniquely rich data set that is highly attractive to biopharma as well as patient adversely groups. This combination produces a more complete picture of the patients, to aid our partners in researching fundamental drivers of disease and its progression. We are, after all, puzzle solvers. And it's important to note that this data set is differentiated from others as our patient population often includes patients with disease, the main focus for our biopharma partners. It's also notable that our data set is linkable to sources such as claims and prescription data, demonstrating a long-standing tenant of ours that data is more valuable when it's shared. And more importantly, our real world data is patient-owned and controlled. It's a critical nuance that we think is important for people to understand that the patients are willing to share their data. Now this data business is just starting to ramp. And as we continue to bring in partners, we'll be able to maximize the number of solutions that impact the highest numbers of patients in turn, attracting more partners powering our flywheel. And here's a few examples of some recent partnerships that we've announced with biopharma companies and patient advice groups that come in to us because of the richness of our data, especially in rare disease. And they're leveraging our data and capabilities to identify and recruit patients, enable IND filings, structure clinical trials and eventually bring new therapies to market faster. Patients win, our partners win and we win. Taking a quick look at our financial performance. Despite second half of 2022 carrying some expected volume downside from the realignment activities like the exit of business lines and territories. Our company executed well in Q4. For full year 2022, we generated approximately $516 million of revenue, representing about 12% growth year-over-year. Importantly, we have decreased our quarterly cash burn to less than $80 million in Q4. This is a continuous trend that began more than a year ago. So overall, we continue to make great progress. According to our plan, and I'm really grateful for the hard work inside of Invitae that has driven this result. So finally, in closing, I'm optimistic about Invitae's future and feel good that we have a solid plan in place for our genomic testing model to translate into a profitable and growing company. Currently, we're setting up our business to evolve from one patient, one test which is the norm that the foundation of the industry has. And with integration connectivity and refined go-to-market strategies, we are shifting to a scenario where each patient test provides many opportunities to deliver solutions for them, for their families and for others in the ecosystem. And then moving beyond that, the ability to leverage the data from our integrated network will allow for collective insights for many patients to provide multiple solutions for multiple use cases and customer types from one patient, one test to many patients, multiple solutions. As a network effect gains traction, we will see leverage from each test and can generate a multiplying value proposition. And we are uniquely positioned to do this, not simply because we think it makes sense, but because patients will demand it. So we're just getting after it. So again, our same mission, new path, this is the recipe for the next chapter for Invitae. And I want to thank you for your attention today and look forward to some questions and answer. Thank you, Ken, for the great overview. There are a number of interesting topics to discuss, but maybe starting with some near-term dynamics congrats on the solid preannouncement of 4Q results. Perhaps you can talk about are there any noteworthy trends or developments to call out? What are the drivers of strength and what surprised the upside or downside? Yes. I mean I'd say that the business has been covering really well. We made some decisions that were necessary to be made in July of last year. And as we've exited territories and exited countries, again, we were selling our products in over 120 countries. Now that number is less than a dozen. We stabilized our portfolio. We really feel good about our plan and it's executing to our expectations. As we've also seen that our customers have continued to support Invitae. It's something special about having a brand that is based upon the patient at its core and a belief that we are determined to do the things that are best for patients, and we've had a really strong response from our customer base who are pulling for us to continue to provide the services and products that we have in the past. So I'd say we feel good about where we are. Great. Now for the hereditary oncology part of your portfolio, Invitae has been a very active for us in kind of trying to push for a guideline expansion for germline testing more oncology patients. How meaningful do you think this trend will be for Invitae over the near to medium term? How quickly will payers and physicians follow suit, if we have those guidelines in place? And how to think about the degree of penetration you think you can achieve in these oncology patients? Yes, that's a great question. I mean I think there's a couple of trends that we're seeing is that, if you look back over the last decade, the time from guideline expansion to adoption to reimbursement, it's been years and maybe five years in some cases. What we're seeing is that, that timeline is compressing as guidelines are coming into play. The path from guideline to adoption to reimbursement is shrinking. So that's, I think, a good news. That's a tailwind for our business. But the other part of our growth story is not just hoping for more guideline expansion is also to grow the pie. If you think about our hereditary cancer business, we are a leader in that space, but we also know Dr. Bob often reminds me that less than half the patients who are diagnosed with cancer actually received hereditary cancer screen. And so expanding the pie is part of our strategy for 2023, and that means expanding call points and reaching into community health settings more than we have in the past. And we think interlocking our customer experience is going to be an accelerator, a catalyst for our ability to expand access to genetic testing outside of the traditional paths that they're in today. This is still a nascent industry, and the ability for us to expand adoption of tests that are already properly reimbursed is also part of our strategy. If I just add one another comment. For example, the work we've done with the Mayo Clinic and with a number of other collaborators, showing that essentially patients who don't meet guidelines have almost the same level of hereditary cancer pathogenic variants as to families and patients do. The family history is insensitive and that it is time actually to get rid of what are essentially old legacy guidelines. The paper that we just recently published in the Journal of Clinical Oncology Precision Oncology was one of the most highly mentioned papers of 2022. In that paper, we demonstrated that restricting germline testing owned to those patients, who meet legacy guidelines, deprives large numbers of patients from information that they and their families need. Excellent. Just sticking on that topic, how many of your existing germline testing volume is for these kind of oncology patients already that are not reimbursed? And then how should we think about the ASP potential if and when those guidelines are in place. I'm not sure I have that number right at my fingertips. What we find is that most of the patients that we test in our hereditary cancer franchise are patients diagnosed with cancer. And the quality of reimbursement in that franchise is really strong. And there are still tumor areas that can get better. I mean -- and NCC and guidelines are expanding, and they're going to help us with that. But the reimbursement rate in our hereditary cancer business is very small. Great. I'll switch into the somatic part of oncology, which is a much more exciting growth driver for you going forward. Can you give us a sense of how much of your somatic franchises, therapy selection versus MRD and in terms of where future growth will come from, like which part of the portfolio plays a bigger role. Yes. So our initial entrant into the somatic offering is, in fact, our MRD product, PCM. And so right now, we're getting great uptake from a fee-for-service standpoint. So we're working with biopharma partners, and we have a pipeline that is driving revenue for our PCM product. And as we look at our big bet that we're making in MRD, we're putting human and financial capital behind, continuing to get clinical validation of our product, getting acceptance and adoption and then driving revenue recognition through reimbursement. And so for us, the -- our entrance into somatic is focused on our MRD product. Therapy guidance will come at a later date. Can you give us a sense of for MRD, how is the test currently doing volume-wise? And how much traction are you getting from pharma versus clinical? Yes. I mean, so we're pleased with the uptake and the support we're getting from our biopharma partners. I'm not going to share the revenue numbers. We don't break out our oncology franchise that way. We, kind of, summarize it in totality, but we're pleased with the uptake that we're getting. And the work to getting the kind of commercial revenue for the product, as I said before, clinical data validation, adoption and reimbursement, is an ongoing process, and we are all in to make that happen. We have resources that are committed to doing that. We have a market access team that is working on it day and night. And so more to come as to when we will share what the revenue implications are. We've not built a 2023 plan that is dependent upon a high amount of revenue from a commercial standpoint for our MRD product. So, we recognize this is a little bit of a journey, but we like what we hear right now. Got it. I think we can all appreciate that especially with guideline endorsement coming MRD is a vast market, whether there's any opportunities and especially for Invitae, a long runway ahead. But at the same time, we're all seeing the competitive landscape evolving. So, I guess an interesting question is, how do you see PCM positioned competitively in this market? What really differentiates this product versus other movers who have a first mover advantage ahead of you guys? Yes. I'll let Dr. Bob add some color to that, too. I mean, first of all, our product is patient specific and it's tumor-specific is tumor informed and patient informed. And when we -- our analytical studies have shown that the performance of our product is in line with is as good, if not better than anybody else's. And so we're looking forward to getting clinical validation to confirm that, but I think the patient and tumor-specific aspects of what we're doing with MRD is a differentiator. Now time will tell if the market believes that as well and -- but we believe it, and so that's the bet we're making that patient and tumor-specific provides more precision in the treatment of that patient and better outcomes. And so, Dr. Bob? I would just add that we're very confident that we have an extremely sensitive test and also that it is a highly specific test. And so, the false positive rates will not be problem in these patients and that false negatives will be minimized. As we all know, not all cancer shed ctDNA to the same level. But if it's there, we feel comfortable that we will see it. Great. So is it fair to say that before you have more clinical validation data readout the PCM franchise is more driven by biopharma activities? And then how should we think about the timeline of going those trials and reimbursement in place? Yes. I think what we would say is that the timelines are somewhat difficult to predict, but the effort is predictable. And so, we're working extremely hard to get clarity in those timelines. As I said, we built a business plan for '23 that anticipates there's going to be some work to do on getting commercial revenue from the product, but we also have seen extremely positive response from the biopharma community, and we've got solid revenue coming in from that path. Thank you. I was trying to get your attention, but you saw me. Earlier, you had mentioned engaging community providers, so I was wondering, if you could talk a little bit about challenges with penetrating that market? Sure. I was wondering if you could talk a little bit about challenges with penetrating that market. So thinking about have you seen any pushback with respect to disruption to physician workflow, things like that? And how do you think about overcoming those challenges? Yes. I mean, I think first of all, in many cases, the community setting is especially for hereditary cancer, let's say, there's not enough genetic counsels to go around. And so in many cases, the connection point is a different connection point. And we believe to enhancing our customer experiences and our ordering workflows and the way we present our information is going to be helpful. And actually, I'd say the partnership with Dr. Montgomery Rice and the Morehouse School of Medicine is a perfect example of how you can't take a traditional approach to the community health setting that we've done with the maybe larger academic medical centers. And so, I think that's going to be -- that's an example of how we are innovating and creating different paths to take the offerings that we have and the value that we can bring to the health of those communities in a different path. And so go ahead, Dr. Rice, please. Yes. So, if I make comment about [indiscernible] one of the reasons that we are partnering with Invitae because they created an opportunity for us to co-create a solution of how we were going to engage the community. So, our teams have been working together over a year to work and to co-create what is the right solution so that we do not disrupt the workflow for the providers, bringing in the providers and saying, okay, how do we get permission upfront to get more patients who are interested in understanding hereditary cancer and that they should at least consider screening, right? So that begins with while patients are sitting in a waiting room and listening to infocommercials. They listen to info-commercials that educated them on about hereditary cancer. We're doing the right type of family screening, which enables them to ask the question, well, have you considered me for this type of study when I am being diagnosed with the disease, but it really is increasing the database of information that we have on diverse populations to ensure that when we are offering precision medicine, it is actually precise because when we currently look at the current genome, only 2.4% of it includes ancestry from African descent. And so, I'm not quite sure it's going to be as precise as we need to. So, we need to include and increase the reference genomes that we are using, but then we also need to co-create solutions that don't disrupt the workflow, and that is bringing in providers and also then going out into the community. So one of the things that we also saw was that when we went out to the community and started to do webinars and focus groups, et cetera, what we found was they were very receptive to this when they were asked. But about 30% of the time, you will see that persons of color are not asked to participate in research trials or they are not asked also to consider genetic testing for their tumors. Can I just ask two separate questions? One, just on the renewed focus on certain business areas of hereditary, for example, are you starting to take share from competitors like Myriad and Natera? And then secondly, very good results in the fourth quarter on cash burn. It makes me think that you could potentially do better than the $250 million to $300 million cash burn in '23. And I just want to know if that's a possibility in your mind as of now? Yes, I'll start with the first one, and I'll let Roxi answer the second one. I mean, look, our hereditary cancer business is growing year-over-year. I think some of our competitors have indicated that they've had negative share growth or volume growth. And so I think you can interpolate if we're growing year-over-year, and they're not, especially in the somewhat constrained marketplace of genetic counselor prescribing of hereditary cancer screening, we can interpolate that we are taking share. But again, I want to focus on -- that's important, and that's a success. That's a win for us. One of our themes for 2022 -- 2023 is the stack wins, by the way. So that's a win, and we'll take it. But the other aspect of this is growing the pie and expanding adoption and broader adoption. So, I wanted to answer your question. I think we are taking share, but the bigger picture is how do we get more than the less than 50% of cancer patients to be screened with hereditary cancer testing, and that's what we're going after wholeheartedly. Sure. Thanks for the question. So we're very encouraged by the Q4 performance, especially our cash -- continued cash burn reduction since the beginning of the year when it was approaching $200 million. And so as far as next year's guidance, we will be providing specific guidance at the end of February when we do our 2022 whole year financial review with the Street, including our cash burn. So, we're not updating guidance today here. But again, we're encouraged by our performance, and we -- the previous guidance 225 to 275 range continue to be a comfortable range for us. And we are importantly to point out here that we're running a business. So running a business, you need to plan for upside and downside. So that range is good for us to continue to provide to The Street. And yes, we -- less than $80 million cash burn in Q4 is a good outcome, but we will also continue the trend and execute the growth path for the business that Ken point out.
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EarningCall_1256
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Good morning, everybody. I'm Chris Schott at J.P. Morgan and it's great to see everyone back in person again at the conference. It's my pleasure today to be introducing Bristol-Myers Squibb to again kick-off the J.P. Morgan Conference. From the company, we have Chris Boerner, the Chief Commercial Officer. And unfortunately, Giovanni was unable to be with us today as he is recovering from COVID. Before I turn it over to Chris, I did want to remind people that we've moved away from the breakout session format this year at the conference. So we're going to be doing Q&A from the stage after the presentation. And if anybody has any questions, you can use the app to send those to me and I'll work them into the conversation. So with that, Chris, Happy New Year, thanks for joining us and look forward to the presentation. Thank you, Chris. So, good morning everyone. It's great to be back live with all of you and to help kick off this year's J.P. Morgan. It is such an exciting time and interesting time to be in the industry. I know we're certainly looking forward to a productive week here in San Francisco. And from our perspective, it's also a great opportunity to give you an update on our performance and to talk a bit about why we see such an exciting future at Bristol-Myers Squibb. So let's dive into it. This is obviously our disclosure side. And so let me start by reminding you of the strategic foundation of the company. So we have been executing on a very consistent strategy at Bristol-Myers Squibb for well over a decade. And that strategy centers on us as an innovation-driven company, developing medicines in areas of high unmet need. And this is a strategy that has served us very well. It's a strategy that has enabled us to deliver profoundly important drugs to patients across a host of therapeutic areas and it is one that has led to a significant transformation of the company. And the output of that transformation is what you see on this slide. When you look at Bristol-Myers Squibb today, we are in a very strong position. And importantly, we have multiple waves of innovation that support long-term growth. When you look across the therapeutic areas that we focus on, the therapeutic areas that you see on the top of this slide, we continue to build breadth and depth, including having important and, in many cases, leading in-line assets and exciting portfolio of new products that have significant long-term opportunity and key mid- to late-stage assets in our pipeline. And all of these support our ability to renew and grow our business. And of course, we have more catalysts coming this year that will continue to evolve this picture. And clearly, you get here as a result of very strong execution. And so on this slide, let me show you a little bit about how we got here. When we were last together in 2020, we talked a bit about what we needed to accomplish from a financial standpoint as well as with respect to progressing our portfolio. And as we look across these metrics, we see a very strong track record of execution. Financially, as promised, we've grown our company. We've grown with respect to revenue as well as EPS. We've reduced our debt. And in fact, we have over delivered on our synergy expectations and we've generated significant cash flow and that's important, obviously, as an enabler of our ability to continue to invest in the business but also and we'll talk more about this to continue to focus extensively on business development. We've also delivered on our portfolio. We've launched 9 new medicines, including 3 medicines, all of which were first-in-class last year. And similarly, we've continued to execute on business development. And as a result of this, we are well positioned to renew our portfolio and deliver long-term growth over multiple waves. And those waves of innovation are graphically depicted here. And I like this framework because it highlights the progress that we are making in securing near-term growth as well as articulating multiple paths and optionality for growth in the latter half of the decade. And it starts with the 9 new products that I referenced earlier. The growth from those products has been bolstered by a second wave of innovation coming from 6 registrational assets, collectively which have substantial growth and if you combine the early execution of our pipeline, along with our continued disciplined business development, we now have visibility into a third wave of growth that will become increasingly important in the latter part of the decade. And I'll dive into each of these waves of innovation in more detail on subsequent slides but let me first tell you a bit about what it means for us from a financial standpoint as well as with respect to our portfolio. The net effect of the progress that we have made is to solidify our confidence in our growth trajectory as a company. If you combine the performance of our base business as well as the potential that we see from our new product portfolio, we continue to have confidence in the growth prospects that we have in the short term to grow through the exposure we have from Revlimid's LOE and deliver on the commitments that you see on the left-hand side of this slide. Thus, the focus shifts to the paths for growth in the latter part of the decade. And here too, we see multiple paths for growth stemming from the waves of innovation that I referenced earlier. And of course, as we pursue these paths for growth, we continue to diversify and build a much more resilient portfolio. That diversification you see on this slide. As the decade progresses, we transition from a company that was concentrated with a few relatively large products spread across our therapeutic areas to a company that is a much more diversified portfolio with multiple large and important medicines within each of our therapeutic areas as well as a portfolio that is earlier in its life cycle. And we see this making us a much more resilient company, especially as we think about navigating the increasingly complex external environment that was referenced earlier. So for example, as you think about the policy changes in the U.S. embedded in IRA, as we get to the middle of the decade, BMS is a company that not only has a younger portfolio but a portfolio that is also increasingly diversified, diversified across therapeutic areas, diversified across modalities and diversified across payer types. And we think that's going to be critical to our success and our ability to continue to navigate this uncertainty. So I promised that we would double-click on each of those waves of innovation. So let's start doing that now, starting with our new product portfolio. You see on this slide the progress that we're making in terms of renewing our in-line business. We've now launched 9 new products in the U.S. Those products have good momentum collectively and in fact, are annualizing at over $2 billion. And importantly, we see these new products as having significant growth potential, growth potential in the short term from existing indications as well as in the longer term from multiple line extensions. And as many of you may know, we launched 3 of the more important of these medicines last year, all of which were first-in-class medicines. And so let me give you an update on each of those now and I'll start with Camzyos. Camzyos was approved last April and it is the first and only myosin inhibitor targeted for the treatment of obstructive hypertrophic cardiomyopathy. And in fact, it's the only product approved that really gets to the underlying causes of HCM. Since approval, our focus has been on establishing the foundation for the long-term success of this product and we're very pleased with how things are going. You can see on the right side of this slide, some of the progress that we've made recently. During the last quarter, we've increased the breadth of prescribing for this product. We've increased the number of customers who are certified to prescribe Camzyos. We've made nice progress in increasing the number of patients being treated as well as very good progress in converting those treated patient scripts into commercial dispense. And all of that gives us very good momentum coming out of 2022 into this year where we'll continue to drive growth for this very important product for patients. The newest product that we've launched is Sotyktu. Sotyktu is the first and only TYK2 inhibitor on the market. It was approved in psoriasis last September. And many of you may recall, we were successfully able to negotiate a very clean label for this product and that label reflects both the science that went into the development of the drug as well as all of the data that we've seen coming out of our Phase II and Phase III clinical programs. This launch is going very well. We're building volume quickly which is the focus that we have commercially for this product. We already have over 2,000 scripts. And importantly, in just the first month, 1.5 months post approval over 1/4 of all new oral scripts in psoriasis are going to Sotyktu. We're sourcing patients evenly across naive patients as well as those patients who are experienced on Otezla or a biologic which confirms physicians' willingness to use Sotyktu across multiple patient types and that's important. And we've seen good momentum in terms of new volume month-over-month. And all of that gives us confidence that the profile of Sotyktu is resonating with both physicians and with patients. And importantly, as we continue to build volume quickly, this puts us in a much better position to be able to negotiate a better market access position as we get later into this year and certainly as we get into 2024. Let me briefly touch on Opdualag which is our third I-O checkpoint inhibitor in melanoma. This launch continues to perform very well. We have share now in the high teens in first-line melanoma and we still have room to grow this product given the fact that PD-1 monotherapy, where we expect that the majority of patients will come from that share in first-line melanoma is still between 15% and 20%. And as we get more clinical data with this program, Opdualag has the potential to extend our I-O franchise well into the next decade. So what does this mean for us when you put it all together? Well, a few things are clear. First, if you combine the performance of our base business as well as the new product portfolio performance, we remain confident in the $10 billion to $13 billion of risk-adjusted revenue that we expect from the new products in 2025 and that's going to be important to delivering near-term growth for the company. Second, with the line extensions for this new product portfolio that have already read out, we have significantly derisked the $25-plus billion in non-risk-adjusted long-term potential that we see for this portfolio. And then finally, as you see in the middle of this slide, we have additional derisking events that we expect over the next 2 to 3 years. So net-net, we feel very good about where we are with this new product portfolio. And we feel very good about the ability of this portfolio to help us compensate for near-term LOE exposure as well as to meaningfully contribute to the long-term growth of the company. Now as I just told you, we have a lot more to the story than just our new product portfolio. So let me talk for a minute specifically about some key late-stage assets. We now have 6 assets that are in or very close to registrational development. And each of these assets has the potential to significantly benefit patients and support the long-term growth profile of the company. And taken together, we believe that this portfolio has well in excess of $10 billion in potential at peak. And while peak may be beyond 2030, we think the performance of these drugs, once approved, will still have the potential to further our growth profile in the latter half of the decade. So let me give you a quick update on each of these products and I'll start with milvexian. Milvexian is an asset that we think has the potential to extend our leading cardiovascular franchise well into the next decade. Based on all of the data we've seen from our monotherapy as well as our combination studies, we think it has the potential to deliver efficacy at least as good as what we see with Factor Xas but with a better bleeding profile. And that's why, along with our partner, J&J, we are planning a registrational program that consists of 3 indications the first of which is in secondary stroke prevention which we anticipate starting soon. You can see on the bottom of this slide, some of the specifics around that first study. And of course, we'll continue to update you on the details of the other studies as we flesh those out in the coming months. But based on what we've seen with the Milvexian data thus far, we think it has the potential to be a very important next-generation antithrombotic with an excess of $5 billion of potential across 3 indications, specifically SSP, AFib and acute coronary syndrome. Turning to our 2 CELMoDs in multiple myeloma. We see a place for these 2 agents in different segments of multiple myeloma. We're developing iberdomide to be a potential new backbone therapy in the post-transplant maintenance setting, I think many of you know this is a large opportunity. It has over 10,000 patients in the U.S. mezigdomide, we think, has the potential to be an important medicine in the relapsed/refractory setting. Importantly, last year, we made good progress. We advanced both of these drugs into registrational development. And I think all of you know, multiple myeloma is a very large market in excess -- well in excess of $20 billion but in spite of a lot of innovation that we've seen in multiple myeloma, there continues to be considerable unmet need and we think these 2 drugs have the potential to help address that unmet need. LPA1 is of our newest opportunities, this one in pulmonary fibrosis. For those of you who don't know pulmonary fibrosis as a disease with a very high unmet medical need. It's a roughly $3 billion a year market. Today, there are 2 medications approved for the treatment of pulmonary fibrosis. Unfortunately, they have limited efficacy and some tolerability disadvantages. We actually know this mechanism has the potential to slow progression and potentially address the underlying fibrosis of the disease based on a first generation asset. Late last year, we saw data from our Phase II program with a second-generation asset that showed good efficacy as well as a favorable safety profile. And so that allows us to move into a Phase III which we will do later this year. And based on the Phase II data, we believe this has the potential to be an important new option for the treatment of patients with lung fibrosis. And it's also a nice illustration of the optionality that comes from having a very deep and broad pipeline. Let me spend a minute on repotrectinib. Repotrectinib is our opportunity in ROS1-positive lung cancer. I think many of you will remember we acquired this asset as a result of the acquisition of turning point last year. We think repotrectinib has the potential to be a best-in-class ROS1 inhibitor based on the compelling efficacy data as well as particularly compelling duration of response data. Currently, the ROS1 market is about a $500 million to $600 million annual market. We believe, based on the profile we've seen with repotrectinib, we have the potential to possibly double the size of that market and we very much look forward to launching this asset soon. Finally, I'll turn quickly to cendakimab. Our focus with cendakimab is as a potentially differentiated IL-13 for the treatment of eosinophilic esophagitis. EoE is a new and evolving market with a large opportunity for new therapies. Today, there is only one drug that is approved and there remains significant unmet need for this debilitating disease. The Phase III for cendakimab is already underway and we could see data as early as next year. Of course, there's more to the pipeline than just the late-stage assets. So let me transition quickly to speak to the optionality that we see coming from the early-stage pipeline as well as business development. We have a very strong innovation engine at BMS. If you combine the execution of our internal discovery expertise with the broad external relationships we've established, we have built an exciting pipeline of over 50 Phase I and Phase II assets. This pipeline sits on top of a platform -- multiple platforms that include small molecules, complex biologics and cell therapy. And of course, we continue to execute against this pipeline. In fact, we expect over 15 proof-of-concept decisions over the next 18 months or so. And then we'll talk about a couple of -- a few of the assets that we think will be moving into potentially registrational development or late development on the next slide. In addition, we'll be bringing in over 30 additional assets entering the clinic we expect over the next couple of years. So you can see on this slide a few of the assets with the potential to move to full development in the near term. Alnuctamab is our BCMA bispecific. We presented very encouraging data at ASH just a month or so ago. Data that showed good efficacy as well as favorable safety. From our protein homeostasis platform, we're advancing another CELMoD in hematology, this one in lymphoma. We think CC 282 has the potential to combine with both standard of care as well as novel agents and we expect proof-of-concept data for this asset later this year which, of course, will inform our Phase III. And we also have an opportunity to expand this platform into solid tumors with a small molecule that's targeting prostate cancer, the proof of concept and dose optimization study for this asset is already underway. These are just 3 illustrations of the optionality that's emerging from our pipeline and we look further -- we look forward to continuing to update you on the progress of these programs as well as other programs from the pipeline. Tying things together really across the portfolio, what you see are multiple near-term catalysts. We've used this scorecard format to update you on our performance in recent years. And as you can see, this is already a busy slide. And as we continue to execute across our pipeline, we anticipate continuing to fill this slide out. And of course, we're going to update you on the performance against each of these catalysts as we go forward. Beyond the pipeline optionality, we continue to be in a strong financial position and pursue a balanced capital allocation approach. This means that we have been able to reduce our leverage, return cash to shareholders through growing the dividend, remain opportunistic around share repurchases and importantly, remain focused on business development as a top priority. With respect to business development, we'll continue to assess deals based on their strategic alignment, the soundness of the science as well as the attractiveness of the financials. We're also going to continue to focus on deals that further strengthen the growth profile of the company. Given the importance of business development, let me give you a little bit more color on our efforts. We have a very strong track record, as I think many of you know, of converting balance sheet favorability and flexibility to revenue growth. And you can see some of the recent transactions that we've executed on the left-hand side of the slide. These recent deals have brought into the company multiple new products as well as attractive pipeline assets and significantly they have strengthened the growth profile of the company. Looking forward, we have developed very deep scientific, financial and executional skills with respect to business development and that puts us in a very good position to continue to execute disciplined business development going forward. So to summarize, we are very well positioned to renew and continue to grow the business in the long term. We've executed very well across core elements of the business and that puts us in a very strong position today. The new product portfolio is off to a very good start. And the long-term potential of this portfolio of assets continues to be significantly derisked. Coming behind these new products, our late-stage pipeline that continues to advance and an early-stage pipeline with considerable optionality. And we're in a very strong financial position and that gives us considerable firepower to continue to further strengthen the growth outlook of the company through business development. So hopefully, this gives you a flavor of why we are so excited about the future of Bristol-Myers Squibb. And with that, I will look forward to answering your questions. I'll turn it back to you, Chris. Thank you. So while you're walking over here. I thought I'd start with a big picture question. So I think -- the Street remains very focused on some of your late decade LOEs. And I think you talked about in the slides, your $25 billion kind of nonrisk adjusted target. So if you could just maybe elaborate a bit on how confident you're feeling today about Bristol's ability to manage through that patent cycle that we're all kind of looking at, looking out 5, 6 years? Yes. So I think we feel very good about the opportunity and the growth profile that we have for the company throughout the decade. Obviously, you don't get to the outer years of the decade to your question until you get to the middle of the decade. And on that front, as we -- as I highlighted just now, we feel really good about our ability to grow through the middle of the decade and that initial LOE exposure that we have with Revlimid, the new product portfolio is off to a good start. It's already annualizing with significant revenue. We have to remember that a number of these products are still very early in the launch cycle, so products like Camzyos and Sotyktu there's additional catalysts that we have as we expand capacity and cell therapy. So all of that along with the performance of the base business gives us a lot of confidence in that middle of the decade which, of course, establishes a very solid foundation as we think about the back half of the decade. Clearly, as you get further out, there's just by definition, more uncertainty. So the way we think about it is wanting to have multiple pathways for growth. And there, I think as I mentioned, we've got multiple ways to continue to grow as a company. One, the new product portfolio not only has a lot of momentum into the midterm but it has a lot of potential that has been significantly derisked already as we think about the long-term opportunity. Second, we've got those registrational products that I highlighted and embedded in those are potentially very meaningful products. I know milvexian which has a lot of potential the CELMoD programs. Obviously, you have to wait and see the data. But those programs have potential and even though you have smaller opportunities there like LPA 1, collectively, those are potentially very significant contributors to growth in the outer years. And then, of course, we've got optionality and the ability to do business development as well. So we step back from it and look at it in its totality, we feel very good about the prospects we have to grow through the decade as well as those 2 periods of LOE exposure. And another big picture one for me is you've obviously derisked a number of the pipeline assets. But I think that some of the launches, at least relative to Street expectations have maybe been a bit more gradual than we've been expecting. So maybe just to hear your perspective, I know you're doing a $2 billion run rate with the new product portfolio. But how have these launches gone? Have there been any kind of learnings or how should we think about that, I guess, over the next few years of these ramps? Yes. I think in totality, the launches, we're very happy with the performance. Remember, a number of these products, as I mentioned, are still very early in the cycle. In fact, 2 of the most important products we launched last year, Sotyktu and Camzyos. We're still very -- in the very early days of those launches. We anticipate, as we expand cell therapy capacity, we have the ability to ramp those 2 products, the profile for both of those agents is holding up very well. And we've seen either already executed or have the opportunity to expand the label for both of those products. And then this is going to be an important year to continue to drive incremental growth with products like Reblozyl and with increasing access Zeposia. So overall, we feel very good about those launches. Now when you launch 9 new assets in a short period of time in the midst of a global pandemic, not everything is going to go exactly to script. So I would say that there are a number of things that as we look back on it, that we continue to learn and adjust to and I'd like to highlight maybe a few things. First, obviously, we launched some of these early assets at the beginning of COVID. And that, I think, was something we all had to adjust to very quickly, not only did we have to adjust how we had to engage with customers but customers had to engage with how they staffed up and engaged with us. And I think that I've been a little surprised at the variability with which some of those markets have come back. We're still seeing, as we've discussed, in oncology, a number of indications that are still 15% to 20% behind new patient volume that we saw pre-COVID. So that's something that we continue to have to work our way through. Logistics have been very important across these launches, not only our logistics but for a product like Camzyos, we've had to work with customers to make sure they've got the infrastructure set up to prescribe that product. A number of these launches were in areas that we had to build de novo capabilities in. And so as we've thought about building patient support programs for a drug like Zeposia, some things worked very well, some things didn't. We had to adjust quickly and learn not only for that product but also to incorporate those learnings into the patient support programs we have for Sotyktu and Camzyos. And so that's gone very well. But it sort of emphasizes the need for agility and very quick learning and adaptation. The good news is really across all of these launches is we have a great team. That team has stuck with us through all of the ups and downs of COVID and I think from a commercial and medical standpoint, we've been able to identify those things that have gone really well and leverage those and those things that haven't gone as well and learn from them. So it sounds like -- so a lot of opportunity in the peak sales forecasts are largely intact and just kind of continuing to execute along. Maybe just pivoting to the individual products and some of the statistics on the Sotyktu are interesting. Just a little bit more about just the experience that you're finding with that initial launch. So are you finding the drug resonating more with community physicians versus KOLs? Or just any more color we can get on that uptick. Yes, the launch for Sotyktu going very well. And we continue to be impressed, not only with the resonance of the profile of Sotyktu with academic physicians, most of whom we have been engaging with on discussions around the label going into the approval but particularly in the community setting. In fact, we've seen significant uptake of Sotyktu in the community where the vast majority of these patients are going to set. So in that dimension, we feel really, really good. The profile continues to resonate and that's, I think, reflective of the fact that we have a very clean label which enables us to articulate a very clear differentiation against Otezla which as you know, coming into this launch was the standard of care for oral psoriasis. In terms of what we've heard back, we've got good uptake in terms of new trials for this product. We see increasing in trialist and the number of trialists as well as the depth of trialist week-over-week. The volume coming out of this early launch is also continuing to increase nicely. I reference that, that volume becomes important because one of the things we've got to do is build volume quickly to be able to negotiate a better access position for this product as soon as possible and particularly nice -- a particularly nice statistic for Sotyktu is the fact that we have got over 1/4 of new product scripts already going to Sotyktu. And that's something that is a particularly impressive number just one month after the approval of the drug. So you add it all up, we feel like we're coming out of the first full quarter of the launch of this product, feeling great about where we are. Great. And I think you talked more about '24 as being a time horizon where we see broad coverage of the drug. But as you mentioned, the 25% kind of new start share, if you're able to sustain that, is there a possibility some of that coverage gets pulled into 2023? We get asked that question a lot and I would say our incentives are completely aligned with everyone who asked me that question because obviously, our focus is to ensure that this product which is not only first-in-class but clearly based on its profile, we believe best -- the best product for the treatment of psoriasis from an oral standpoint. We want to get that into the hands of patients as quickly as possible. And that means making sure that we get access as quickly as possible. The thing that we control in order to do that is to drive volume very, very quickly. And so while we've talked about the importance of those negotiations as it relates to the January formulary updates, we're obviously going to do everything we can to pull that forward. And the way we do that is to take the momentum we have coming out of 2022 and continue to drive that forward in '23. Okay. One more on this one. I think from the slide it says about evenly split the volume so far of naive patients versus Otezla failures. Is that what you would have anticipated? And as we as longer term, where do you see the role for Sotyktu? Is it a -- do we see Otezla still being kind of like the frontline drug and then you step into Sotyktu? Or do you think the drug can move into kind of a frontline systemic kind of position over time? Well, our position is that this needs to be the oral of choice. And given the fact that as when you come off of topicals, typically what you will do is you'll start with an oral therapy, we very much envision that that's where Sotyktu is going to play. I think with respect to what we're seeing thus far, it's not terribly surprising just given the fact that when you launch a new product, physicians are going to find a way to incorporate that into how they're treating their patients. And when you have a drug with the profile that Sotyktu has, very clear and compelling efficacy differentiation across relative to the existing oral therapy, physicians are going to find for the patient setting in front of them, a way to potentially use that product. In some cases, where access would allow it, they'll go for a naive patient. But in many cases, it's going to be those patients at least initially who have experience on a biologic or on Otezla already. So in some ways, that dynamic is playing out as expected. Great. Maybe just continue on in the new practice side, CAR-T capacity, I think it was a big topic in 2022. Just maybe on, Breyanzi, just give us an update, where are we in terms of getting more capacity to be able to really ramp that product? Yes. We're very excited about the potential that we have with Breyanzi given the fact that we've expanded that label. And that expansion actually roughly doubles the opportunity that we have with the initial indications when you go from third line into second line. And so clearly, capacity becomes important. What we've said last year was that we anticipated being able to ramp capacity coming into '23 through this year and we're very much on track to being able to do that. And then as I step back, as I said in my prepared remarks, we're very happy with the profile of this drug, it's holding up exceptionally well. And I would say the same is true actually for Abecma as I think we discussed on the third quarter call, we were actually able to increase our supply of Abecma in the second half of last year and we feel very good about the trajectory for capacity without asset as well. When I think about that capacity coming on board for Breyanzi, is it a fairly tight kind of window between when you get capacity and when we see revenue step up? Or is there promotion efforts and education efforts that need to go into the product that you can't really do until you have the capacity. Well, I think it's a little bit of both. I think that initially, what you can say really with respect to both of these assets is that in these later lines of therapy, there's probably more demand for these products than the capacity that exists not just from us but in many respects in the market. And so in that regard, as more capacity comes online, those -- that translates into additional patients being treated. Now I think where promotion becomes particularly important is as you expand the label opportunity for these assets. Obviously, you got to make sure that you're educating customers on the opportunity that you have with cell therapy. And increasingly, it's important to make sure you maintain a very good connection with customers because where you encounter potential challenges with capacity, you've got to make sure you're able to keep physicians engaged and customers engaged with the product and we done that exceptionally well. But I think in general, as you think about the ramp of this, it's more going to be a steady increase as capacity comes online, additional patients will be treated. Okay, great. Camzyos continuing on the kind of the big new launch opportunities. I guess any surprises from the education process or roll out so far that kind of inform your view of how this good reposition in the market? I think the biggest surprise that we had and I think there was a positive end and more challenging aspect to it was and we talked about this previously, is that when we launched we had a number of accounts that were a little slower in terms of getting their internal logistics set up. Those were some of the larger centers of excellence. We've spent probably the majority of our time in this launch, getting those centers up and running. Now the interesting thing is while a handful of these larger centers had to work through some of the logistics associated with this product. We had a number of medium and smaller-sized institutions that got up to speed very quickly and began putting multiple patients on therapy. So I think we feel very good about having navigated that but that was probably the biggest surprise in terms of sort of the execution of the launch. I will say a second surprise with this asset has been the consistency with which the feedback on this drug has been overwhelmingly positive. Physicians are seeing the benefit of this product. They're seeing it impact patients very, very quickly, as quickly as 1 or 2 cycles into therapy. And that not only confirms for us the profile that we were attracted to with Camzyos but how that profile is actually playing out in the real world. So entering '23 are we at a point with Camzyos where it is more focused on kind of commercial ramp? Or are we still in part of that education kind of certification process? Remember we targeted this initial phase of launch to roughly 500 institutions that account for roughly 60% of the business. And there, we made very good progress in terms of engaging with customers not only on the initial discussions of getting certified, working through the RMS [ph] but also continuing to update them on the clinical profile and what we're hearing from other customers. That process has gone very well and will continue. But I think the focus really is within these institutions to get patients onto therapy. We had always anticipated that patients would come on to therapy as they come in for those routine visits. I think we're starting to see, particularly some of these larger institutions try to get patients more quickly. That actually creates some of the logistical challenges because you're going to have 100 or 200 patients that could potentially at an institution be treated. How do you manage those patients coming in, how do you get them in and who's going to actually work through some of the requirements to get patients initiated. So we worked through that but I think our focus right now is get as many of those patients into the clinic and on therapy just given the profile of this drug. Great. Maybe turning to the next 6 assets. I think milvexian got lot of attention. Just from your perspective, what do you think we need to can see from these Phase III studies to help us differentiate from Eliquis? And I'm kind of thinking most of the life cycle that drug is going to be a world where there's generic Eliquis. So tell me a bit about what type of profile you ideally want to see to be able to be successful with that. Yes. Well, remember, just if we step back. As we think about the milvexian development program, first and foremost, we're going to be developing this in large part where Factor Xas don't play. So right now, you don't see much use of Factor Xas in SSP or ACS, primarily and this actually speaks to the reason to develop Milvexian. You don't see that because it's very difficult to combine Factor Xa with the standard of care dual platelet therapy that's the backbone for treatment of those 2 diseases. And you can't combine those primarily because of the toxicity and specifically the bleed rates. And so there's a big push of the development program we have with this agent that won't be in a space where Factor Xas or even generic Xas would be at play. Now as we think about AFib which is really the area where that's relevant, our focus is on demonstrating with the milvexian the ability to have efficacy at least as good as what you see with backbone Factor Xa but with a better bleed profile. And what we know from our experience with Eliquis is that a large percentage, upwards of 40% of patients either don't get a Factor Xa or undertreated primarily because of a concern of bleed rates, bleeding. And so for those patients, we think there's a clear opportunity with milvexian if the data play out as we expect. Now as you think about the broader population in AFib, that's where a concern about potentially generic Factor Xas being relevant. And there the reality is it's going to be data dependent. But what I would say is we thought about the commercial opportunity for milvexian, we'd anticipated that the vast majority of the use that we get in AFib is going to be in that 40% of patients for whom Factor Xa is not relevant today. Okay, that makes sense. Maybe in the last minute or so here. Just talk about capital deployment and kind of priorities there. Last year, it seems like we had the ASR, we had a couple of smaller tuck-in deals. I guess as a kind of a road map to think about Bristol's capital deployment kind of strategies going forward? Or could we see that skew more towards BD or even more, share your thoughts as just -- how do you think about this year setting up? Well, I think the way we talk about capital allocation is that we started from the fact that we are in a very strong financial position. And what that gives us the ability to do is continue to return cash to shareholders via the dividend and growing that dividend. We continue to have optionality in terms of share buybacks but business development remains a top priority for us. And so the way we think about business development is we're going to continue to put a significant focus there. We'll continue to be size agnostic. We'll focus on deals that, as I mentioned before, make strategic sense for the company that have science where we feel that we can contribute and be a leader in and obviously, the financials have to be important. And we're going to continue also to focus on deals that continue to further strengthen the growth profile of the company and contribute to those multiple ways of how we think about growing the business.
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EarningCall_1257
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Good morning, ladies and gentlemen. And welcome to Group 1 Automotive's 2022 Fourth Quarter and Full Year Financial Results Conference Call. Please be advised today's conference call is being recorded. At this time, I'd like to turn the conference call over to Mr. Pete DeLongchamps, Group 1's Senior Vice President of Manufacturer Relations, Financial Services and Public Affairs. Please go ahead, Mr. DeLongchamps. Thank you, Jamie. And good morning, everyone, and welcome to today's call. The earnings release we issued this morning and a related slide presentation that include reconciliations related to the adjusted results we will refer to on this call for comparison purposes have been posted to Group 1's website. Before we begin, I'd like to make some brief remarks about forward-looking statements and the use of non-GAAP financial measures. Except for historical information mentioned during the conference call, statements made by management of Group 1 Automotive are forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve both known and unknown risks and uncertainties, which may cause the company's actual results in future periods to differ materially from forecasted results. Those risks include, but are not limited to, risks associated with pricing, volume, inventory supply due to increased customer demand and reduced manufacturing production levels due to component shortages, conditions of markets and adverse developments in the global economy and resulting impacts on the demand for new and used vehicles and related services. Those and other risks are described in the company's filings with the Securities and Exchange Commission. In addition, certain non-GAAP financial measures, as defined under SEC rules, may be discussed on this call. As required by applicable SEC rules, the company provides reconciliations of any non-GAAP financial measures to the most directly comparable GAAP measures on its website. Participating with me today on the call Daryl Kenningham, our President and Chief Executive Officer, and Daniel McHenry, Senior Vice President and Chief Financial Officer. Thank you, Pete. Good morning, everyone. 2022 was a record year for Group 1 Automotive, driven by outstanding aftersales growth, strong margins, all-time record profitability in our UK operation and disciplined expense control. Adjusted net income grew 15% to a record $729 million. Adjusted EPS grew 32% to an all-time high of $45.71. 2022 was also another strong year of external growth for Group 1. We acquired nearly $1 billion of revenue in 2022 and have now acquired over $3 billion in revenues over the past 15 months. We also returned meaningful capital to our shareholders by repurchasing $521 million in shares during the calendar year. Over the past 15 months, we've now repurchased over 22% of the company's outstanding shares. Our strong cash flow and leverage position, which Daniel will cover in a moment, will continue to allow for significant capital allocation flexibility in 2023. Turning to our fourth quarter results. I'm pleased to report that, for the quarter, Group 1 generated adjusted net income from continuing operations of $158 million or $10.86 per diluted share in EPS, an increase of 15% over the fourth quarter last year. Our adjusted results exclude non-core items totaling $1.7 million of after-tax losses, which primarily resulted from the pending disposition of two U.S. franchise points. Starting with our U.S. operations. As of December 31, we had 8,000 new vehicles in inventory, representing a 21-day supply, up 6 days from September. This inventory increase was primarily in our domestic brands as import brands remained very constrained. 30% of our US business is Toyota and Lexus, which continues to be very tight at a combined 4 days' supply. We expect a gradual decline in new vehicle margins over the course of 2023 as inventory continues to recover. We do, however, expect normalized new vehicle margins to eventually settle above our pre-pandemic levels. One of the continued challenges we faced in the quarter was a decline in industry used vehicle pricing, which results in a used vehicle sequential margin decline of $235 to roughly $1,350. Partially offsetting this was an 8% increase in same store used vehicle unit sales. Our organic sourcing efforts, including the acquisition of over 10,300 vehicles from individuals through AcceleRide continued to minimize our reliance on public auctions. We maintained our discipline with a 28 day supply of used inventory, which is within our target of 30 days. And the F&I business has remained strong at $2,369 per unit, showing only a minimal sequential decline. Looking forward, we do expect some modest headwinds due to pressure on finance penetration rates. Turning to aftersales, our US performance was outstanding once again, generating double-digits same store revenue growth, following high teen growth comps a year ago. Our customer pay business generated 13% same store growth. Collision increased 14%, warranty 8% and wholesale parts 3%. Through our technician recruiting and retention efforts, we increased our same store technician headcount by 16% in 2022. We foresee after sales continuing to be a strength over the course of 2023 for Group 1. We continued to maintain cost discipline, despite the decline in new and used vehicle markets. Our fourth quarter US adjusted SG&A as a percentage of gross profit was 61%, an increase of only 1 percentage point from the prior year and down from 71% in pre-pandemic 2019. A material portion of these cost savings will be permanent as we continue to leverage technology to drive customer and employee efficiencies. In the fourth quarter, we sold an all-time record 10,100 vehicles through AcceleRide, 15% of our total US retail sales, also an all-time record. Over 75% of our customers used AcceleRide in their transaction in some way in the fourth quarter, a percentage that continues to increase. We're also looking to our full integration of AcceleRide with our DMS, CRM and credit software. We continue to test it in several dealerships and expect a full rollout this year. Our early results are very positive, and we expect this will provide faster and more transparent transactions for our customers. Now turning to the UK. Vehicle demand remains steady and new vehicle availability is still constrained. Our new vehicle order bank at year-end was approximately 16,000 units, over six months' worth of sales, which remained fairly consistent with the prior quarter. As a reminder, our UK business mix is predominantly luxury. And those consumers are more resilient during times of economic uncertainty. We continue to believe that pent up demand built over the past several years due to both Brexit and a very strict pandemic lockdowns will help drive strong UK vehicle demand throughout 2023. Our aftersales growth in the UK has been just as strong as the US, with same store gross profit growth on a local currency base of 13% for both the fourth quarter and the full year of 2022. And finally, we expect the AcceleRide platform in the UK to be fully integrated in the second quarter of this year. Thank you, Daryl. And good morning, everyone. As of December 31, we had $48 million of cash on hand and another $154 million invested in our floorplan offset accounts, bringing total cash liquidity to $202 million. We also had $437 million available to borrow on our acquisition line, bringing total immediate available liquidity to $639 million. In 2022, we generated $916 million of adjusted operating cash flow and $803 million of free cash flow after backing out $113 million of CapEx. This capital was deployed through a combination of acquisitions, share repurchases and dividends. In 2022, we spent $521 million, repurchasing approximately 3 million shares at an average price of $172.54. And in the month, we spent an additional $13.7 million, repurchasing 76,300 shares. The result of this repurchase activity is just over a 22% reduction in our share count over the last 15 months. Our share count as of today is down to approximately 14.2 million. Our rent adjusted leverage ratio as defined by our US syndicated credit facility was 1.9 times at the end of December. Our strong balance sheet will continue to allow for meaningful and balanced capital deployment. Our quarterly floorplan interest of $9.6 million was an increase of $2.4 million from the prior year due entirely to higher vehicle inventory holdings. Non-floorplan interest expense of $22 million increased $6 million from prior year, both due to the debt rates in conjunction with the prime acquisition as well as higher interest rates. As a reminder, the majority of our debt has been fixed through interest rate swaps. As of December 31, approximately 70% of our $3.1 billion in floorplan and other debt was fixed. Therefore, an annual EPS impact is only about $0.50 for every 100 basis point increase in the secured overnight funding rate, which is the benchmark rate referenced in our floorplan and mortgage debt instruments. For additional detail regarding our financial condition, please refer to the schedules of have additional information attached to the news release, as well as the investor presentation posted on our website. Thank you, Daniel. Related to our corporate development efforts, we expect to find additional growth opportunities in 2023. Growing our US and UK businesses remains our top capital allocation priority. However, our balance sheet, cash flow generation and leverage position will continue to support a flexible capital allocation approach, which will likely also include serious consideration of share purchases. This concludes our prepared remarks. I will now turn the call over to the operator to begin the question-and-answer session. Operator? I have to one core question and one follow-up. Just on new GPUs, Daryl, you mentioned you expect them to normalize over time, but still be higher than they were pre-pandemic. I'm just curious, what timeframe you think that happens in. I know that's a tough question, but if you could give us sort of some idea of your thought process there. And then also just the corollary savings on SG&A that that just falls out as grosses come down, meaning what part of that goes out to sales comp? So, is there sort of just a natural sort of hedge or savings as those GPUs come down? John, this is Daryl. I can't tell you with any specificity when we think it will normalize, other than what we've seen is a real steady glide path really since middle of last year, the gross profits decline, and we expect we'll see something similar through this year. And in some brands, our grosses are holding up quite well because they're still very tight. Inventories are still very tight. In a couple of brands, we saw the gross has increased during the quarter. And then, in a couple of brands that we got quite a bit of inventory. In our domestics, we saw the most erosion. But I can't give you a specific time, other than as the inventories and total come back, we expect it to be a gradual change. On SG&A, or our infills expense in particular, John, which I think you're referring to, I think there's a couple of things out there that's really going to help us going forward. And, clearly, the reduction in profitability drives SG&A as a percent of growth, but I think our use of the AcceleRide platform, how we've integrated that into our dealerships, and I think, importantly, the integration that we're going through, integrating AcceleRide or DMS, CRM and credit software, that's going to help us further increase the utilization of our sales executives going forward. And I think some of that will help reduce that SG&A impact going forward. Just one kind of follow up on parts and service. You said 16% growth in techs in 2022. Am I correct to read the gating factor on same store sales growth in parts and service is those techs and what was sort of the cadence of the hiring of those techs through the course of the year? Because if you kind of assume they happen during the course of the year, you might, on a same store basis, have 8% more techs in 2023 versus 2022, right, assuming half were â they were hired smoothly through the year. Just kind of understand that cadence, so we can think about where at even capacity sits right now. We picked up more in the second half of the year than we did in the first half, John. And I expect, as they get assimilated â our belief is adding capacity in aftersales drives our ability to service more customers when they want to do business with us. And so, I expect will see that ability with these technicians we've added in 2023. And we're continuing to press to hire more techs beyond the number that you see there as well. Daniel, I wonder if you can walk me through that slide 11 that you have in your handout, just on what you're doing as far as the floorplan swap, the layers and the impact of higher interest rates? Because I think that's unique relative to the rest of the group. It's Daniel. Let me just pull up slide 11. You're correct. We've got layers of interest rate swaps all the way out to 2031. What that's enabled us to do is to fix a big proportion of our interest. You can see the layers in the deck and the rates that we've fixed them in at. And the rate out to 2031 is at 0.67%. So I think that's going to help with â a differentiator for us versus our competitors. As interest rates go up on the floor plan, the number that we see, the 9.6%, whatever it was in the quarter, we won't see that increase at the same rate that we see others? Do these swap cost offset or the benefits? That is correct, Mike. 70% of our debt is at a fixed rate. So, we will not see the same increase as our competitors. You mentioned the really tight Toyota Lexus supply. And I'm just curious if you think that the worst of their production stoppages from either COVID absenteeism or more like more easier to predict maybe the chip shortage, but is there still â are you much more confident about 2023 product allocation from them? Or is there still little to no visibility from the factory on that? We're more optimistic, David, with Toyota. They're telling us they have more optimism in their plans. I think the thing that Toyota is really fighting is they have such a pent up demand for their brand with customers. And if you look at our presales, typically, presales and pipeline orders are typically kind of luxury brand kind of things, except for our Toyota stores. And we have significant numbers of presales even in our Toyota stores. So I expect they'll have a higher production this year, but I also expect much of that'll get will get soaked up by some of these presales that are still out there. On new vehicle affordability, there's a lot of attention given to poor used vehicle affordability, but all the automakers CEOs don't seem too concerned about the high price of new vehicles. What about you guys at the consumer level? Are you at all concerned? When you bundle everything, interest rates plus the average selling price, I think it's certainly something to think about. The cost of vehicle ownership is probably down a bit, given the gas prices are down versus a year ago, quite a bit in some parts of the country. And we're seeing a little more support in terms of incentives from the OEMs. So I think maybe publicly some of them are saying they're not worried about it. But internally, we're seeing more support. I saw an announcement this morning from one of the OEMs on some interest rate support, as a matter of fact, on some of their vehicles. And I would expect you would continue to see that, especially in those brands that have built inventory. Can you give us a bit of a view into January and how that started, particularly on both new and used GPUs? And anything you've seen in terms of impact on demand for your brands from the fairly sizable price cuts on Teslas? And I have a follow-up. On January, tough for us to comment on January, Rajat. What was the second half of your question? You cut out on our speaker. Maybe on the used car business, execution was pretty strong. GPUs are still above pre-pandemic levels. Inventory under 30 days. Can you give us a sense of how you're managing the current pricing environment? Maybe any comment on your approach on GPUs versus volumes? And do you see GPUs falling below pre-pandemic levels temporarily during this pricing transition period at all? Well, the trade off on volume in GPUs, we want to err on the side of volume. Not that it's volume at all costs. That's never something we want to do. We price based on market value of those vehicles and we reprice constantly, more often than daily in many cases. And we want to be at the market or better all the time. And then we want the volume because of the F&I attachment, which is a real strength for us. Also, that puts more units in operation out there for our stores and another opportunity for us to do parts and service business with those customers. So, philosophically, we like that volume versus GPU trade-off for that reason. Moving forward, if you look at it on a macro basis over the next couple of years, what firms like Cox are saying, which I tend to agree with them is I believe we're going to see somewhat of a shortage on used cars because of the pandemic-related SAR declines that we saw for three years. And that will take some used cars out of the market for the coming three or four â couple of years anyway. And I believe that could support PRUs over the next couple of years. So, that's something we think is probably going to happen, is the way we see it. This is Joe Enderlin on for Daniel. Just looking at the UK vehicle backlog, it sounds like that took a slight step down this quarter. Just wondering, do you think demand remains relatively consistent there? Have you seen any noticeable changes in the consumer backdrop from last quarter? No, we haven't seen any material change at all. And we've seen strength in that backlog and just minor changes. I wouldn't take the changes quarter-over-quarter as anything meaningful or anything indicative of a different trend than what we've seen. As a follow up, looking at the slides, it looks like customer retention has increased from about 70% to 88% using AcceleRide over the course of this year. Could you maybe provide some color on how much sure you think that platform is, how much optimization you have left, and then if you have any goals for next year? We believe we're in the first couple of innings of the AcceleRide baseball game. And we feel like it's a customer platform that will help us drive retention and drive value and transparency for customers in a number of areas of our business. Not just in buying new cars or used cars, but in buying â but in them selling their used cars to us, transacting with us, digitally payments, we believe there's so much more we can do with AcceleRide to make that customer experience even better. And we believe that retention number you're looking at is just indicative of how much customers value that experience of AcceleRide. We continue to see the usage go up every month, almost just every single month that's going up. 75% of our customers use AcceleRide now in their transaction in some way. So, we believe there's still a long way to run with AcceleRide. We're really happy with where we are. Just a couple of questions. First, Tesla, those price cuts, I don't remember anyone cutting price like 20%. That's kind of a, maybe you'd agree, pretty unusual situation. And while it doesn't necessarily compete directly with all the nameplates that you guys are selling, some of the stores, you might have a little more head-to-head with that type of product. I'm curious, if this wasn't already covered whether you saw any real time impact after those cuts? And a follow up. This is Daryl. We looked at our used Teslas in inventory immediately after their announcement and we repriced. We didn't have very many honestly. But we did reprice. And so, I would say there was an impact from that perspective, but the numbers are like less than 100 for us across the country. And then, in the segments where we do sell EVs or we sell luxury cars and there's some cross shop between Teslas and luxury ICE vehicles, and we haven't seen a material impact yet on that per se, but it was a bold move they made. That's for sure. And we're watching it every day with what they're doing. Just a couple of little housekeeping ones then for me. Any comments on interest expense either on the floorplan side or other interest expense, just kind of seeing where we are today versus pre-COVID and given the rate environment. I'm not asking you to guide specifically, but something directional or particularly on floor plan, as you kind of get the units rebuilt with the rates kind of creeping up. Adam, it's Daniel. At the moment, we have 70% of our debt swapped out. That's fixed mortgages as well as floorplan. As the inventory continues to rebuild, we will see some increase in interest expense. But at the current rate, we see that at $0.50 of EPS per 100 bps increase in interest. Just more follow-up on pricing. Understood that fourth quarter is before Tesla price cuts came in, but some third party providers suggest that ASPs continued to increase through the quarter. Can you confirm that that they continued to reach new highs through December? And then, is that a function of price, mix or both? I'd have to look at it more to see if parts drove some of that, which it probably did, but we can take a look at that and get back to you. I just had one follow-up on leverage, Daniel. You mentioned 1.9 times as your current leverage. I'm just curious if you saw a good acquisition either in the UK, in the US where you could potentially take that up to and what kind of capacity you think you have to do, potentially a small, mid or even large acquisition? For us, I think what we set out is that we would be prepared to go to 3.5 times levered. Our credit facility allows us to go to 5.75. If it was a really big acquisition or something that we were really interested in doing, we would be prepared to go to 4 times, but that would be on the proviso that we would reduce that back down again to 3 or under 3 times pretty quickly. But you're comfortable with 3 â so you can jump to 3.5 to 4 on an acquisition, you would want to grind that back to 3, but you're very comfortable 3, meaning there's a turn of leverage here that's just up for grabs, depending on â the best way to go. Absolutely, John. We would be happy to go to 3. Clearly, pre-pandemic, we were above those levels and we were okay at those levels as well. Are you going to comment at all, if the consumer backdrop does remain weak, be it higher interest rates, seeing some delinquency defaults picking up and you don't see improvement in new and used car [indiscernible], are you able to comment on what you would see as trough earnings for the company based on today's revenue base and the new share count or any puts and takes or guardrails around that if you could provide? Rajat, we don't. As you know, we don't give guidance. I guess you have modeled it within your model, and I think the model that you have put out there effectively goes back to 2019 levels, but that's as far as we would be prepared to comment on that. I wanted to go back to the 16% increase in tech headcounts. You talked a couple of years ago about how you were â if I remember right, it was doing some new initiatives to get more talent, like a four day work week. Could you just briefly summarize what are the main things you've been doing to have success in getting people? And then also, of the things you're doing, what has been the most top one or two things that candidates are saying they like the best and why they chose to work at Group 1? We pay at market or above market is a real key thing for us. We keep our technicians full of work, busy. Because philosophically we keep our schedules wide open for our customers. We don't make our customers do business with us when it's convenient for us. We do it when it's convenient for the customers, which usually means they want to do business right now, which puts pressure on our on our stores because that creates a lot of traffic in the stores. And then, the four day workweek, we continue to work that. We're in 80 stores today, which is about half of our rooftop count in the US. That's an important thing. We are looking at different compensation schemes in â I say schemes, compensation plans across our footprint to determine ways to make it an even better place to work. And we're not ready to comment on those specifically. But that's something that is front and center in our thinking right now as well. Also, we have mentoring programs that we have in a number of markets and a number of stores across the country and relationships with a number of technical schools and training schools that help us help feed techs to us. So, we have a number of different things that we do, a number of different things. It's never-ending. You said the four day workweek is in about half of the stores. Do you see that getting drastically higher over time? Yes, we continue to find ways to put that in more and more stores over time. And we invest. We brought $3 billion in revenue in the last year-and-a-half. Inevitably, what we find when we buy a store is there's underinvestment in aftersales. And that usually means equipment. That means training. That means staffing and facilities. And as one of the very first things we do when we integrate a new dealership is we invest in aftersales in all of those areas and we think that pays off for us in tech recruitment, tech retention as well. And ladies and gentlemen, in showing no further questions, we'll be ending today's question-and-answer session as well as today's presentation. The conference has now concluded. We do thank you for attending. You may now disconnect your lines.
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EarningCall_1258
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Welcome to the Pentair Fourth Quarter 2022 Earnings Conference Call. All participants will be in 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. On the call with me are John Stauch, our President and Chief Executive Officer; and Bob Fishman, our Chief Financial Officer. On today's call, we will provide details on our fourth quarter and full year performance as outlined in this morning's press release. On the Pentair Investor Relations website, you can find our earnings release and slide deck, which is intended to supplement our prepared remarks during today's call and provide a reconciliation of differences between GAAP and non-GAAP financial measures that we will reference. 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 company's performance in addition to the impact these items and events have on the financial results. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements, which are predictions, projections or other statements about future events. 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 Pentair. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors in our most recent Form 10-Q and Form 10-K and today's release. We will also reference certain non-GAAP measures. Following our prepared remarks, we will open the call up for questions. Please limit your questions to one plus a follow-up, then re-enter the queue in order to allow everyone an opportunity to ask questions. Let's begin with Slide 4, titled Executive Summary. We closed out 2022 with strong sales, segment income and adjusted EPS, which is a direct result of the hard work and dedication of our focused employees across the world. Sales increased 9% to $4.1 billion; segment income rose 12% to $768 million; ROS expanded by 40 basis points to 18.6%; and adjusted EPS increased 8% to $3.68. A few of our key wins during the year include: strategic progress on our transformation initiatives, which we expect to drive significant margin expansion over the next several years; the acquisition of Manitowoc Ice, a complementary and accretive acquisition which further enhances our commercial water solutions business; and recognition for our leadership in social responsibility and sustainability. All in, we are focused on building the Pentair in the future by investing in sustainable growth and expanding profitability through strengthening our operational and financial foundation, which we expect to create long-term value for our stakeholders. Bob will discuss our first quarter and full year 2023 guidance in more detail, but I wanted to share some [Technical Difficulty] thoughts. We are confident in our business model, diversified portfolio and our transformation initiatives, which we expect to drive long-term shareholder value and contribute significantly to 2023. As we look specifically at 2023, we are working through near-term macroeconomic-driven challenges, which we are driving -- which is driving lower-than-expected volumes in our residential businesses. However, we expect to see more normalized demand in 2024 and view 2023 as a catch-up year for excess demand that was realized in 2020 through the first half of 2022. Please turn to Slide 5, titled 5 Year Pentair Performance. Reflecting on the last five years is a focused, smart, sustainable water solutions company. We drove strong financial performance by: increasing revenue at an 8% compounded annual growth rate; increasing EPS at a 14% compounded annual growth rate; and we have also generated over $2 billion of free cash flow; and ended 2022 with nearly a 16% ROIC. These are metrics that we are very proud of and share with our incredible team here at Pentair. This is a testament to our relentless efforts to deliver premium quality, innovative products and services to our consumers. We believe the largest opportunity is improving ROS, which did not improve materially over the last five years. The strong demand we realized later in 2020 through the first half of 2022 came with disrupted supply chains and unprecedented inflation that was hard to outpace. We believe our second half of 2022 demonstrates that we have finally made progress on price versus cost. However, we still have significant opportunities to improve our operating and cost efficiencies across all of Pentair through transformation and recovery of the inefficiencies that we realized. Please turn to Slide 6, labeled Pentair at a Glance. For those of you listening today who may be new to our story, I wanted to reiterate a few important key metrics that I discussed last quarter. In 2022, we generated $4.1 billion in sales with approximately a 50% mix from residential channels and 50% from commercial, industrial and infrastructure channels. We have decent profitability at 18.6%, but as I mentioned previously, we have a lot of opportunity to improve this. We believe our large installed base is an advantage and an opportunity for us. For example, 75% of our products are replacement inside a large installed base that benefits from over 75,000 focused trade partners. We believe these relationships with our trade channel partners drive resiliency of revenue and create a great opportunity for continued growth as we introduce new products and technologies. We have a long successful track record of generating cash flow and being disciplined with our capital allocation. In fact, we have increased our dividend for the 47th consecutive year, putting us in a very small group inside of the S&P 500, and we are especially proud of our high-teens ROIC, demonstrating that we continue to be good stewards with your invested money. We believe we have a very solid foundation and we know there's still more we can do. Please turn to Slide 7, labeled Our Impact: Making Better Essential for People and the Planet. Our work on ESG and social responsibility continues to be at the forefront of how we operate and how we work to make the planet better. At Pentair, we take great pride in the products we develop that are providing solutions to some of the world's largest challenges, including safe and healthy drinking water, climate change and water shortages to name just a few. We also seek to make better essential for people and the planet. For example, our products and solutions improve water efficiency, reduce and capture carbon emissions and avoid the need for single-use water bottles. Here are a few highlights. 71% of Pentair solutions support water efficiency; 15.9 million tons of CO2 emissions have been avoided by U.S. consumers using Pentair's energy efficient pool pump since 2005; and nearly 8 billion single-use plastic water bottles have been avoided in 2022 due to Pentair's water filtration products. Furthermore, our leadership and social responsibility is being recognized by third-party organizations, including Forbes and others. We look forward to continued progress and plan to share additional details in our 2022 Corporate Responsibility Report, which we expect to publish this spring. Please turn to Slide 8, labeled Strategic Framework. Our purpose, mission, vision, values and impact are critical components of our strategic framework. Our purpose matters and is to create a better world for people in the planet through smart sustainable water solutions. Our mission as a company is to help the world sustainably move, improve and enjoy water, life's most essential resource. And we do this in residential, commercial, agriculture and industrial applications. As of January 1st of this year, we have split our Consumer Solutions segment into Pool and Water Solutions. This creates three focus segments as IFT remains unchanged. We expect this to not only improve transparency, but further improve customer service, differentiate our products, measure our success externally and drive greater profitability for our shareholders. Our three segments are now Industrial & Flow Technologies, Water Solutions and Pool. We continue to see great opportunity in all three of these segments and the businesses that each of them lead. Our Industrial & Flow Technologies segment helps move water where you need it, when you need it more efficiently in our pump businesses. The segment also focuses on transforming waste into value through our sustainable gas and membrane businesses. Our Water Solutions segment, which includes our most recent acquisition, Manitowoc Ice, is a leading platform to provide water and ice to our food service and residential customers. These businesses improve water by providing great tasting, higher-quality water and ice while helping our customers use more -- water more productively. Our Pool business helps enjoy water by using less energy and chemicals. In North America, it also has a large installed base of approximately 5.4 million pools with an average age of 20 to 25 years. The industry is approximately 60% break and fix, 20% major remodeling, and 20% new pools. Only about 50% of all in-ground pools have some form of automation, which we believe is a long-term opportunity for Pentair. I will now pass the call over to Bob, who will discuss our performance and financial results in more detail. Bob? Please turn to Slide 9, labeled Q4 2022 Pentair Performance. I will also be discussing our full year performance on Slide 10. We delivered fourth quarter sales growth of 1% with core sales declining 3% as strong price contribution was not enough to offset volume decline. Consumer Solutions core sales were down 11%, as expected and previously communicated, due to residential channel inventory levels rebalancing and as a result of our lead times beginning to return to more normal levels. Industrial & Flow Technologies reported strong 11% core sales growth with strength in commercial flow and industrial solutions. For the full year, sales grew 9% with core sales up 6%. Consumer Solutions delivered 4% core sales growth, and Industrial & Flow Technologies saw core sales growth of 10%. Fourth quarter segment income increased 10%, and return on sales expanded 130 basis points year-over-year to 18.2%, driven primarily by price, significantly offsetting inflation. Productivity was negatively impacted by lower volume in the quarter. Adjusted EPS of $0.82 was down 6% versus the prior year, but exceeded our guidance for the quarter. Net interest and other expense was $28.2 million, which represented our first full quarter of new financing post the Manitowoc acquisition. And our adjusted tax rate was 12.7% during the quarter, with a share count of 165.2 million. For the full year, segment income grew 12% and return on sales expanded 40 basis points to 18.6%. Adjusted EPS increased 8% for the year to $3.68. Our tax rate ended the year at 14.5%, and our share count was 165.6 million. Please turn to Slide 11, labeled Q4 2022 Consumer Solutions Performance. In addition to the fourth quarter performance for Consumer Solutions, I will also be referencing the full year performance on Slide 12. In the fourth quarter, Consumer Solutions sales declined 1% with core sales declining 11%, comprised of 15 points of price, offset by 26 points of volume decline. This was in line with our expectations. The volume decline was due to difficult year-over-year comparisons and the anticipated inventory correction across many product lines in our residential channels. Segment income grew 7%, and return on sales expanded 150 basis points to 23.1%, as strong pricing measures continued to play out along with the contribution from Manitowoc Ice. For the year, Consumer Solutions sales grew 12% with core sales up 4%. Segment income grew 10%, and return on sales declined 40 basis points to 23.3%. Our pool business had sales growth of 4% for the year. Water treatment saw sales growth of 28%, led by contribution from the Manitowoc Ice acquisition, which was completed at the end of July. Please turn to Slide 13, labeled Q4 2022 Industrial & Flow Technologies Performance. In addition to the fourth quarter performance for Industrial & Flow Technologies, I will also be referencing the full year performance on Slide 14. Industrial & Flow Technologies grew sales 5% in the quarter, partially offset by a 4% FX headwind with core sales increasing 11%. Segment income grew 21%, and return on sales expanded an impressive 240 basis points to 17.4%, marking the second consecutive quarter of greater than 200 basis points of improvement. The strong margin expansion was a result of significant price contribution and moderating inflation. For the year, sales increased 6% with core sales increasing 10%. Segment income grew 14%, and return on sales increased 110 basis points to 16.1%, as strong price more than offset inflation and FX headwinds. IFT saw sales growth across the segment with residential flow up 3%, commercial flow up 6% and industrial solutions up 10%. Please turn to Slide 15, labeled Balance Sheet and Cash Flow. As a reminder, this slide reflects the closing of the Manitowoc acquisition at the end of July. We ended the quarter with pro forma a leverage of 2.5 times, and our return on invested capital was at 15.7%, declining slightly due to the acquisition of Manitowoc Ice. I would like to remind you that given the rising interest rate environment, we are comfortable being two-thirds variable as we were less inclined to lock into higher rates for longer. We have no significant long-term debt maturing for the next few years and the majority of our debt is in term loans going out three to five years. We generated $283 million of free cash flow from continuing operations in the year, which was in line with our messaging on the Q3 earnings call. Working capital was a significant headwind this year, primarily inventories, which has led to a timing issue on cash flow. Our inventories were higher largely due to inflation, [buy-ahead] (ph) and inefficiencies in the supply chain. We expect to benefit from working capital improvement in 2023 and generate free cash flow in line with our historical performance of 100% of net income. In 2022, we returned roughly two-thirds of our free cash flow to shareholders through dividends and share repurchases. We plan to remain disciplined with our capital, and we'll continue to focus on debt reduction amid the higher interest rate environment. Please turn to Slide 16, labeled Segment Structure Beginning in 2023. As John discussed, we moved to three reporting segments effective January 01, 2023. We have included realigned historical information for these segments from 2019 to 2022 in the supplemental data section of our earnings presentation. Our Industrial & Flow Technologies segment had roughly $1.5 billion of revenue in 2022 with a ROS of approximately 16%. This business grows sales at roughly single digits over the long term in a very large industry. Water Solutions consists of residential and commercial and was roughly $1.2 billion of revenue on a pro forma basis when including a full year of Manitowoc Ice. This is a mid-single digit sales growth contributor over the long term, operating in a very large industry. Finally, Pool was roughly $1.6 billion of revenue in 2022 and is our highest profitability segment that we expect will grow sales mid-single digit plus over the long term. Please turn to Slide 17, labeled Transformation Expectations. We have moved transformation from funnel to execution, and we expect more material benefits to contribute to our longer-term margin expansion targets. In 2022, we made strategic progress on our transformation initiatives with a primary focus on two of our four key themes: pricing excellence and strategic sourcing. Overall, we believe transformation will be a key driver in value creation over the next three years. For example, through our transformation initiative, we have identified over 400 basis points of targeted margin expansion by 2025, up from the 300 basis points that we discussed at our previous Investor Day. A significant portion of that is due to a focus on material costs, which represent roughly 40% of our sales. By driving transformation excellence through pricing and sourcing, we believe this will have the most significant impact on overall cost efficiencies. With the work we have completed in 2022, we believe that we can expand return on sales to approximately 23% in 2025. In pricing, we have completed wave one, which has established a new strategic pricing playbook. This creates a foundation for pricing across our different go-to-market strategies and includes looking at our dealer and distributor programs to better optimize them. We are gaining insight into profitability by customer and product category and using this data to better drive our forecast. We believe pricing remains a big opportunity. We are building capabilities and starting to see benefits materialize. We expect future waves to include the implementation of our pricing playbook across all categories. We are furthest along in our strategic sourcing initiatives. We have completed wave one that focused on key categories, like electronics, motors and drives, castings, packaging, logistics and MRO. Wave one included roughly 35% of material spend and has generated over 12% in savings opportunities. We expect to unlock value through supplier-dedicated resources, supply base reduction, inventory solutions, enhanced supplier executive level relationships and rebate programs. We expect to reduce complexity across our entire organization and to see close to 80% supplier reduction in some of our commodity groups. Over 75 Pentair team members attended 3,000 plus hours of formal classroom instruction and workshops in supply chain topics. As we institutionalize our wave one learnings, we expect this will drive future waves as we look at additional categories. Wave two is scheduled to start in 2023 and is planned to cover another 35% of material spend for commodity groups such as metals, plastics and molding, purchase finished goods, transportation, and indirect spend such as IT, fleet management and office supplies. We expect this will create a funnel of savings for 2023 and 2024. In operations excellence, we are focused on reducing complexity and driving lean processes across all our operations. In 2022, we made a few small strides on footprint optimization. We believe this presents longer-term opportunities, but not until 2024 and beyond, as we build out the funnel. Lastly, in organizational effectiveness, we are focusing on sales and functional excellence to simplify our organization. From an organizational standpoint, we believe ample opportunities remain for complexity reduction across the entire portfolio and a realignment of needed skills within our top priorities. We continue to believe that our transformation initiatives will be a large value creation opportunity for Pentair. Please turn to Slide 18, labeled Q1 and Full Year 2023 Pentair Outlook. For the full year, we are introducing adjusted EPS guidance of approximately $3.50 to $3.70, which represents a year-over-year range of down 5% to up 1%. We expect sales to be roughly down 3% to up 1%. We expect segment income to increase 5% to 10%, with corporate expense of approximately $80 million, net interest expense of roughly $125 million, an adjusted tax rate of approximately 15% and a share count of 165 million to 166 million. We are targeting free cash flow of approximately 100% of net income as we expect working capital to improve and inventory levels to come down. For the first quarter, we are introducing adjusted EPS guidance of approximately $0.76 to $0.78, which represents a year-over-year decrease of approximately 8% to 11%. We expect sales to be roughly flat to up 1%, as the contribution of Manitowoc Ice helps offset expected volume declines from the rebalancing of residential channel inventory. We expect segment income to increase 5% to 8%, with corporate expense coming in around $21 million, net interest expense of roughly $33 million, an adjusted tax rate of approximately 15% and a share count of 165 million to 166 million. Please turn to Slide 19, labeled Full Year 2023 Guidance at Midpoint. The chart on Slide 19 shows a walk of sales and segment income at the midpoint of our full year 2023 guidance. From the sales walk on the left-hand side, you will see that we expect sales to be down roughly 1% at the midpoint. We expect volume to be down approximately 10%, primarily due to our residential businesses. We expect price benefit of approximately 5% and a benefit from acquisitions/divestitures of roughly 5%, primarily due to a full year of Manitowoc Ice, partially offset by exits in the residential businesses and water solutions. We expect Pool sales to be down low double digits at the midpoint in 2023 after growing 14% in 2020, 40% in 2021 and 4% in 2022. We believe 2023 will be an inventory rebalancing year across the pool industry. We do think that there was a higher-than-normal level of demand in 2020 and 2021 that led to timing and supply chain disruptions in the industry and, therefore, created larger-than-normal impact between sell-through and sell-in reflected in our results. We estimate that from a sell-through perspective, the overall industry grew about 4% on a volume basis from 2019 to 2022, roughly in line with historical levels. As we have discussed, our Pool sales consists of 20% from new pools 20% from remodels and 60% from the aftermarket. At the midpoint, we expect that new pools and remodels will be down approximately 20% in 2023 and the aftermarket business, including inventory corrections in Q1 through Q3, will be down approximately 15%. We expect price carryover for Pool will be up roughly mid-single digit. We do expect the industry and our Pool revenue to return to more normalized growth later in 2023 and in 2024, reflecting a more even balance of sell-through and distribution buying patterns. As a reminder, even with an expected [Pool] (ph) year of down double digits in 2023, we expect to grow at a double digit CAGR in Pool from 2019 through 2023. We expect our Water Solutions segment sales to be up mid-teens at the midpoint, including up approximately 40% in our commercial business with a full year of Manitowoc Ice and down approximately 10% in our residential business. We expect IFT sales to be up slightly at the midpoint with the commercial, industrial and infrastructure businesses up approximately mid-single digits and residential down approximately double digits. On the segment income side, we expect segment income to grow approximately 8% at the midpoint and to expand ROS roughly 150 basis points. We expect price to slightly exceed inflation. We expect approximately 35% ROS from our acquisitions and divestitures. Our transformation initiatives and productivity should deliver over 200 basis points of margin expansion. And we expect drop through of roughly 30% on the decrease in volume. We expect our greater than 200 basis points of transformation and productivity benefit will be the result of volume rightsizing actions that we undertook in the fourth quarter of 2022, inefficiencies in our 2022 results that will not repeat in 2023 and our transformation initiatives. Our comments are based on the midpoint of the range. The lower end of our range would be reflective of higher interest rates, impacting housing demand and residential sales and increasing our interest expense. As we think about the higher end of our range, our main drivers would be a better outcome in the residential businesses, primarily Pool, and overdriving some of the transformation benefits. In closing, we expect the lower Pool year in 2023 to be offset by the strength of our diversified portfolio and our transformation initiatives. We are confident in the expected benefits from our transformation initiatives and we believe we are gaining continued momentum, to not only drive savings in 2023, but to build a strong funnel for 2024 and 2025, with significant ROS expansion. We also expect ROS expansion as our residential businesses return to more normalized growth in 2024 and beyond. I'd now like to turn the call over to the operator for Q&A, after which John will have a few closing remarks. Kate, please open the line for questions. Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question is from Joe Giordano of Cowen. Please go ahead. Maybe, I'm going to start [not] (ph) on Pool. Can you talk about the residential portfolio that you have within the old Consumer Solutions group? You made a couple of acquisitions over the years, Pelican, Aquion and Rocean, and small deals, but now we're talking about some exits that you're making. So, maybe just give us an update on where that portfolio is? Where is it maybe versus what you thought it might look like when you started making those deals? And kind of like an update on the strategy going forward from there? Yes. I mean, first of all, I think about it as roughly still 40% of the overall Water Solutions segment. And think of all the core that we were focused on for the last five to ten years, which is really about the trade and the professional channel, all being a big part of our strategy and still performing. What we did exit was our attempts at the direct-to-consumer side of the business, which we felt were not going to gain the traction that we originally hoped they would, but also they were confusing the trade channel as far as our partnership to support them. And so, now we're focused on being back to where we were, which is pulling demand through our professional trade channel and ensuring that we're winning with the best products and solutions, Joe. That makes sense. And then just a follow-up on the 2025 margin target. Can you maybe walk us through the relative contributions from the three segments? Like, I guess, Pool doesn't have as much upside given how strong it's been, but if you could kind of help us frame that up? Yes. Joe, we were pleased to be able to increase the ROS expansion due to the -- what we're seeing in the transformation initiatives. We still have work to do to break it out by segment, but overall, we would expect each of the segments to be contributors to that ROS expansion. And so, when you think of the increase in the target, as Bob mentioned, 100 basis points of that comes from candidly the fact that we're mixing up with the Manitowoc acquisition. And then we felt like stepping up the expectations on the transformation was helpful for two reasons. One is, we believe that we're making progress with the actual work we're doing. But the second one is we have inefficiencies that we uncovered over the last couple of years of being challenged by the supply chain, which we want to make sure are included in the transformation journey that we're on. And just to bridge the gap, when we had our Investor Day, we talked about going from 18% to 21% in 2025. We then acquired Manitowoc. So that gave us another approximately 100 basis points to bring us to 22%, and then we found another 100 basis points in the transformation initiatives to get us to the 23%. Okay. And having owned Manitowoc Ice bit longer, any update you can offer on the commercial synergies that you've seen to date or what's expected between Everpure, Manitowoc and KBI? Yes, we're really pleased with the start. I think these all come together nicely and I think we continue to see significant opportunities for our customers to benefit from the end-to-end solutions that we now provide in commercial water solutions. And just to provide a little more detail, the Water Solutions does have commercial [up] (ph) approximately 40%, residential down approximately 10%. Hey, good morning, everyone. First, a follow-up to Joe's second question. Just what kind of volume assumptions are embedded in those margin targets, if any? Or are those exclusive volume expectations over the next few years? In other words, is there a level of revenue or volumes you need to get to be able to achieve these targets? Well, I mean, we're making significant impact in 2023 even with the down volume. So, I think the jumpstart in 2023 reflects the aggressive efforts to get the labor in line with the volume and also to recover those inefficiencies. As we go forward, we'd be looking at the normalized growth rates of each of the segments being included in our efforts to get to the ROS targets that we implied. Okay. That makes sense. And then, just from a guidance perspective, could you help with the cadencing a little bit through the year. When you think about normal seasonality and there's a lot of moving pieces particularly in Pools, some of the destocking, how are you guys thinking about what the normal seasonal cadence looks like by segment within the guidance? We are starting to move back to a more typical seasonality where Q2 is typically our largest quarter followed by Q3. I would say that we expect to see slightly less than 50% of our EPS in the first half, primarily because interest expense is a little bit higher in the first half and transformation initiatives play out a little bit more strongly in the back half. But we are returning to more traditional seasonality than what we saw during the COVID years. And I would just add that you should assume that most of the residential channel challenges will come through Q1, Q2 and Q3, and we have easier comparisons in the back half of the year as we look at what those year-over-year impacts would be. Thanks. Good morning. I just wanted to understand your sort of conviction level around the price tailwinds. You had 5 points of price dialed in for this year after sort of low teens ending last year. So, maybe sort of give some more color on the price confidence and how you see the sort of needed inventory liquidation in a lot of pool products perhaps weighing on that? Yes. So, I'll start and then Bob can bring some more in. I think first of all, the price that we're anticipating is actions that have already been taken. And we feel good about the decisions we've made and we feel like we have, as we said, stickiness in the channel. I do think it's fair to assume that as we get through the year, we have to anticipate that there might be ideas from the channel to participate in rebates or discounts. We've assumed a little of that in our guide. But we're hopeful that our balanced view of the revenue projections that we have don't encourage us to think that we need to do significant discounting to achieve our expectations. Appreciate all the detail in the presentation this morning. I'm going to ask about Pool. You talked about in the prepared comments Bob, 2019 through 2023 double-digit growth in Pool, [indiscernible] what's in the guidance for '23. I think historically that had been more like 7% or 8%. Can you talk about what was price versus volume in that? How much higher was price than you would normally have? I'm just trying to get an idea in a sense of, are we kind of back to a normalized volume growth? If you take that period from '19 to '23 where we pulled forward demand early, we're giving some [backing] (ph) and now are we kind of back to that normal trend line? We think if you looked at it, Nathan, on a sell-through basis, we'll be normalized from a volume from a sell-through basis. Obviously, we got a little disconnected on the sell-in versus the sell-out. But overall, we believe we're tracking to historical volume levels with where we end up. So, you should assume that we've had a significant price benefit over the last four years that we've realized. With the change in the reporting structure, is there a change in the way you're managing any of those businesses? And if so, how do you think that benefits the customer experience of buying to Pentair? Just any color you can give us on the change in reporting strategy if there's a change in the actual business management structure? Yes. We've committed a lot of effort and resources to run at what we call the category level, which is the products that go to the market and serve the customer streams. So that's our focus. And the new segment line-up allows us to be aligned. Pool for pool, and then, we've been able to split the Water Solutions businesses to the residential and commercial where we have the varying go-to-market channels, and IFT remain the same. So, we feel really good about our customer-centric efforts both on sales, marketing and NPI. And we're very encouraged on how the new segments will help enable the focus on the growth journeys of these three different areas. Maybe just shifting -- hey, back to the margin outlook here. I appreciate the update of you through '25. I guess just sort of drilling into '23 a bit here, you mentioned the 100 basis points from the Manitowoc. When I look at just Slide 19, can you kind of give us a sense of if that's your sort of entire transformation contribution in '23? Or maybe just walk us through some of the pieces, including how much of that 100 basis points from Manitowoc is embedded in the '23? Yes, let me do that. I would say roughly 50 basis points to 60 basis points comes from Manitowoc of that 160 basis point increase. So, the way that you should think about Manitowoc is we had roughly $150 million of revenue in our P&L in 2022; $60 million in Q3, $90 million in Q4. And as we mentioned before, we drive about 30% of Ross on that Manitowoc business. We'll increase to about $370 million of revenue in 2023. So, think of revenue going up about $220 million in Manitowoc at that 30% income level. We also get by exiting the residential businesses, we'll lose about $25 million of revenue in 2023, but we'll gain about $10 million of income, those were loss making businesses in 2022. So, when I talked about acquisitions and divestitures benefiting about 5% top-line and roughly 35% from a ROS perspective, that was the breakout. Okay. That's great. Appreciate that color. And then, just a quick question on the Pool side. I don't know if you quantified this, but you're talking about the channel inventory sort of coming down maybe normalizing in the 2Q-3Q timeframe. Can you quantify sort of where you see inventory levels sort of weeks and then -- or I guess months and where you would need to get to sort of get a normalized level? Yes, I'm looking at it slightly different than that. I think we've shared with you that we think we're down about 20% each on new pool builds and also the aftermarket remodeled side. So, think of that as each of those two 20% is down 20%. And then, we group the aftermarket and the inventory piece, and we assume that what we're going to see is lower pull-through from the sell-through and demand, because as Bob mentioned, we think some of the aftermarket demand was serviced earlier. And because of that, we feel like we got to balance the shipments into the channel and the industry to serve that lower demand. And most of that we think happens over Q1, Q2 and Q3. Just the inflation number, I'm not sure if you said that so far, what's the actual number? I mean, you could kind of eyeball the chart there, but just curious what the actual inflation headwind is for '23? Well, if you think about prices being about 5%, so call that, $200 million benefit, I think about inflation at 4.5% is being around $180 million. Okay. So, moderately positive. When you think about the pricing in the other businesses, anything going on there? Any kind of surcharges? Or anything moving around in the non, I guess, the more industrial businesses? No, real surcharges, Steve. We're back to more normalized price actions and having to go out and compete competitively from a standpoint of making sure that quoting those jobs by anticipating the impact of inflation, and then winning [the future] (ph) sourcing inflation as we satisfy the industrial projects. So, supply chain inflation, obviously, looked better in Consumer Solutions in Q4, but I think you mentioned productivity was negative because of a decline in revenue. I know you said you expect inefficiencies to lessen as you go into '23. So, just sort of what that happened in Q4 was just lower revenue, and do you still see that sort of $50 million of incremental improvement for manufacturing inefficiency getting better in '23 versus '22? Absolutely. So, the significantly lower volume in Q4, while we put actions in place, that's what primarily drove the negative productivity. As we look at 2023, those inefficiencies whether it was air freighting, spot buys, whether it was supply chain challenges, those will reduce significantly and, obviously, help our productivity. Those will be one area. Then, just the actions we took in Q4 around adjusting for the lower volume will benefit us. And then, in addition to that, the transformation initiatives that are starting to benefit us in 2023. Very helpful. And then, Bob, maybe the conviction level to get back to free cash flow conversion of 100%? And if you do get there, obviously, you've got some leverage here, but we've seen more recent announcements of a little bit of consolidation in, call it, the water equipment space. So, where does Pentair go from here on the M&A front? Yes, I'll definitely take the first one. We have high confidence in our free cash flow. We will benefit from working capital coming down in 2023, primarily inventories. We've established targets and are starting to chart progress. So, I'm confident around the inventory space. We'll also see benefits versus 2022 in terms of accruals and cash being paid out. So, overall, there's three or four different areas that give us confidence in the free cash flow. Historically, we do drive a 100% of net income. And when we've had a challenging year, we turn around the next year and get back to our typical path. So, high confidence there. Yes. And as far as the M&A, I mean, short term, we're going to service the debt just because of the high interest rates. We love our strategy. We believe the move and proven enjoy gives us a lot of flexibility to add to our existing portfolio. But we're going to be smart. I mean, call me old fashioned, but I think ROIC matters in the long run. It used to be how we measured performance. I still think it matters and I think we have to be disciplined with your capital. And we need to make sure if we put that capital work that we can make these acquisitions deliver to the expectations. Hey. And on Manitowoc, just can we circle back on this? One of the obvious upsides was the whole cross-sell opportunity, making sure every one of those ice machines has a Pentair filter. Just can you share with us on the take rate there? Any initiatives that you have to make sure that that process happens smoothly? Yes. Deane, first of all, I still think we think across all the synergies we said that we're going to experience those. And we do believe, as we said, there's certainly account management and making sure that we can service the key accounts across all three platforms, KBI being one of those platforms as well on the service side. We do believe that every ice machine should have a filter and we would hope that it's our filter since we think we are the best filtration company. But that has been [independent] (ph) choice, of course, made by the distributor and the end market. And I think we can help them be aware of why our filters do better and we do believe that take rate is going to be serviced over time. Got it. And then, for Bob, the idea here is you've got this whole working capital normalization happening. Wouldn't it be fair to expect that cash conversion would be well above 100% at some point in '23, just given the kind of cash conversion that you'd expect from working capital alone? We've looked at the free cash flow and certainly don't want to get ahead of ourselves. One of the pacing items is the transformation piece. So, we expect to spend less on transformation and restructuring in 2023 than we did in '22, but we still have to invest to drive the benefit. So, those will be good payback items that we spend the money on, but that is one of the items that contains the free cash flow slightly. The only other thing I want to mention on your first question relating to scorekeeping for Manitowoc is that as we drive synergies, it's all within commercial water solutions, but some of the benefits goes to commercial filtration as they sell filters, some of it goes to our Ken's Beverage as they drive more services relating to the ice machine. So, all of the synergies are not necessarily captured in just Manitowoc Ice. Just on -- just back on Pool and the destocking, I'm just wondering, one, kind of how you think of inventories on your balance sheet versus those at the distributor channel? And then, just if any early buy kind of played in any part and kind of the pacing of destocking? To the second one, and really when we think of inventories, you have -- a reminder that some of our inventories are across the entire portfolio. Our project businesses, our electronics, the tougher to get componentry is where a lot of our inventory resides, Jeff. It's not like we're sitting on finished goods inventory ready to go out. So, it's not that simple. Okay. Just on res pool, I think you put -- around Pool, you've got 28% margins in '22. How should we think about decrementals as you go through this transition and kind of where you think those margins bottom out? We expect to drive margin improvement in 2023, Jeff. I mean, as a reminder, our volume in Pool was down roughly 30% in Q4. And that's one of the reasons we didn't get to get that leverage up. And as we take a look at 2023 when we get the costs in line and balance out against these new production levels, we do believe we're going to drive margin improvement in Pool in 2023. Hey, good morning, and welcome, Shelley. So, just to couple of questions, one on the Pool, one on the commercial water treatment. I know you said for commercial water to expect sort of a mid-single digit growth this year, I'm curious does that include Manitowoc Ice on sort of pro forma... I -- no. And I'm sorry that we weren't clear. I thought the question was what was core growth of commercial water solutions, and I said mid-single digits. Inclusive, of the acquisitions, it's much higher than that, which is on the chart as mid-teens. Okay. Thank you. The other question is around Pool. So, there's a pretty big change in your assumption. I think you were looking at, thinking, last quarter that aftermarket would be about flat, and now you're kind of looping that together with the continued destock. And I'm just curious because there are more pools in the grounds, so I would have almost thought that naturally that aftermarket might have even been up this year. So, is that essentially saying that the destock is kind of more than 100% of the decline? Or am I thinking about that right? Yes. I think it's really the result of the significant growth in '20 and '21 and first half of '22 that the industry saw. And if you think about a more normalized growth, it would suggest that key items like heaters and lighting were probably pulled into those earlier years. And that is probably challenging the aftermarket assumptions. Now all of that's great, because we're adding to content in existing pools and there will be some replacement of those products down the road. So, I think long-term trajectories are fine. We just think that some of the demand was pulled into the earlier years. This concludes our question-and-answer session. I would like to turn the conference back over to John Stauch, President and Chief Executive Officer, for closing remarks. Thank you, and thank you for joining us today. We're excited about the future Pentair and focused on creating a better world for people on the planet through smart sustainable water solutions. Our focus on driving superior shareholder value is fueled by our mission to help the world sustainably move, improve and enjoy water, life's most essential resource.
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EarningCall_1259
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Thank you for standing by, and welcome to the Interactive Brokers Group Fourth Quarter 2022 Earnings Call. [Operator Instructions] I would now like to hand the conference over to Director of Investor Relations, Nancy Stuebe. Please go ahead. Thank you. Good afternoon, happy new year, and thank you for joining us for our fourth quarter 2022 earnings call. Thomas is on the call, and asked me to present his comments on the business. Also joining us today are Milan Galik, our CEO, and Paul Brody, our CFO. After prepared remarks, we will have a Q&A. As a reminder, todayâs call may include forward-looking statements, which represent the companyâs belief regarding future events, which by their nature, are not certain and are outside of the companyâs control. Our actual results and financial condition may differ, possibly materially, from what is indicated in these forward-looking statements. We ask that you refer to disclaimers in our press release. You should also review a description of risk factors contained in our financial reports filed with the SEC. The good news about 2022 can be seen in our numbers. We now have over 2 million customers around the world. We earned $3 billion in net revenues for the first time. In the fourth quarter, our pretax margin reached 71% â by far the highest in the industry. After two years of unprecedented investor interest in the markets overall, we now see some retrenchment and more localized engagement in particular product segments, like futures and options, rather than across the board. Rising inflation and interest rates â as well as geopolitical uncertainty in places around the globe â helped commodity, interest rate and stock index futures become more popular, while options were increasingly used to manage risk. Equity markets grew weaker as inflation and the impact of central bank policies took hold. After years of persistent deficit spending, with zero [and negative] interest rate policies around the world, I believe inflation is going to stay with us. It is likely to stay above 4%, and the Federal Reserve will keep rates at this level or higher, and eventually will have to give up on getting inflation down to its current 2% target. We believe that the target will be raised. Higher inflation and lower equities markets impacted our industry. For us, our year-on-year account growth was 25% in 2022. While for many companies this would be good news, we want to do better. Our ânaturalâ account growth, by word of mouth, is 10-20%: when markets go down, as they are now, that growth is closer to 10%; when the market goes up, that growth is more like 20%. Our sales efforts also add another 10 to 20% on top of that, though in the short-term, that growth can be very âlumpyâ. We still see the bulk of the onboarding of the two new introducing broker clients we have mentioned happening in the second and third quarters of this year. There is a lot of discussion today around market structure, and Interactive Brokersâ auction model for options offers customers a path to best execution. In a volatile market, options have continued to be a security of choice for investors, both to take on exposure to a security at a lower cost than buying the stock outright, and as a way to mitigate risk. Industry-listed U.S. optionsâ average daily volume was over 41 million contracts in 2022, up from under 40 million the prior year. We do not accept payment for order flow for IBKR Pro customer orders. Rather, we invite pegged to the mid-price orders by institutions and market-makers to our ATS to trade with our retail orders. Somewhat similarly, we auction off each option order among 22 top market makers and other professional traders, who give their best bids and offers for every order our customers enter. These auctions last something on the order of 100 milliseconds, and the winner chooses which exchange it wants to use to trade with the order. We then post the order for a second auction at the exchange, and if nobody improves on the price, the original winner of the auction trades the contract at the previously agreed upon price. This all happens in a fraction of a second. All participants use automated processes, and they automatically feed the amount of price improvement they are interested in competing on for any specific option contract, at that specific time, to trade with. This competition to win the auction means our customers can take advantage of a leading-edge system designed to get them the best available price. We are now going to enhance this system by enabling our own customers, who are so inclined, to participate in this process on the market-maker side. We are going to give them an order type with which they can signify the option or options they want to buy or sell, and when we receive an opposing order, we will bid or offer on their behalf along with the market-makers. They will also tell us the price relative to the floating mid-price, the middle of the bid/offer spread, that they are willing to pay up to and our software will do the bidding for them. We still have some minor details we must work out with this project but we are hoping to be able to introduce this capability to our customers by the end of this month. We are at the cutting edge of this best execution through auction process. We were the largest market makers in options for over 30 years, so we are very well-versed in these processes, and we have been keeping them up to date over the years. With the potential for a new regulatory process, in addition to new exchanges and continuously evolving new rules, we have a team of programmers regularly engaged in this activity. If some similar method becomes required, sophisticated mechanisms like the ones we use, could take a long time â and great expense â for others to create. There is a lot of debate on this, but we will be good with whatever ends up being the outcome. By the way, we are always happy to welcome more market makers to our platform â we added another 4 this past year â so please get in touch if youâd like to join us. We introduced more new products and expanded the capabilities of existing ones. Recognizing our global customer reach, we introduced GlobalTrader, a streamlined version of our platform for mobile devices, which allows our clients to trade in over 90 stock markets worldwide. We continue to enhance our options trading tools, from mobile options trading to our rollover options tool, Strategy Builder, and Probability Lab. We will be upgrading our platform with more features and capabilities. We are introducing new tools for financial advisors, ones they have been asking for and that will set our offering apart as best in its class, as well as being among the lowest cost for an advisor to use. We are also adding new countries where our clients can trade. We were pleased to receive our bank license in Hungary, and plan to make it operational in 2023. Unlike in the US, customer funds on deposit with an EU broker, may not be used to finance margin borrowings by other customers of the broker. Only banks can lend their customersâ funds to other customers, no matter what kind of collateral is involved. Our primary purpose with this EU bank is to facilitate such financing. There is much to look forward to. The Interactive Brokers platform is built with the purpose of bringing investors and marketplaces together all over the world, optimizing the allocation of capital and resources. It is our job to develop the best tools and capabilities to facilitate that. We are as busy programming as weâve ever been. This, and our much lower cost structure, is what sets up apart, and will continue to do so in the years ahead. Paul? Thank you, Nancy. Welcome, everyone, to the call. Iâll review our fourth quarter results, and then will open it up for questions. Starting with our Revenue items on page 3 of the release, we are pleased with the record financial results we achieved this quarter. Commissions rose versus last year, despite declining global market indices, reaching $331 million, our third-highest quarter ever. For the full year, commissions were $1.3 billion, down only slightly from 2021âs âmeme stockâ spike in trading. We saw higher trading volumes in futures and options in 2022, coming from our large base of sophisticated and active traders, investors and advisors. Net interest income of $565 million for the quarter and $1.7 billion for the year reflected increases in benchmark rates worldwide. US rates have moved from an average effective rate of 0.08% in the 4th quarter of 2021, to 3.65% in the 4th quarter of 2022. This led to higher interest earned on margin loans and our segregated cash portfolio. These were partially offset by the higher interest paid to our customers on their cash balances, as Interactive Brokers passes through to them all rate hikes above the first 50 basis points on their qualified funds. Other fees and services generated $43 million for the quarter and $184 million for the year. The drop from the prior year quarter was driven primarily by the risk-off positioning of customers, which led to a reduction in risk exposure fees from $18 million to $6 million. FDIC sweeps fees rose to $3 million this quarter, while market data fees of $18 million and exchange liquidity payments of $9 million were both off 10%. Other income includes gains and losses on our investments, our currency diversification strategy and principal transactions. Note that many of these non-core items are excluded in our adjusted earnings. Without these excluded items, Other income was $19 million for the quarter and $39 million for the year. Turning to expenses, Execution, Clearing and Distribution costs were $90 million in the quarter, and $324 million for the year. The increases were led by lower liquidity rebates; a nonrecurrence of 2021âs options fee reductions and âfee holidaysâ from unusually high volumes throughout the industry; higher futures volumes, which carry higher fees; and an increase in the SEC fee rate on US stocks and options. As a percent of commission revenues, Execution & Clearing costs were 21% in the fourth quarter. Note that we report Market Data expense, a pass-through item, in âExecution, Clearing & Distribution Feesâ, while the corresponding revenue item, Market Data revenue, is included in âOther fees and servicesâ. To align the volume-based costs with commissions, we look at Execution & Clearing costs ex-market data expense. Compensation & Benefits expense was $119 million for the quarter, for a ratio of Compensation expense to Adjusted Net Revenues of 12%. For the year, this ratio was 14%, unchanged from last year despite a 10% increase in headcount. We continue to focus on expense discipline while improving our strong top line. Our headcount at year-end was 2,820. G&A expenses were up from the year-ago quarter, primarily on higher legal expenses from relatively low numbers last year; though for the full year they were down 6%, reflecting the non-recurrence of Brexit-related costs and a reduction in consulting expenses and bank fees. Our pretax margin was a record 71%. Automation and expense control, along with prudent management of our balance sheet, remain our key means of maintaining high margins, while we continue to hire talented people and invest in the future of our business. Income Taxes of $56 million reflects the sum of the public companyâs $31 million and the operating companiesâ $25 million. For the year, taxes of $156 million are the sum of the public companyâs $87 million and the operating companiesâ $69 million. Moving to the balance sheet on page 5 of the Release, our total assets ended the year at $115 billion, with growth driven by higher customer cash balances, partially offset by lower customer margin lending. We maintain a balance sheet geared towards supporting our growing business and providing sufficient financial resources during volatile markets. We have no long-term debt. Our ample capital base is not only deployed in running our current business, it helps us win new business, by showing the strength and depth of our balance sheet to current and prospective clients and partners; and it positions us to capture numerous growth and investment opportunities we see worldwide. In our operating data, on pages 6 and 7, our contract volumes for all customers rose 23% over the prior-year quarter in futures, well above industry growth. Options contract and stock share volumes declined versus unusually high volumes last year. For the full year, options and futures contract volumes rose 3% and 33%, respectively. The decrease in Stock share volume was largely attributable to lower trading in pink sheet and other very low-priced stocks. On page 7, you can see that: Account growth remains robust, with 415 thousand net new account adds for the year. Total accounts broke through the 2 million mark in 2022, closing the year at 2.1 million, up 25% over the prior year. Total Customer DARTs were 1.9 million trades per day, reflecting a risk-off period for investors and down from last yearâs stronger market environment. Commission per Cleared Commissionable Order of $3.15 was up 32% from last year, as our clientsâ volume mix included fewer low-priced stock trades and larger average trade size in options. Page 8 shows our Net Interest Margin numbers. Total GAAP net interest income was $565 million for the quarter, up 92%, and $1.7 billion for the year, up 45%. These reflected strength in margin loan and segregated cash interest, partially offset by higher interest expense on customer cash balances. The Federal Reserve raised interest rates twice in the quarter, by 75 basis points in November, and a further 50 basis points in mid-December. These increases had a partial positive impact in a 12-week quarter, but will have a full impact in the first quarter of 2023. Other central banks also raised rates this quarter, including the UK, Hong Kong, Canada, Australia, the Eurozone and Switzerland. Higher interest rates led to margin loan interest income up 32% over the third quarter and 182% over the prior-year quarter, more than compensating for lower average balances in both periods. Securities lending net interest was not as strong as in the prior year for a few reasons. First, while overall customer demand for shorting stocks and borrowing shares rose, there were fewer âhard to borrowâ names throughout the industry. Second, benchmark rates are rising. The interest we earn on cash collateral received in exchange for lending stocks is also rising. Thatâs good news. Because this cash collateral is invested as segregated funds, the interest earned on it falls under the heading âNet interest income on Segregated Cashâ in our NIM table, rather than âSecurities Borrowed and Loanedâ. We estimate that the incremental interest earned on this stock loan cash collateral from rate increases was $42 million for the quarter. Interest on Customer Credit Balances, or the interest we pay to our customers, increased. Higher rates in nearly all currencies led to our paying interest on qualifying balances as we pass through these rate increases to our customers. We paid $487 million to our customers on these balances in the fourth quarter, and a total of $763 million for the year. Fully rate-sensitive balances were about $20 billion this quarter. Now, for our estimates of the impact of increases in rates. Given market expectations of more rate hikes to come, we estimate the effects of increases in the Fed Funds rate to produce additional annual net interest income as follows: At 25 basis points, an increase of $49 million; at 50 basis points, an increase of $97 million; at 75 basis points, an increase of $146 million; and at 100 basis points, an increase of $195 million. Note that our starting point for these estimates is December 31st, with the Fed Funds effective rate at 4.33%, and our balances at that date. About 25% of our customer segregated cash is not in US dollars, so estimates of US rate change impacts exclude those currencies. We estimate a 25-basis point increase in all the relevant non-USD benchmark rates would produce additional annual net interest income of $25 million, and rising to about $100 million at a 100 basis point rate increase. In conclusion, we had a financially strong quarter to close out a record year in net revenues and pretax margin, reflecting our continued ability to grow our customer base and deliver on our core value proposition to customers. We have done this while highlighting the attractiveness of our strategy to automate for growth: expanding what we offer while minimizing what we charge. We do this at low cost, managing our growing business effectively and with strong expense control. I guess my question, Thomas had to do with the introduction and how you talked about Interactive Brokers technology being so adept, I guess, in the options auctions. And I guess the question is, okay, it looks like we could have auctions implemented into equities. And could you just talk about if thereâs any first impressions of what the SEC has rolled out? And what do you think is the impact? And would you have that sameâ I guess youâre saying you have that same advantage of the experience of the auctions from options and can apply it to equities. Is that what the message was? Yes. So, I havenât heard anything, and I do not expect that the SEC will require an auction process for options. But to the extent that they will do so for securities, I think that gives us a great leg up in marketing our auction process for options because obviously, if auctions are good for securities, they are good for options, too. As a matter of fact, the fact is that it is better for optionsâ because on options, the bid-offer spread is relatively wider than it is in securities. So, a $3 option that really costs, say, $300 for a contract, the bid-offer spread is often as wide as $0.05 to $0.06 or $5 to $6 on a $300 trade, right? So, a facility whereby the participants can meetsomewhere in the middle and the spread is saved to our two customers on each side of the trade, I think itâs a huge leg up and we can market the hell out of it. Thatâs the idea here. I guess just a quick follow-up on that, but you donât consider the options price improvement sort ofâ I thought those were called auctions, but you donât consider them equivalent to what the SEC has sort of outlined at this point? Well, it is equivalent in the stock space, but I havenât heard them talking about options. But we are basically proposing to do the same thing in options as they may require for stocks. Okay. And one other financial analysis question. Paul, can you give us sort of expectations for expenses in the coming year? It looks like the adjustedâI think if our number is right, somewhere about 15% year-over-year increase in expenses this year. Is that a good number to sort of use as a benchmark or rule of thumb for 2023? Yeah, I think our increaseâ I think weâre going to increase expenses roughly 15% a year as we have done in the past. We continue to grow. We continue to come up with new things, and we continue to pay to attract new talent. But as long as our expenses donât increase any higher than our revenues, I think weâre going to continue to run at around 70% profit margin, and thatâs good enough for us. So, if we exclude the two large introducing broker wins that are going to start funding in 2Q, how does the future i-broker pipeline look? And could you announce additional large i-broker wins over the course of the next year? Could weâsure, we could. The question is will we, and I am not so sure we will. I mean, obviously, we have a lot of people out there who are trying to recruit i-brokers and the more we get on the platform, the more they will hear about it and the more of them will come to us. The idea basically is that worldwide, it is very difficult to create a system that is compliant with all the regulations all over the world. And so we have a huge leg up in having done so, and I think we donât have anyâ basically, I donât think we have any serious competitors in this space. Got it, Thomas. And then just for my follow-up, I heard Paulâs comments on higher legal expenses in G&A. Should we assume part of that as onetime as we workâ¦.? And Iâm just thinking, is there a good number for us to work off for 1Q â23 relative to the $48 million in 4Q? Legal expenses getâ they go up, they go down, cases come by, regulatory things come by. Maybe the bestâ the most realistic thing you could look at is on the year as opposed to on the quarter. I kind of wanted to follow up on the spending, but maybe kind of a higher-level question. Can you maybe talk about some of your strategic priorities for this year? I think in the past, youâve kind of indicated the more geographic expansion, digging deeper into the hedge fund business. Where are you kind of focused in terms of spending, your top priorities? Thanks for the question. We are focusing on making our systems more robust. The more i-brokers we get on the platform, some of them being large multinational banks, they require a very high level of reliability and redundancy. We have had back up data centers, online, available to us for a long time, but we are not able to turn them on in a matter of seconds or minutes. So that is where significant expenditure is going to go. As far as growing the staff, weâre going to be flexible in the area of compliance and customer service, and we will respond to the increase in the number of accounts and the trading activity. As far as the technology is concerned, we will continue hiring the talent as we have in the past. Great. Super helpful. And then if I could follow up on kind of a comment you guys made earlier on â I know you said that the account growth, thereâs kind of a mix between natural word of mouth and sales, which can be quite lumpy. Iâm just wondering kind of in the most recent months, what has been the mix. Has it been sort of even or more geared one way or another? Thomas, I wanted to get your thoughts on just the elevated use of options as well as futures and maybe the sustainability of that as you think about 2023 and whether weâre above average, below or you think we can still grow from here? So, as you know, I started my career in this business as an options trader on the floor of the AMEX, and all I have seen over the past 46 years is a continuous increase in options trading. And what we see now is in addition to the U.S. growth, growth is now beginning to pick up in Asia and in Europe in the options space because they basically got into the options business about 20 or 30 years ago and then it slowly dwindled down to nothing over there. And now it is finally picking up again. So, I am extremely optimistic about the growth in options trading. Obviously, if you just look at the idea of doing vertical spreads, when your losses are very limited, and you can put on some terrific positions in vertical spreads, itâs much better than trading stocks. Good evening. Maybe just a follow-up on the commentary earlier regarding the sales effort adding 10% to 20% to account growth per year. Iâm just wondering is that, with the current sales team and marketing budget and when we think about that 15% expense growth, is sales and marketing an area youâre prioritizing? Iâm just wondering like, bigger picture, are there larger changes in advertising strategy that youâre contemplating, I guess, as you look out to next year? So, weâre working this across the board. Weâre continuously trying to train new salespeople who basically come to begin working on our professional help desk. And after they went through that for about 2 or 3 years, they are mature enough to bring onto the sales team and begin to sell. As far as advertising, as you know, itâs the digital advertising space, itâs a situation in flux to the extent that I am in a flux trying to talk about it. So basically, what Iâm saying is reflecting whatâs going on there and the way I say it. So, weâre continuously working on it, and we do not have budget constraints anywhere, but we are trying to get a good return on the investment. So, we are not going to throw a lot of money on various campaigns unless we see that it proves itself. So, we try small and if it works, we keep trying to get it bigger and bigger and bigger. But usually, as we find it â when we start something, it starts working, and as we keep growing, it works less and less. I donât know why that is so, but thatâs how it is. So, we have a lot more, we would love to spend a lot more money advertising, but we wonât do it without having a reasonable return. Understood. Maybe I shift over to NII. Just curious, strategically speaking, if we start to see the central banks cut overnight rates potentially by later this year, does that change your strategy on the duration of the segregated cash portfolio at all? I guess if we do start to see that move, I guess, does that change your viewpoint or is what you said earlier? It is a risk we cannot take because if youâre right, weâll actually make extra money. But if weâre wrong, we can lose a fortune because as rates go up, we have to raise the rate that we pay to our clients. And we donât want to be a situation where we are lent out on the long end and weâre borrowing on the short term from our customers. So, we can get creamed that way, and we will not do that. Understood. And last question for me. Itâs just the yield on customer credit balances that youâre paying out the clients came in a bit lower than we expected. Paul, I know you said $20 billion is the fully rate-sensitive cash figure. I just want to confirm that $20 billion figure, does that also include balances that are partially rate sensitive within there? I just wanted to confirm that. Right. I mean it includes the equivalent of the fully sensitive balance, right? So, we pay a pro rata portion of our full rate on accounts that have between $10,000 and $100,000 in equity. Weâve calculated the equivalent effective principal on which the full rate would have been paid right? So, itâs a good number to assume theyâre fully sensitive. Yes. And the interest rate sensitivity that you gave earlier, Paul, I just want to confirm as well, that does not include, Iâm assuming, the additional interest that youâd also earn on corporate cash balances. Is that correct? No, it does assume that both the customer side and the investment side move together, right? And we have quite a short duration. And so those are fully absorbed run rates, but it wouldnât take us that long to get there as rates move around given that our duration is short. I was wondering if maybe you could give some color just in terms of the account growth â were there any strength in any particular customer segments or regions relative to any others this quarter? Well, look, our fastest account growth is individuals, followed by prop traders, followed by hedge funds, followed by i-brokers, and lastly, financial advisers. So thatâs the relative rate of growth. And that is for the last 12 months, so I have not broken this out for the last quarter. Butâ so look, basically, probably the last quarter, hedge fund growth is probablyâ yes, that is unusually high. And we donât do as well with financial advisers as we do with hedge funds. The software development that Milan mentioned having to do with financial advisers is meant to better that growth rate. Yes, I think itâs to a large extent, this is a word-of-mouth game, right? And it just so happens that we are doing very well among hedge fund people, and financial advisers are more or less locked up to the extent that they are associated with Morgan Stanley and UBS, they are locked up there. To the extent they are independent, they are with Schwab and Ameritrade. And so, they are not as easilyâ and there are not so many new of them that start, right? So, it is a more difficult task to get new financial advisers than it is to get hedge funds. Got it. And is there any way you guys can frame out the Hungary bank license, what that might mean just in terms of the inability to fund margin loans in Europe, EU right now, what the demand would theoretically beâ any way to think about that? Margin accounts, currently, we cannot use customer monies to lend out to other customers in the EU, and we have roughly a similar demand in the EU as we have in the U.S. for that. And so, we are currently using our own money. In the future, we will be able to use other customersâ money. Yes, sorry. First, just a couple of quick accounting follow-ups. Paul, you said that -- I thought you said that the market data expense went into execution and clearing. I didnât get the number. Can you give us the amount that went into the execution and clearing expense? Right. So, the line item is called âexecution, clearing and distributionâ, where the distribution is really distribution of market data. What I was pointing out is that when we talk about the expense portion of executing a trade about 21% cost versus the commission that we earned. And in order to get a reasonable number there, an accurate number, you have to pull out from the line item, market data, which doesnât go into commission, it goes into the Other income line. Thatâs how itâs paired up, right? Itâs marginally profitable every year because thereâs a little bit of markup and some estimates on how we have to estimate our costs and pass through. But in other words, what I was pointing out is to get rid of the noise when youâre thinking about the marginal gross profit that we get when we execute a trade and earn a commission. Not especially other than, as I said, legal fees go up and down. They were up a bit higher this year, but they were especially low last year. So, itâsâ as I said, nothing else of note and itâs better to look at probably the whole year to understand something more about our run rate. Okay. And then the last question is I believe the sensitivity, the interest rate sensitivity for the 25-basis point rate hike is smaller than it was what you said it was last quarter. I believe it was $54, going down to $49. If I do have that correct, can -- I know margin balances are down, but is that just the prime culprit because seg cash balances are up and -- Iâm just trying to get why is it down. Right. So, thereâs a few different scenarios that we talk about. If we assume that all currencies, understand itâs a hypothetical case. If all currencies raised rates together, the numbers are actually up from last quarter, the projected numbers are up. When we assume that the USD onlyâonly the Fed funds will increase, and other currencies will not, what happens is that thereâs an overlay of currency swaps because in order to protect customer money for the U.S. customers when we receive other currencies, we swap them into U.S. dollars and put them into segregation, and thereâs a cost to that. And when the USD rates go up, that cost goes up. And so, as you project out a higher interest rate increase only in the U.S. dollars, there is some offsetting effect that would tend to dampen the incremental number at any given increaseâ 25 basis points, 100 basis points. Congratulations on the quarter and the year, very strong progress. My question is around providing an update on your efforts to attract larger institutional customers to interact with your order flow. And I was wondering if some of the talk about the changes in potential market structure, is that helping to drive some further discussions with other clients as well. Yes, we continue to attract institutional traders into our ATS. They have at their disposalâ they have a number of order types they can trade against the client flow that we have. They can use peg to mid orders, they can use pegged best orders. We will continue the effort to get more onto the platform. We are approaching various algorithmic trading firms and algo providers. We believe that they would enjoy the quality of the flow that they get to interact with. As far as the upcoming changes that the SEC announced â to put them into perspective, the comment time period ends at the end of March. There are going to be a lot of industry participants responding to the proposals, we will submit our own comment letter. After that, itâs going to be decided what will finally get accepted and adopted, and I think it is going to take approximately 2 years for any change to take place. Now as to what exactly is going to happen in the area of auctions, it somewhat depends, because the details were not really specified. What we do know is that some percentage of the retail flow will have to be exposed into the exchange auctions. This is typically a flow of clients that trade around 240 times in 6 months. So, these are not frequently-trading accounts, and their flow is going to be subject to auctions. But there is a way around that. If a broker holding this order does not want the order to go into an auction, he can fill it at the mid-price, at the mid-price that he can find somewhere at an open market, or at an ATS or in a dark pool, or he can fill it against his own inventory. Now, exactly what the limitations are going to be is unclear. The SEC may have a preference for a very large portion of these orders to go into the auctions, and limit the number of orders that the brokers can fill outside of the auctions. We donât know the details. And I think all this is going to be cleared up after the industry has time and opportunity to respond, and the SEC carefully evaluates the responses. Thank you, everyone, for participating today. As a reminder, this call will be available for replay on our website, and we will also be posting a clean version of our transcript on the site tomorrow. Thank you again, and we will talk to you next quarter end.
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EarningCall_1260
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Good afternoon everyone. This is Therese Byars speaking and I'm the Corporate Secretary of FRMO Corp. Thank you for joining us today for the Company's 2023 second quarter earnings conference call. The statements made on this call apply only as of today. The information on this call should not be construed to be a recommendation to purchase or sell any particular security or investment funds. The opinions referenced on this call today are not intended to be a forecast of future events or a guarantee of future results. It should not be assumed that any of the security transactions referenced today have been or will prove to be profitable or that future investment decisions will be profitable or will equal or exceed the past performance of the investments. Today's discussion will be led by Murray Stahl, Chairman and Chief Executive Officer and Steven Bregman, President and Chief Financial Officer. They will review key points related to the 2023 second quarter earnings. A replay of this call will be available on the FRMO Corp.'s website until the summary transcript is posted. Okay. Thanks Therese, and thanks, everybody, for joining us today. Before I start talking about FRMO I just wanted to acknowledge the ultimate founder of FRMO was an attorney called Lester Tanner and he passed away a couple of days ago and Sunday was his funeral. I just want to acknowledge him. He was just an incredible unbelievably brilliant and warm human being and we probably wouldnât have even have an FRMO Corporation, and in fact I should say probably we definitely wouldnât have an FRMO Corporation were it not for his leadership and insight, and if we had more time I would tell you about his just amazing wife which he did amazing things even in retirement. So I just wanted to acknowledge him as a human being. He will be sorely missed. He was a great guy. He is one-of-a-kind and we're going to miss him dearly. Anyway, with that, we're never going to forget him and we shouldn't and I'll go into FRMO. So as you can see, the quarter was pretty good, at least I think so. We have -- this is FRMO's itself shows equity of $224 million which I believe is a record. We've got plenty of liquidity. We've got $36 million in cash. We have de minimis or at least I think it's de minimis amount of debt. That debt incidentally leads to a building which is the building that houses our investment in HashMaster one of our various cryptocurrency investments and more about that later. The thing I want to focus on for the quarter is the development of our strategy in currency. I'll first touch on Horizon. So Horizon itself has done pretty well. Horizon is for the year closing December 31, 2022 we collected a number of performance fees and a fair amount of net income, therefore that's going to spillover in the revenue in next quarter FRMO because you will recall we have our revenue share. And there's also some investments in FRMO and there are very comparable investments in Horizon, so they are going to have very similar kinds performance so expect some good news over there. And you'll recall that everything is reported with regard to Horizon with a lag. So in our next quarter which for us is the calendar ending February 28, the Horizon information is going to be included as of December 31, just to your edification, and I know we've said this many times before, but just to bear that in mind, so there's always a lag. So right now from a Horizon point of view, we're reporting things that are really September 30, as if they happened on December 31, because this was a bit of information we had at the time we did these financial statements. And the financial statements for us let's not forget, as of November 30. Now our cryptocurrency strategy you will recall we entered cryptocurrency you might say gingerly and we were particular in maintaining that posture in the past year. In the past year other than may be the last week or so, cryptocurrency led by Bitcoin, basically declined endlessly. The cryptocurrency mining machinery declined even more and the cryptocurrencies declined more than Bitcoin. The reason for that is, and we'll cover it later, there are three vectors that really govern the price of cryptocurrency particularly Bitcoin. And you can bid cryptocurrency up, but you have to be very cognizant that's a function of the always upcoming halving, the halving, that we're to have halving basically means that the block award for mining Bitcoin is going to be cut in half, that's why they call it halving and that's cutting about 470 days. In the case of Litecoin I think it is a 198 days if I'm not mistaken. And you're always in a world of mining where you should always be preparing for that. And in the prior year people not only didnât prepare for it, they didnât realize that as we approach the halving the equipment used for mining is just worth less money. So the idea of bidding up crypto mining equipment is a very bizarre idea and we did very little in the world of investing in crypto. Now you can say more or less the market is properly discounting the halving. So we're much, much more favorably inclined to crypto. Now in our cryptocurrency exposure, apart from the crypto we own directly and indirectly in the funds, we have four cryptocurrency investments. I'm going to just mention them, because we don't really highlight these things in the financial statements. One is called consensus mining, that is the merger and the capital raise of the original HK cryptocurrency mining partnerships and we did an offering. That offering is going to be listed in tradable and not in the distant future I'm guessing, but I'm thinking 60 to 75 days from now, maybe sooner. So consensus mining watchful trading and we own some shares of that, and there is Winland, which we used to call Winland Electronics, now it's called Winland Holding because it's holding a variety of cryptocurrency investments. I will read all our cryptocurrency figures and our investment figures in our moment. We own 7.1% interest in HashMaster. HashMaster is a number of things. HashMaster is a mining repair company, mining crypto repair company. It's also a hosting company for mining, so it's our default mining site. So we don't want to or we cannot, or we'd find it disadvantageous to be in certain other sites, kind of we retreat the HashMaster. We've done that more than once when we couldnât get terms that we need and of course that company repairs our equipment. And also there's some HashMaster mining for its own account that goes on there. And lastly we own an investment in Digital Currency Group which is a long-term investment for us and since we bought it, it's done fairly well. And then we have the following investments now, I'm going to mention TPL in a minute, but let's go through the various cryptocurrency elements. So we have -- first we'll read, this is where you, from a list obviously, these are the holdings we have so to speak implied, mean our pro rata share via partnerships. We have 596,936 shares of the Bitcoin Investment Trust, GBTC. We have 4287 Ethereum Classic Investment Trust, ETCG is the symbol of that. We own 27,186 shares and Bitcoin Cash Investment Trust always fund the Grayscale as part of cryptocurrency group, BCHG is the symbol. We own 616 shares of Grayscale Zcash Investment Trust, ZCSH is the symbol and we own 6582 shares of Litecoin Investment Trust. We own 227 coins of Bitcoin Gold, we actually own that directly that was a fork from the Bitcoin we own directly and which has owned the funds held directly. We have 139.6 actual Bitcoin or which we might. We also own directly 7647 shares of GBTC the Bitcoin Investment Trust. We own 18 shares of the Ethereum Classic Investment Trust. We own 40 shares of Bitcoin Cash Investment Trust all directly, 283 shares of the Litecoin Investment Trust. We own 1763.5 actual Litecoin that we mined. This is in FRMO itself. We own 35 Ethereum that we mine. You can't mine Ethereum anymore because it went to proof of stake, for proof of work. We own 661.7 Ethereum Classic coins. We own 6.7 Bitcoin Cash coins that we mined and we own 62 Zcash coins that we mined. Now we own 30.8% as of the last reckoning of Winland, now called Winland Holdings, formerly known as Winland Electronics. So, what I'm going to do is, I'm going to read you what Winland owns and you can multiply by 0.308 and get the right number. So this is what Winland owns, I think it's relevant. 63.3 Bitcoin, all which it mined, 7.4 Bitcoin that we didnât mine. We actually bought it. 14.9 Litecoin that we bought or acquired in various ways. 53.5 Zcash that we acquired in various ways including purchase. One Bitcoin Cash coin. 8.7 Bitcoin Gold got that out of the fork and 9.4 Ethereum Classic that we actually purchased in the marketplace. And remember we own, this is FRMO 30.8% of Winland. In terms of Texas Land Trust, which is our biggest investment at the moment as you well know, we have direct holdings of 7,449 shares and indirect holdings basically in various funds everything from Polestar to HK Hard Assets. We have 52,224 shares and you can add them and you can multiply by price and you can see what it's worth. Those are our investments. Now the point that I want to make is, and may be there'll be some questions about crypto. So there are some similar events that happened or are in the process of happening crypto that I think are very positive. So I'll mention those things and I'll make some comments about Horizon and maybe we can go to the questions and answers. So the CBOE, Chicago Board Options Exchange, you will observe now has a digital asset exchange. It's really important to the future of crypto SBS spot, regulated market for crypto in order for crypto to be an accepted asset class. And that's in the process happening. Obviously it's going to start small because it is in test mode, but the regular exchange CBOE already has a digital asset exchange. Before very many months elapse, I personally expect other exchanges to have digital asset exchanges as well. CME of course already has some Bitcoin features. The Banks for International Settlements some number of weeks ago announced that they are because they are quasi-regulator of banks around the world it is now possible to have 2% of a bank balance sheet to be crypto. Now there are some pretty big banks in the world. Can you imagine if 2% when the bigger banks were crypto, can you imagine if 2% of the bank were Bitcoin what that would mean for the price of Bitcoin, well that's in the process of happening. Now digital assets mean a lot of different things to a lot of different people. There are already digital assets that need to trade that can trade. I'll give you some examples. Airline miles, lot of people in this call probably have airline miles, might donât even know they have them, have airline miles, maybe have no intention to use them. There is no reason that those can't trade on a regulated exchange and there is no reason why they can't trade in the form of being paired with the appropriate cryptocurrency whatever it happens to be. Loyalty points, coupons, CBS, Walgreen, just examples. There are many, many retailers that have these things. You may not wish to use them, you may not know you have them. When on a Blockchain you'd be able to look it up, if they were put on a Blockchain. And they were in the process, all these assets I'm going to refer to, or I've just referred to, are in the process of being put on Blockchains and they will be paired with various cryptocurrencies, and they will be traded on the exchanges. So credits may be you subscribe to some service online that you never use. They debit your credit card every month. Maybe somebody wants that service. Maybe you can sell that service to somebody else, that's a digital asset. So there is no shortage of digital assets that have yet to be truly digitized in the cryptocurrency sense of the word. All of that is in process of taking place. So we expect really similar developments in the world of crypto in the not-too-distant future. Now you might have observed that in Horizon we have a little ETF that we started called the Blockchain development ETF and if you look very closely you'll see a lot of that ETF is probably traded exchanges and there is a reason for that. So we can't introduce cryptocurrency especially in digital assets in the sense that I just referenced without having regulated exchanges. It's a recipe for disaster. The regulated exchanges have to be properly set up to do these things and that takes a lot of doing. So all the process of happening. So, I personally predicted, it might sound like an outlandish statement, but the day will come when cryptocurrency is going to be the biggest traded assets. I would compare it as think back half a century the Chicago Mercantile Exchange. At that time it was a mere commodities exchange. And as a mere commodity exchange you trade less commodities as it does right now. For example, Bitcoin is a commodity and there was no record of that in the early 70s, 50 years ago. In any event currency became currency futures I should say became tradable. If you go back to the Wall Street Journal at 50 years ago and look up the day that currency future started trading because you always have gone to a bank and exchanged your currency, could even have done a forward swap at a bank. So you didnât technically need a future, but we ended up having futures. If you were to read the op-eds in the Wall Street Journal on the day currency futures started trading in the CME and you were to cross out the word currency futures and write in the word cryptocurrency, you could publish that article today. The same things people said then we're saying now. How much bigger is currency futures than commodities and how much bigger is bond futures and currencies? No one thought about futures although they needed it 50 years ago and now we have it. Look how big it is. I think I hope I'm right about this, I'm doing this memory so forgive me if I misstated slightly, I don't think I'll be very far off. I believe that commodities account for about 7% of the revenue of Chicago Mercantile Exchange. So growth in exchanges would not have been possible without bigger asset classes and new asset classes and we had them. They were unimaginable 50 years ago. Still it's hard to imagine Cryptocurrency as an asset class being respected and a larger institution having a cryptocurrency allocation of varying sizes might be in its coming. So I think cryptocurrency has an extremely bright future and I invite your questions on that. I would just like to interject a tiny bit of color. You can do it better yourself, but you decided to be efficient with your time which I think you might need to be with all the questions. But indeed at the time that CME was proposing currency futures, it was actually fought by many responsible people including policymakers that number one it would be illegal and if it wasnât it should be because it could actually be dangerous for the entire financial system. It could undermine the sovereignty of nations. That was the kind of discussion or rhetoric that was going on at that time. Yes that was the argument and just to give you a little bit more color, we have so many questions, I want to make sure I get to them and deal with all of them, but to just give you a little more color on that point, there were many reasons why it, they thought it would undermine nations. So I'll just give you two. One is, you're buying a future. It could be argued and it was argued at the time, you're betting on the future value of a currency relative to another. So if you're betting on the future value of a currency relative to another, which say, we don't even think about that, that's a standard and prudent hedging practice. 50 years ago they said that was gambling and of course, 50 years ago gambling was illegal. So was gambling really illegal or was hedging your currency exposure illegal? Today I think we can state without equivocation that the authorities effectively, although intent might have been related to gambling, their intent was different than what actually happened. They didn't want to make prudent hedging of currency exposure illegal, but that's what they did. It was impossible to hedge your currency exposure. For companies, like we had in the United States of America they were branching out internationally. So if you thought about it in the forward-looking sense, the companies are branching out internationally, there's going be a need to hedge their currency exposure. Couldn't do it without getting yourself arrested. It's amazing, but that's what people said. And then of course the idea, remember this is the early seventies, the United States was not yet off the gold standard. The idea was no currency should be allowed to float because a nation needs to control the price of its currency. Experience informed us during the seventies with the inflation, no nation was a, was ever able to truly, really control the value of its currency relative to other currencies and they basically gave up. And then suddenly they gave up pricing their currencies in gold. So currencies no longer had the fixed reference of gold and they basically gave up on fixed currencies. So that change, put yourself in the position of policy makers in that era to give up fixed currencies in that era it's a much bigger change, a much bigger sea change and simply allowing cryptocurrencies today. So what we ask for in cryptocurrencies is de minimus relative to what actually happened. It was earth shattering at that time. So anyway, I was going mention HK Hard Assets is the last thing, and we'll take the questions. So HK Hard Assets, we're building it up. Remember its purpose is to be, to get other investments not revealing what the investments are and we are approaching the $4 million mark in money in HK Hard Assets. Who's in HK Hard assets? FRMO, me, a company called Horizon Common, some other partners in Horizon. So we've just started ourselves and we'll build it up in the way we built HK Hard Assets to up, designed to benefit from inflation and I think that's happening. Oh, I have to make one other, yes, I forgot, and one other thing which I should have said at the beginning, so you might know that we in FRMO have an investment in the Mesabi Trust. And I didn't know this until a couple days ago. This is an odd fact about the Mesabi Trust. So I'm not really talking about the Mesabi Trust in its investment sense. In 1962, the Mesabi Trust was listed. It's Mesabi Trust is the kind of investment we like, which is it just collect revenue, it doesn't really have any employees. In 1962 to list at New York Stock Exhange was considered to be extraordinarily controversial. And I am reliably informed by people who know about this subject that the SEC had objections to listing such an enterprise on the New York Stock Exchange. And you could see it from their point of view, it's not really a business of course. It is a business and the way I look at it, and of course it is listed in New York Stock Exchange and has been for more than half a century and it's now no longer controversial. However, the attorney representing the Mesabi Trust to get it listed was none other than Lester Tanner, the founder of FRMO, so a little bit of irony there. It shows you something about the circle of life. We touch each other in ways that we don't realize. I didn't know that until a couple days ago. Anyway, I'll leave you with that thought. And unless you have something to add, Steve, could we go to questions? Okay Thérèse, if you could facilitate that, read the question and we'll endeavor to give the best answer we can to the subject. It will be my pleasure. The first question, what are the revenues that FRMO receives from its ownership interest in HK LLC revenue stream that is valued on the balance sheet at $10.2 million? Is this figure a straight flow through to FRMO's bottom line or is it offset by any cost/taxes? Now this does this figure very much. Do you want to answer? There's more, but⦠Well, let's do that. So let's do it this way. We're getting, it's, I remember the number exactly, we're getting a little bit less than 5% of HK's revenue. So it varies with HK's re revenue and HK's revenue varies in a couple ways. One is, sometimes you get performance fees and sometimes you don't get performance fees, so it varies that way. It varies with market value fluctuation of the assets we manage and of course it varies with the clientele. So there's no tax offset or anything else. So what you get is what you get. There's no -- we don't take anything out of it. It just is what it is. So you apply the pro rata figure to whatever the gross revenue is for that quarter. And the fourth quarter, as I said earlier, can be a big quarter with performance fees. This is the fourth quarter Horizon or it just passed. And we have a respectable amount of performance fees. So we'll have an unusually large revenue to report in February 28th mostly coming from Horizon. Now was there a question about HK Hard Assets? I think they meant Horizon. So⦠Yes. The only thing we get from HK Hard Assets is the dividends. So our biggest investment in HK Hard Assets, there's no secret, is TPL. There's some other things in there, but it's all revenue that comes from HK Hard Assets. So I just took the liberty of interpreting the question referred to Horizon itself, not Horizon Hard Assets. So if there's more, I think now is the time to get to it. Okay, I'll just rebuild that. So does this figure vary much each year based on performance fees or other factors? And I think you just answered that. If so, would it be possible to provide the revenues to FRMO for the past few years and/or what is expected in 2023, 2024? This is obviously a very valuable asset for FRMO, and I would be interested in how Murray and Steve think about its value as it is essentially a royalty stream. Okay, well, let's see. If you want the back numbers, it's easy to get because if you look at our financial statements for the various years and you would divide our revenue by the probation factor, which I should think is some like of something like 0.0493 or something like that. Anyway, somewhere in the annual report you'll see it. And divide what, so if we get $3 million divide by that number and that will give you the Horizon revenue for that time period. So that's easy to do. So I probably should have memorized the number exactly, but I guess I'm too lazy. I've never memorized it, but it's somewhere in this document. And if you can't find it, I know it's in this document, if you can't find it we'll get you the number, but it's something like 0.04 93 or oh 0.95 or something like that. So is there anything I haven't answered in that? Now if you want me to do a future forecast, obviously I can't do a future forecast without getting myself in some legal trouble. So if you don't mind, I'd rather not get myself in legal trouble and truth be said, I can't know exactly what it's going to be. If I can just tell you this, if cryptocurrency does well, you'll be very happy with the revenues produced by Horizon. Next question. What is the difference between the above item that is the participation in the revenue stream and the investment in Horizon Kinetics LLC that sits on the balance sheet as $14.6 million? Is there income to FRMO that flows through from this investment separate and distinct from the interest in the revenue stream mentioned before? How should one think about the true value within a range of this ownership stake relative to the $14.6 million stated value on the balance sheet? Yes. So basically there's two components set. The first component is yes, we don't get revenue. We, own a piece of the profits. So basically we get distribution that's designed to offset, it gives us enough capital to pay our taxes. A certain amount of Horizon is other than the tax distribution is reinvested. So that number on the balance sheet, the $14 million odd, that doesn't represent our assessment of the value. It basically represents the investments on Horizon's balance sheet. There is a little bit of goodwill there, not a lot of it. So you can decide if that goodwill is merit or not, but it's mostly cash and investments. So for the most part, it's a hard book. At some point we're going to have to monetize horizon and then you'll get to see a real trading value and you'll know for sure. But right now I think the number is something like, either 4.93 or 4.95. So if you take that let's call it 14.5 million to make it easy and you divide by 0.0495, which is approximately right, so 14,563,000, I'll use a calculator. I make it a little precise divide by 0.0495, and that's $294,202,000. That's the value. We don't have $242 million in cash and hard assets there. It's not that much. So there's some goodwill there, but we've got a lot. So I'm not disclosing the number we have right now yet, but as I said, there's not a lot of goodwill there, especially not for an investment management company. In the right market, there'll be some type of monetization event, probably a listing at some point and you'll get to see what the trading value is because it's going to have to happen at some point, just not happening today. So but it's a sympathy, but to answer your question directly, it's separate and distinct from the revenue share. Next question regarding Winland, my understanding was that one of the strategies was to grow the mining operations significantly. With the current level of distress in crypto mining, is there any reason why Winland has not acquired additional significant mining assets or made strategic investments like the Argo blockchain Senior Notes, which are currently paying and were available at 4 cents on the dollar or less than four months of accrued interest to quote Hillel the Elder, "If not now, when?" Okay, well, the answer is very simple and you can see it quantitatively on what's called Luxor ASIC Price Index. The prices machines are collapsing. So to go out and acquire machines, there's no reason to do that when the prices are collapsing. The machine prices are not properly discounting the mining reality and approaching halving, we don't want to buy any machines. And the mining business, the word mining equipment was tremendously overvalued. How overvalued is it? Can we give you something quantitative? That's a rhetorical question. I believe it's implied in the question I just got, so I'll answer it. You'll recall about two and a half years ago, we did a swap with Winland. FRMO bought some equipment, brand new equipment, which we in turn immediately sold to Winland in exchange for shares of Winland. So I think we got a pretty good deal relative to price winland was trading at that time. That equipment, if you look at this price index, that equipment rose in value a lot through December or November of 2021. And then if you look at that Luxor ASIC prices and machines proceeded to collapse. When I say collapse, I may be a percent or two off, I would say lost from the high point 86, 88, maybe 89% of their value, something in that range. Okay? If today you wanted to buy the machines that we had sold to Winland two and a half years ago, which by the way, we'd depreciate over three years and it's been over two and a half years, so it, they're almost fully appreciated machines, you would pay a price today, even not dramatically different than what Winland paid or what we paid to buy them FRMO few years ago. So it still hasn't discounted reality, so you just had to stay away. What we did in FRMO is, we were nibbling away when we thought it was appropriate at Winland shares and we thought that was the best use of the capital given what was going on and based number of shares and Winland itself is not, we have liquid, we didn't buy a tremendous number of shares, but the price we got Winland at so far we made a, I would say a respectable profit at. So that's how, that's what we're doing in investment sense. During the collapse it just didn't make sense to be very active in this area other than what I just told you and we weren't very active. In the future, we're getting more constructive and we're probably going to be interested in buying some equipment at some point. But we want to buy and it's not everything we do. We really weren't interested in buying used equipment that had been used for three plus years because it's nearing the end of its useful life. Yes, we could, we could have repaired it and throw some money into it, but I don't know if we'd ultimately break even or not. We didn't want to do that. So our next move, if we decide is the right move, we're probably going to buy some state-of-the-art equipment. And don't forget, we did very, very maybe a month or two ago we did buy some equipment in consensus mining, brand new state-of-art equipment, which is now functioning and earning a very high rate of return. Remember, when you buy equipment, you always have be cognizant of the approaching halving. So at this stage, we're going to have to buy some new equipment. At least we think that's the best value. So I hope that's thorough enough. Next question. What are management's thoughts on oil royalty businesses making acquisitions right now at the expense of shareholder dilution, for example, as is the case for Sitio Royalties acquiring Brigham Minerals? Okay, well, let's just say that's a very elegantly phrased question. Thank you so much for phrasing it that way. And basically we don't want to, I or let's put it this way, I don't agree that it makes sense to acquire royalty interests for equity like we've done in a transaction that you described. So I'll explain why. The royalty, no matter how good the royalty is, the royalty is finite. Sooner or later, so every oil royalty has a decline curve. Sooner or later it will produce no oil, even if it's great and lasts long period of time. The equity is forever. So equity is a perpetuity. So generally speaking, that's one of the reasons, and this is generalizable to acquisitions in a lot of businesses. You buy a business, whatever it is, in this case it's royalties, but it could be technology, it could be machinery, it could be even pharmaceuticals, it could be anything. However brilliant, let's use the example of pharmaceutical, however brilliant it is, however wonderful it is, the pace of human knowledge and human progress, it continues. And let's say it was a pharmaceutical, one of two things are going to happen. Either A, it's going to go off patent and you'll get a lot less revenue for it, or B, which is more likely in the fullness of time, some company will develop something which is a superior treatment to what currently exists. So when you offer stock for someone else's business, the business you buy is going to have finite life. The stock you were offering has changed to that has an infinite life. And that's the problem with using equity in acquisitions. Now, books are written about in the seventies. This was very popular and textbooks are written, case studies are written at major universities about using equity to buy a variety of businesses. The idea was, it was very similar. If you think about to what we now call modern portfolio theory, you would use equity to buy a variety of businesses. Every business has its own cyclicality and if you're very clever about it, you'd buy a bunch of businesses where the cyclicality of one will offset the cyclicality of the other and you will develop a stable earnings and revenue stream. But the problem is every business is like a human being. It has a finite life and the equity has an infinite life. So ultimately it's not a sensible strategy and I don't think very highly of it. And when the reason is why we don't use equity very much to buy things at FRMO. So that's how I feel about that. Next, being on the Board of Directors and large shareholder of TPL, would management be able to speak on why Texas Pacific Land Corporation does not publish any kind of "proved, probable and possible reserves" analysis in their annual reports as other royalty businesses like Brigham, Blackstone, and Fifer [ph] Energy do? The TPL 10-K does not exactly make clear why these figures are "unavailable". In March, 2022, Bloomberg article noted that the Permian, the "Permian Basin is uniquely positioned to become the world's most important growth engine for oil production." So it seems like making the data public on TPL's reserves should be beneficial for shareholder returns, unless it wouldn't, in which case shareholders should know about this as well? Well, all I can say in the answer to that question is given my position on the board, number one, given the current circumstances, which if you read the SEC filings, you'll know what the current circumstances are. I'm just not in a position to comment on that particular subject. So I just, I normally like to answer every question, but I'm just not liberty to answer that question in the manner that is phrased. So unfortunately I'm going to have to decline to answer that. Okay. The next question. Could management give us an update on FRMO's MIAX Investments now that Miami International Holdings has filed for an IPO, what is the outlook for MIAX's asset classes? Does management think it will gain market share? For example, spike futures appear to trade in a similar manner to MIAX, but with the added friction of lower liquidity, why would traders want to switch to trading with this new instrument? Does MIAX have any pricing power versus other exchanges? Well, let's put it this way. The best way to judge MIAX is just to go on the website and look at the volume. So all exchanges, the profitability is really a function of volume. So to do more volume, it raises the expenses a little bit, but doesn't raise the expenses a lot. So in a really bad market, the volume contracts, and in MIAX's case it actually didn't contract, even the last year was a pretty rotten market. The volume contracts and there's very little you can do to cut expenses because it's so efficient, the margins are just so high. So what I can tell you is that in the world of exchanges, we're going to create just completely new and just amazing, and I think that's the best way to talk about sets of assets. I'm personally prejudiced and MIAX, I think they have the best technology. But you know it's not objective. I'm just saying it because I happen to like MIAX, but I really believe it. In any event, so this is just an example, it's nothing that MIAX is going to do. I want to give you an example of how the exchanges in the future are going to be different and why I like exchanges so much and like MIAX in particular. Somebody, an investment manager will say, I think the GDP is going to go up or down by a certain amount and therefore I will go longer short the S&P in a certain quantity. The trouble with that is that S&P trade as logical as it is, and even though the premise upon which it's based might be spot on accurate, is a very idiosyncratic trade. So the economy might go up or down as forecasted, but other things happen. So the values of currencies rise and fall, interest rates, wax and wane, company's profit margins expand and contract. So you can't simply generalize that a GDP of X will lead to an S&P return of some properly commensurate amount, either positive or negative. In the world of the future, what you will be able to do, you'll be able to do the following. You'll be able to say, I think the GDP of United States is going to rise by 3%. You will even buy a future that will pay you or some type of its mentality that will pay you. If the GDP doesn't point in fact rise by 3% and the GDP does not rise by 3% and rises by less than 3% or it actually becomes negative, then you're going to pay someone else and you will know before you do that trade how much exactly you will make or lose if the GDP performs in a certain manner. So that's going to be possible in a Blockchain cryptocurrency environment. So you're going to be able to do things that today you really can't do. So there are only a handful of big exchanges with licenses. I mentioned today only a tiny subset of the types of products that are possible. They're more product conceivable than all the exchanges where all their technology put together can't handle at the moment. It's going to be just an incredible experience. Now, as far as the IPO goes, it's no secret that the IPO market is just, at least until a week or two ago, the IPO market was the worst IPO market in a very long period of time. I think in the year 2020, hardly any companies came public. I don't, I'd looked at the list, I don't remember how many were, werenât very many. So it's just a horrible environment to come public and why come public in a horrible environment. Much more logical, come public in a better environment, which we will have eventually in due course, we just have to be patient. I don't know when there's going to be an IPO obviously, but it will happen in due course and we'll see what the value is and I'm very, very optimistic about the future of MIAX I hope that addresses what you wanted me to address. Yes. So the next question, could you please talk about the prospects for FRMO smaller investments like Digital Currency Group, Winland Holdings, Miami International Holdings and HM Tech? Okay, so MIAX did that one first. I think I addressed it. So I like exchanges in general. I like MIAX in particular. I think the future is bright. I think if you just look at the volume every day and it's all publicly available, that's your best indicator. You'll know more or less what's happening by looking at the volume and it's growing and there lots of things are possible. So very bright future. Winland is evolving into a mining company. It was not prudent in the last 12 months to buy any more mining equipment. So it's probably going to soon be prudent to buy some mining equipment and you're going to see more investment along those lines. What exactly we're going to do and how we're exactly going to do it? I canât say, I donât actually know at the moment how weâre going to go about it, but I think weâre coming to a much better period for cryptocurrency, so look for more investment there. Winland anyway, Winland has prospered. One of the things that Winland is getting or is in the process of getting right now, Winland invested some number of years ago in, you might recall Mt. Gox, which went bankrupt. They were bankruptcy claims, trade claims for the crypto there. And the bankruptcy is now concluding and we are going to monetize the trade claims. So weâll put that cash to good use, I hope. And thatâs one of the things thatâs happening in Winland, continues to mine and continues to build cryptocurrency. One thing I should say about Winland is, if you think about in a way itâs almost like a quasi-Bitcoin ETF. So when you buy a Bitcoin ETF, if there were a Bitcoin ETF, just remember, unlike a mutual fund or an ETF, Bitcoin has no dividends. So you can paint a piece for. So what would happen is, if there were a Bitcoin ETF, the operator, whoever it is, would have to every, each and every quarter or probably every month, would have to sell some Bitcoin to pay the fees. So letâs just take the abstraction. No one puts money in, no one puts, takes money out to the ETF. Thereâs a certain amount of coin there and every year the amount of coin is going to diminish. In Winland as you can see and why we read these statements every quarter, the amount of coin there increases because we mine it. So which would you rather have? Would you rather have a cryptocurrency investment where the coin diminishes, or would you rather have investment where the coins increase? I believe one day the day will come when there are Bitcoin ETFs and there are people going to understand the distinction between the two classes. And there are people who will go long the mining companies like Winland and go short the cryptocurrency ETFs and lock themselves in a certain return based on how fast we can grow to Bitcoin with mining. So thatâs Winland. HashMaster is actually doing very well. So the HashMaster is organized in such a way that the different businesses offset one another. So for example, hosting for a lot of businesses became problematic. So we ourselves had equipment and hosting companies that were having difficulties. So we actually had the ability to send our equipment to HashMaster and we have a greater liberty of action, how we go about mining, how we go about buying electric power. So if we another mining company, we have to buy electric power on their terms effectively through them because Winland, we control, we can buy electric power on our terms. So thatâs a pretty good thing to have. The repair business was doing less well during the calamity of the equipment price crash. On the other hand, the movement of our equipment HashMaster was a positive thing. So you could say in that sense, in equilibrium. And during the year we actually expanded HashMaster. We bought a transformer. So what it did is, it gave us the ability to draw more power. And now you know the reason why we wanted to draw more power and that kind of worked out rather well I think. During the months when the electric utility was installing a transformer, the crypto was having its carnage, so we werenât any of the worst for wear and now itâs pretty good we had that capacity there. The building itself, which is owned by FRMO Iâm told, or letâs say Iâm reliably informed that we could sell the building now weâre going to, we could sell the building for twice to what we paid for it. So itâs nice to know that. So HashMaster is a nice little asset doing very well. Digital Currency Group, as youâve seen, theyâve had their challenges obviously, but the quarter business is fabulous. Whatâs the quarter business? Itâs a Bitcoin Investment Trust and you know what the assets under management are, you know what the fees are and much of that goes right to the bottom line. So there are challenges and other aspects of it is, you can read in the journals, but we never got involved in lending out crypto or any of that stuff. We donât really believe much in it. And in the future I donât think youâre going to see this sort of activity in general in the cryptocurrency world. Itâs really something thatâs best done in banking. So the core business of Digital Currency Group I think itâs great. If Bitcoin or the other cryptos rise in value, which I suspect they will, itâs going to be even better. So the core remains, I think barely robust. So those are the four that Iâve covered. I think thatâs complete. So⦠Yes, this is a follow up on questioner seven from the fiscal year 2021 second quarter earnings call. âInstead of reviewing it only verbally on the conference call, can you please; can you also please begin to list exactly what the exposures are of the major assets that everyone wants to know about? A small table that shows the number of look through shares of TPL, Bitcoin mining equipment, Winland shares, et cetera, would be very helpful. If that is not possible for some reason, then my question is what specifically prevents you from doing this, is it choice specific regulationsâ? Okay, well nothing prevents me from doing it since I just read it and I read it off a table, so I donât see any reason why we canât put the table somewhere. So could you do that Thérèse, could you arrange to have the table put either on the website or someplace appropriate so everyone could see it? Because I donât think thereâs a regulatory reason, so could we rely upon you to do that? So youâll take care of it. So weâll take care of that and hopefully it will be up there in due course and everybody can see it. Okay, next, why are there no first quarter or third quarter transcripts for the year 2021 and no first quarter transcript for the fiscal year 2022? That actually was just put up on the FRMO website, they appear to have been skipped over. That falls on my broad shoulders. One of the deficits, well first of all, Iâll simply say my fault, I should have done it. And as happened with this particular cycle, I had that document in front of me on my computer screen for quite some weeks and other things kept coming up and I never quite got to it. And thatâs been a bit of a pattern and itâs not a pattern that should be repeated. And one of the deficits weâve had operationally is we havenât really had the kind of professional at Horizon Kinetics. Iâll call it professional editorial and editing function or layer for various kinds of public facing documents and content producing. And Iâve been on the lookout for qualified people to do that for quite a long time. And Iâve had different experiments with people with different qualifications. And just so happens a contributing reason why this one was actually posted to our website is that in recent weeks, and I mean this only in the last two or three weeks, Iâve been beginning to work with somebody who I think fits the bill and heâs an extremely qualified, very seasoned professional author and journalist, particularly financial journalist. And heâs actually started helping me out in recent weeks and heâs freed me up to take a look at this kind of thing and he can do it himself. Weâve so far been playing around with kind of like who takes which assignments. And if he works out overtime, itâs early yet and but if someone like him actually works out on a longer term basis, I think we would actually establish a department and proper style, style book and so forth for everything we do and things will work more smoothly. So anyway, I think weâre on track for that. And next order of business on this small end of things is to catch up with the prior two or three that have been skipped. Next is management has mentioned that they, apart from Jay Kesslen, Thérèse Byars, and now there are three new directors, are they only employees of FRMO and that management takes no compensation. Could management explain what the costs are in the operating expenses of the income statements as well as what determines the fluctuations in FRMO's operating expenses? Operating expenses were broken down into more detailed lines in annual reports. For example, âemployee compensation and benefitsâ until 2019 where they began to be rolled into a single SG&A expense line. So it is no longer as clear. Okay, well maybe we should reveal it. So Steve and I, weâre not taking any money, so weâre not getting anything because we own the stock and if it goes up, weâll make money on it. The expenses primarily are the professional fees of the audit, the accounting, that line of country, thatâs the primary. Thereâs the primary fees. Thereâs some fees associated with OTC markets. Thereâs some computer stuff to the degree that we buy electricity for cryptocurrency, thereâs that. Thatâs the primary stuff. Directors donât get cash compensation. We give them some options to buy FRMO stock and sometimes the stock goes up and they exercise it and sometimes the stock doesnât go up and they expire unexercised and thatâs what directors get paid. So weâre not giving cash compensation to directors. Occasionally we have a legal bill, nothing big. Thereâs a question, we need research, can we do X or should we not do X? And we go to an outside law firm and thatâs an expense and doesnât always happen. So thatâs a variability. Those are basically the expenses. I donât think Iâm missing anything important. So anyway there you have it. If you need to break down, Iâm sure we can obtain that view. Next is Charlie Munger recently celebrated his 99th birthday this January. Unlike Warren Buffettâs permanent capital vehicle, Berkshire, FRMO has not explicated plans for any type of succession. While Iâm sure all FRMO shareholders and Horizon clients would wish for current management to remain at the helm of capital allocation for as long as possible. And I recall that in past meetings, management has stated they have no intent on retiring. Could management detail what they see as the most likely outcome for FRMO shareholders once Mr. Stahl and Mr. Bregman are no longer running the show, any succession plans regarding FRMO management? Well, letâs just say this, there are people who could probably do it. Talk to a variety of people that are not FRMO employees right now, but Iâm sure theyâd be interested in doing it. So it would be someone or some persons, theyâre currently active in the investment management realm and obviously going to be younger than us and we want them be active investment management realm. Why donât we want to make them employees of Horizon or something? Because we want to see what they would do unconstrained by us. So if there were our employees, whether we give them total freedom or not even implicitly. Theyâre going to be operating on our constraints. We donât know what theyâre going to do. They got to be running their own show. So maybe a way to do it is theyâre running their own show, theyâre doing whatever theyâre doing. Maybe when the time came, we would take a FRMO merged with whatever their enterprises. Now theyâre going to run the show and theyâd be unconstrained by us. Other than the fact that we respect what theyâre doing but theyâre different people and maybe thatâs the way it should be. So thatâs the way I see it happening. So have people in mind. But they have to be at least 20 years younger than us, maybe more if we can get that. So maybe 25 even, we can achieve that. But then on the other hand, weâre not going to let any 25-year-old young people do it because number one, theyâre not seasoned. Number two, we donât have the experience of seeing them operate in the variety of unpleasant investment environments that happen from time-to-time. So anybody weâd even consider wouldâve to be someone that has, so to speak, theyâre battle scars. So that be somebody thatâs been around for at least 20 years in the business. So thatâs basically the plan. In the previous earnings call management mentioned that Horizon Kinetics was continually buying shares of FRMO. Could management give some detail on the valuation model that they use to look at FRMO to decide when to buy back share? Well, letâs put it this way. Other than restricted periods, weâre always buying back shares. So we filed one of these programs where weâre able to buy back shares every day. So we donât have a model that weâll buy back shares in month one, but then the stock went up and weâre not going to buy it. Weâre not buying back shares at that month due. Weâre constantly buying back shares. I myself, personally buy a small number of shares to supplement. What Horizon does right now itâs on the restricted list, so I canât buy it. I think a day or two after this phone call, it comes off to restrict list and I will assure you, I will commence bank. So, but we donât have a model and we donât really need a model. And the reason we donât really need it because FRMO is a company with a lot of optionality and itâs very hard to have a model to embrace that. But letâs look at it this way. Take any one of the variables. I personally talked a lot about cryptocurrency today, but Iâll use it. So we have a number of vehicles and cryptocurrency. We can do a lot of different things with them. Weâd like to grow them. We actually are in the process of growing them. If cryptocurrency became the biggest of the asset classes, which I personally think thatâs the outcome, youâll be very happy with the price of FMRO. In interim because obviously thatâs not happen today little by little, we are growing the cryptocurrency assets and weâre growing the cryptocurrency businesses. It didnât make sense jump in with both beat so to speak, but the reasons I mentioned earlier there was a real valuation problem, or letâs put it not, there was more than just evaluation problem. There was a tremendous money relative to what cryptocurrency could absorb come in cryptocurrency. And without reckoning the basics of cryptocurrency, you just have to know that if youâre in a mining business, 50%, assuming the cryptocurrency price remains the same, which has to be your basic assumption, 50% of your revenue is going away every four years. Now in point of fact, over most of the time the cryptocurrency is going to rise, but your equipmentâs going to become obsolete. So you shouldnât expect a much longer life than three years. It turns out that because we have the repair business, weâve been able to use certain machinery for more than three years. Weâve been able to pull it off, but we had no right to expect that. It just so happened. But itâs not going to last for much longer than three years. Maybe itâll last four years; maybe itâll even last four and a half years. Ultimately it goes away and even before it goes away, it becomes less profitable and becomes less profitable because itâs less efficient. None of that was reflected in the cryptocurrency environment, therefore we had to stay away from investing much as we are interested in cryptocurrency. So thatâs that. But doesnât mean that in any way we think these things are undervalued. I think weâre one of the few companies, if I can promote myself for just a moment, I shouldnât do it, but I will. We are able and the figures are available to anybody who cares to look at them. We are able to navigate a brutal, what they call a cryptocurrency winter. We were able to navigate that. Nobody else seemed to be able to do that. So Iâm actually very proud of that. I didnât enjoy the crypto winter, but we were prepared for crypto winter and I think thatâs personally worth a lot anyway Iâm buying FRMO. So take it for whatever itâs worth. Do the co-founders of FRMO own basically the same percent of ownership of Horizon Kinetics, LLC, even though Horizon Kinetics is private, both companies share management and make similar investments? Yes. Theyâre -- the answer is itâs not identical for a whole host of reasons, but itâs similar. So if you were to see the ownership list of Horizon, itâs not radically different than the ownership list of FRMO. As I said, there are a lot of reasons. One of the reasons is Iâm personally, Iâve been buy, Iâve never sold a share of FRMO. Only you bought So Horizonâs a private company weâd never bought or sold shares and FRMO youâre able to do that. So Iâve purchased shares, so my ownership has gone up a little bit. Weâve done some other types of transactions that have altered your ownership structure a little bit, but not radically. So you would recognize the basic shape of the ownership structure if you were to see the shareholder list of Horizon Kinetics. Well, all I can say is its Mea culpa. Itâs totally on me and I keep saying Iâm going to do it and then I just donât have time to do it. So I just didnât do it. Iâd like to do it and as you can see involved in a lot of stuff. So I just havenât add, I can only do so much. So Iâm doing meetings like this, Iâm involved in all sorts of issues that you can read about. I write a lot of research reports, Iâm doing a lot of stuff, so I just donât have time to get to it, but itâs a priority with me. So Iâm going to do it at some point and you wonât be disappointed. Yahoo Finance reported on November 25th, 2022 that in a note to their shareholders, Digital Currency Group, Founder, Barry Silbert attempted to calm investorâs nerves, investor nerves about the financial health of Digital Currency Groupâs subsidiaries including Grayscale Investments. My question is, does management have any concerns about the solvency of the Grayscale cryptocurrency funds that FRMO owns? Do you have any concerns over the solvency of Digital Currency Group? Well, we at Grayscale no concerns whatsoever because theyâre just funds that own a certain amount of cryptocurrency. In the case of the Bitcoin Investment Trust, it just owns Bitcoin. Itâs custody, itâs custody it securely, itâs segregated. I have no concerns whatsoever. In the case of Digital Currency Group, there is some debt, but the debt isnât owed. I think something like 10 years. This was in the public realm. There were articles, that is owed for 10 years and all you really need to do is take the C on the Bitcoin Investment Trust, multiply by the AUM, you can figure out what the revenue is. So I donât think there is any problem there, at least none that I can see. So Iâm not really worried about. In any event on a cost basis, we donât have a lot of money in Digital Currency Group. The issue is what is it worth right now? And there you can get a lot of different numbers. Naturally we want it to be worth as much as possible. I think the current issues as controversial as they are, theyâre not going way tomorrow. But I believe theyâre in principle solvable and you know, theyâll just have to work through them and solve them. Thatâs what happens in crypto winter and thatâs why, and itâs such a Digital Currency Group, itâs every company in crypto with the exception of us. Thatâs why I promote myself shamelessly, which may almost, never do a little while ago. Lots of companies threw a lot of capital at something that they ought not have thrown a lot of capital at. And we had the complete different strategy, created a lot of problems for people and theyâre not the kind of problems that you can master in a week or a month and theyâre quite a few of them. You just have to work through them I guess. And we had a completely different methodology and we donât have any issues like that. So thatâs the flip side of, when you want to be aggressive, I mean at the time I really shouldnât blame people. It made a lot of sense. So let me just go into a little detail. Why did it make a lot of sense? Well, two reasons. The first reason is the basic premise of crypto. So it could be argued that, again this isnât my, this isnât, what my strategy is. This is not my strategy. Iâm just arguing positively rhetorically for somebody elseâs strategy to say why did it make sense at a time? Although it didnât make sense to me. Well, if you believe cryptoâs going to outperform the dollar, which I believe that too, then it seems like the next logical steps should be, well then why donât you borrow money in dollars and youâll eventually pay back in depreciated dollars relative to your crypto investments. Makes so much sense, right? Except itâs problematic to do the accounting that way. I understand thatâs the GAAP accounting and thatâs whatâs required. But just because thatâs required doesnât mean you have to think that way. You can think any way you want. So letâs just go through, compare and contrast the way we look at things. When you buy a cryptocurrency mining machine, it may not be apparent to you, but you donât pay dollars for it. Itâs priced in dollars. But the manufacturers donât want dollars, they want crypto. So when you are buying equipment, the relevant question is, Iâm buying a certain number of machines, youâre not buying one, youâre buying lots of them, youâre buying a certain number of machines, itâs costing you a finite amount of crypto. The relevant question is, over the operative life of the machine, are you going to get more crypto than you paid for the machines? And if the answer is yes, which it may not be, if the answer is yes, well how much more is that going to be? So for example, if you paid a 100 crypto, a 100 Bitcoin letâs say for a group of machines to make it sensible, youâre going to have to get over life in machines at least 160, maybe 175 or 180 Bitcoin back. If you canât see that happening, you ought not to invest in the machines. So the halving, thatâs why I refer to halving, the halving is known in advance. You know how many days you have. So the halving is on a date certain, so you can calculate, well, do I have enough time to get, Iâm usually using the number 180 as an example. If you canât see earning 180 crypto over life machine, when you paid a 100, a 100 crypto for the equipment, you have to cease investing. So the performance of the dollar in relation to Bitcoin or Bitcoin in relation to dollar is irrelevant because youâre raising dollar, youâre not paying dollars. Thatâs the mistake everybody made. And why use equity when you can use debt? Now we donât like the equity for reasons I mentioned earlier because itâs a perpetuity. We donât want to use debt. Debt we donât use as well. So we are trying to create all our capital internally or at least most of it internally, which is another thing people donât want do. So you further complexified the problem. Youâre bringing investors with their capital and now youâre trying to figure out what is the price of Bitcoin in relation to the United States dollar at any point in time. And remember that debt is due on a certain fixed date that's why they call it fixed income. So even if Bitcoin outperforms dollar in the fullness of time, how do you know that Bitcoin is a game performed dollar during the life of the fixed income liability that youâve assumed, you donât really know that do you? So therefore it makes more sense to operate entirely in crypto. And by the way, my second point is, whatâs the purpose of crypto? The whole purpose of crypto is to be outside of the dollar fiat currency system. So if you want to be outside the dollar of fiat currency system, be outside the dollar currency fiat system and calculate everything in Bitcoin because that part of the business, the Bitcoin business, youâre operating outside dollar system. So why would I reenter dollar the system to make investments and be subject to the mutability of the dollar, even though I think in the long run Bitcoin will do better than dollar. I didnât want that. So now you see a difference between their strategy and our strategy and you also further see, if you forget about our strategy for a second, how reasonable all those strategies remember, itâs the majority of people, Iâm not criticizing them, Iâm saying that those strategies ex-postulated the way I just ex-postulated them, theyâre entirely reasonable. Theyâre even defensible, but theyâre embracing a risk that I chose, I have no intention of ever undertaking that risk and I wonât do it and I didnât do it. So you can see why the majority of people felt otherwise because they treated the currency of Bitcoin as if it were the Euro or the Yen or some other type of currency and itâs not, because those are investments. You could have undertaken an investment in Europe or Asia or somewhere else and you can make reasonable assertions, although they might be wrong, but how other currencies will operate, because theyâre all fiat currencies. Bitcoin is not a fiat currency. It operates in accordance with certain strictly defined rules. So in the, in a finite time period, you donât really know whatâs going to happen to crypto, especially if people are incognizant of the effect of their focus in having, which they werenât. So anyway, but Iâm sympathetic to what people did. I just donât agree with it, but itâs entirely reasonable. Just because somethingâs reasonable doesnât mean itâs right, itâs reasonable, itâs defensible. It was just the wrong thing to do and we didnât do it. But thatâs what makes a market, I guess we do different things, but Iâll never criticize it on grounds of unreasonability. It was reasonable. So all companies did that and I think theyâve learned their lesson and it just going to take varying amounts of time to work through those problems and weâll see what happens. So whatâs next? Okay, what does management make of how the FTX contagion is affecting Digital Currency Group and its subsidiaries, Genesis and Grayscale given the FRMOs and Horizon Kinetics funds main Bitcoin exposure comes from GBTC? Okay? Itâs not, FTX is not impacting it. FTX is very simple. FTX is just embezzlement. So thereâs a certain amount of money FTX, whether itâs currency or fiat is irrelevant, itâs just purloined. FTX is very simple. The problem that youâre referring to is, what is the discount to net asset value of the Bitcoin Investment Trust? So there are people who believe that the liability at Digital Currency Group could theoretically be accelerated and they'll have to pay for the asset and theyâll have to, their biggest asset is the shares they own at Bitcoin Investment Trust, which in theory, they could be forced to hand over the, I donât believe itâs likely, but if you want to paint the gruesome scenario that some people paint, so in relation to FTX, well thereâs liability, you have to pay it and youâre going to hand over shares of the Bitcoin Investment Trust, which of course the people get it donât want. So theyâll just throw it on the market and wonât be enough people to buy it and for that reason it will trade at a big discount to an asset value. Thatâs basically that scenario. Personally at this discount net asset value, I think Bitcoin Investment Trust, GBTC is a great buy. And just so you know, I personally bought some today, just so I really did. Iâm not going crazy and buying tremendous amount fit, but I bought some, so I donât know how long the discount to NAV is going to last. Chances are itâs not going away in a day or two, but eventually there will be Bitcoin ETFs and eventually this is going to be a Bitcoin ETF and itâs going to trade at NAV and I believe the Bitcoin price is going to be higher. So letâs assume, of course I could be wrong. So don't go by what I say, but if Bitcoin is going up X percent, whatever that number happens to be, and you are buying the Bitcoin Investment Trust at roughly half of net asset value, well if it traded an asset value and Bitcoin didnât go up, it just traded NAV and youâre at 50% of NAV, youâre doubling your money, itâs a 100% rate of return. Now Bitcoin rises X percent and it trades at debt to net asset value, you can see how robust that return is. So I personally think itâs a really great investment. Anyway, we have lots of shares of it and I wouldnât mind having more shares of it. Thatâs it. The next question is related, does management have any thoughts on the FTX crash and how this may affect Bitcoin and institutional adoption of Bitcoin as a monetary asset going forward? This crash appears to be unique from other previous Bitcoin cryptocurrency related crashes, for example, Mt. Gox, in that this most recent crash has affected a large number of institutional investors, who had stuck their necks out for cryptocurrency. Is this a correct reading of history? Does management with their unique position in running an asset management business themselves see any growing once bitten, forever shy sentiment among institutional investors regarding cryptocurrency or Bitcoin in particular? Okay, well, lot of lot of things I can say about that. Letâs just start with this. So this was embezzlement, this was fraud. So in its own way, in fact patterns a little bit different. Itâs not that dissimilar from Enron, itâs not that dissimilar from the Madoff scandal. So the Madoff scandal, did that stop people from hiring outside investment advisors, the Enron scandal did that stopped people from buying publicly traded securities? I mean at the time it was traumatic, but itâs basically the pledging and looting of client assets. Basically itâs what happened. So had it not been a crypto company, had it been a normal financial advisor, you would have had the exact same outcome and they could have the exact same outcome in dollars. The fact that it had to be crypto had absolutely nothing to do with the ultimate collapse. So they were a money market fund and they were doing nothing other than buying United States treasuries. Well, you steal all the money then youâre not going to get any. So itâs really that simple. The company FTX had a very high ESG rating. I think by the ESG rating companies it had the highest rating you can get. And thatâs the problem, thatâs the problem with ESG and the way things are rated. Just because I have no idea to what degree they complied or did not comply with ESG and I have no idea how these ratings are compiled, but it had a high ESG rating so you could see why an institution would say, well it has a high ESG rating, it must be okay and obviously that was not true. So having a high ESG rating is not the same thing as having probity and what that lacked is probity. So I donât think this is in any way going to lessen or diminish or delay the growth of cryptocurrency as an asset class, because it has absolutely nothing to do with cryptocurrency and itâs just thatâs not made clear in newspaper articles, whatever, probably because the people donât realize who write them, what actually happened, but basically itâs a case of investment. Now, if you wish to verify what I said, the bankruptcy trustee that was appointed to liquidate FTX testified before the United States Congress and that testimony is in the public domain, you can read it and everything I just told you, thatâs where it comes from, so it is testimony under oath. It would be really great if the articles referencing this subject could include the appropriate testimony from the bankruptcy trustee, but it didnât for good or real, but it would be really nice if it did, so maybe at some point, someone will write about that subject. But anyway, thatâs where we are. So I donât think this is a setback for cryptocurrency because it has nothing to do with cryptocurrency. It just so happened this person was involved in cryptocurrency, but there are people who steal dollars and they do it all the time. You donât say, Iâm going to stop using United States dollar because someone stole all the money in a company and nothing but dollars in it. So I donât think you should reach that conclusion with crypto. And I understand in the real world people will reach that conclusion, but I donât think in any way this is going to diminish the progress, thatâs being made in crypto. And you can see it if you follow whatâs happening on Chicago Board Options Exchange and youâll be seeing other things happening in due course in other publicly traded exchanges. So just have to keep your eye out for that. In a 2021 interview, Murray Stahl gave the, gave with a podcast called In the Area, one of the topics covered was the disintermediating effects that Bitcoin and openly discoverable blockchain transactions would have on society in the context of inverting the many to 1, individual to Google to advertising relationship into a one to many individual to advertisers relationship. Wherein advertisers directly pay individuals for the right to advertise to them based on their transaction history. Is management currently investing or investing in or looking at companies that would be along the path towards facilitating this kind of shifting advertising dynamics? For example, for an example though not at all a recommendation, there is the opensource brave web browserâs basic attention token, which seeks to build out a distributed micro/nano payments ledger of crypto tokens minted on proof of user attention given to advertises. Yes, well Iâm, I looked at that, I havenât bought that yet. Iâm not sure thatâs the right way to achieve it. There are many, many different approaches to this subject. Iâm confident someone is going to come up with an approach or Iâm confident many people will come up with approaches. My own view is, the way itâs going to start, it's going to start with assets that people have. They might not even know that they have. So for example, X, Y, Z individual has a subscription, maybe itâs a software, maybe itâs to an online magazine, whatever, they're not even aware that theyâre paying $20 a year on their credit card. They donât even look. And I believe someone is going to start mining that data, put it on a blockchain, so everyone can look and theyâre going to become cognizant that they have assets. Similar thing is going to happen to other digital assets. Itâs going to start with digital assets. And those digital assets are going to be monetized. And whoever does that is going to have a great advantage because youâve now caught the attention of very large numbers of people, literally tens of millions of people. After that, it becomes relatively easier, not easy, but easier to persuade those individuals to entrust their data to the blockchain. And then thereâll be a database of data, and it wonât be gathered by the leading technology companies. Itâll just be gathered by the individuals through this mechanism and theyâll be able to monetize their data if they feel like monetizing their data, which some people may not want to do, but a lot of people will monetize their data. And it can start by something as simple as, do you wish to see an advertisement on a certain subject? And anyway, I believe thatâs how itâs going to evolve. So in my travels, what Iâve seen the most software development on thatâs within striking distance of realization is the mining of data and the possible mining monetization of digital assets anything relating to digital assets and this monetization, thatâs, I think is going to be the first effort and weâll go -- have to go from there. Murray, I thought to go back to a prior question. It was about the once bitten, twice shy sentiment that might be feared among institutional investors regarding Bitcoin. And I understand the reason for the question, but in point of fact then, you gave a couple of factors earlier when you spoke. You can measure that. Youâve explicated a number of different factors overtime that describe various facets of the cryptocurrency industry and its robustness or lack of robustness. And there are all sorts of markers of Bitcoin usage for instance, such as the number of active wallets or the concentration, profile of coins, or the number of lightning network channels and the number of nodes and servers. You can look at institutional changes, whether theyâre private institutions like a Fidelity or, banks that are building robust custody and exchange and pricing, systems and platforms, which you donât do that lightly and Central banks too. And you could make a list or a table. Actually I suggested this to somebody, one of our analysts yesterday. You could make a list or table of all these various factors. So you come up with a dozen factors and then track them over time. Maybe you just make a, an index of, basically itâs about acceptance that you suggested very early on itâs a money and money is that acceptance. And there are different really measures of how broad and deep acceptance is continuing and that hasnât stopped. In fact, itâs only getting deeper, but thatâs the way you can, anybody for themselves can address that. And maybe weâll come up with something of our own, if it seems to hold water. Well, true, itâs definitely true. It will be addressed in due course. If you want something, just the quick and dirty the discount NAV or the Bitcoin Investment Trust, itâs a measure of sentiment in a way. So if you want something very easy to do, thatâs a thing to do. And if you want something a little bit more difficult but not much more difficult to give you a better sense, I would say if you take the single asset digital currency products, so itâs Litecoin Investment Trust and the Ethereum Classic Trust and Zcash Trust the seated discounts, do NAV of those things and look at them, I think youâll get a pretty good indication of what the sentiment is. And but weâre on the verge of just tremendous things in crypto. So I think for the industry quite properly is saying I need to be shown success and theyâre right. They want to see the success and most people will want to see success. Incidentally, you donât need the world to be invested in Bitcoin for this to be incredibly successful. So donât forget this year New York Stock Exchange, democratization meaning the average person start owning stock, that didnât happen until the advent of IRA accounts in the 1980s and beyond that New York Stock Exchange was founded I think in 1797 or something like that. So it took almost two centuries to get that. People made a lot of money in New York Stock Exchange without a lot of stock being owned by the average person. You donât need to have everyone and thatâs the point Iâm trying to make. So itâs going to be successful with or without the participation of the vast investment public. Itâd be nice to have them. We donât need them in the process of happening even without them, just something to be cognizant of that. So other factors in that, does the average person own bond futures? I think not. And look how big the bond futures market is. Does the average person trading currency features? I think not. Look how big the currency market is. Does the average person trade in oil futures? Look how big that market is. So, and by the way, the derivatives market, I donât want to compare Bitcoin derivatives because itâs not the right analogy, but the derivatives market is bigger than the bond futures market. Derivatives market is hundreds of trillions of dollars. Does the average person trade derivatives? No, they do not. Look how big that market is. So I donât think that the, the necessary condition of success is broad public adoption. Nice to have it. Eventually I think weâll get it, but Iâm not waiting for it personally and I donât think I need it. Anyway, I hope that addresses that question. The last question is also related. Are you looking at FTX claims? Do you believe they will have an outcome similar to Mt. Goxâs claims? Okay, am I looking at FTX claims? The answer is no. And Iâll tell you exactly what my reasoning is. So Mt. Gox, there was a hack. Some portion of the Bitcoin was stolen and we knew what that was. So what the management of Mt. Gox society do is, so it wasnât every account that was broken into, it was just if you add up everyoneâs account, X percent, whatever it was of the coins were stolen. But most accounts were in touch. So some accounts had no Bitcoin in it, some accounts lost some of their Bitcoin, some accounts lost no Bitcoin. Most accounts lost, no Bitcoins. Instead of letting just some accounts suffer, what they decided to do in Japan was they decided to socialize losses. Everyone had the identical outcome in terms of the loss. Thatâs the way it worked there. So we knew what we were dealing with. We knew, okay, they socialized losses, we knew what the losses were, thereâs going to be some bankruptcy fees, weâll have to wait a certain amount of time. So the banks reclaim traded a discount appropriate large discount to the amount of Bitcoin we were likely to receive. We knew it was going to be a number of years. This is different. And the reason itâs different is, we donât know what was there in the first place. We donât know exactly how much was stolen. All we know was most of it. So when someone says is a claim that trading at a big discount to its value, well that might be true except we donât know what the value is. We donât know what the bankruptcy trustee is going to be able to recover and then thereâs a further complexification because the Bermuda government has made the assertion that some of the claims are going to be actually seized by Bermuda government. Now obviously the holder is not going to be very happy with that. Thatâs an issue. Itâs got to be resolved in court. So I donât know how these things can possibly be noble at this point in time and therefore with regard to the FTX Iâm not doing anything whatsoever. Iâm not active in it. I mean, I look at it because intellectually itâs interesting and thereâs no harm in looking, but not doing anything whatsoever. So I hope that answers that question. Okay, well I thank everybody for their questions. I thought they were pretty good and I enjoyed answering them. If thereâs something that occurs to you and we didnât cover, that we should have covered or itâs a brand new question, donât hesitate to contact us because we want to get you an answer if we can and of course weâre going to reprise this in about 90 days. And thanks so much for joining us today and thanks for your support and all that remains is just to say goodnight and we always stay and answer every question. So hopefully you enjoyed as much as we did. Thanks so much.
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Welcome to the Karooooo 2023 results webinar. I am Richard, the groupâs COO and we are pleased to present the Q3 results to our shareholders and investors. We are excited to share our performance, growth, and future plans. Our team led by our CEO and Founder, Zak, is committed to delivering on our strategic goals and creating long-term value for all of our stakeholders. With Hoeshin, our Chief Financial Officer and the rest of the team, we are confident in our abilities to continue driving growth and innovation in the future. All shareholders and investors are advised to read this disclaimer. Today, we will review the three entities within Karooooo, mainly Carzuka, Cartrack, and Karooooo Logistics. At Karooooo, we understand that mobility is core to all underground operations. We are not only thinking about connected vehicles and equipment, but also on how to improve the overall mobility ecosystems. We are constantly exploring new ways to use data to optimize operations and make them more efficient. We are establishing the leading connected cloud platform, enabling customers to develop effective controls and workflows, while digitizing their daily operations in one enterprise grade platform. Our cloud platforms seamlessly embeds into the day to day activities of our customers and offers unprecedented visibility of varying aspects of their operations covering driver, vehicle, cargo, worksite and more. Our platform contextualize these data points to offer actionable insights for their challenges. This helps customers understand and ultimately streamline their operations, enabling them to deliver on their service offering to a higher level and remain competitive within their industries. We are committed to providing our customers with the best possible service and support, and we are constantly looking for new ways to improve our platform and our service offering. Karooooo's cloud platform is well-positioned to successfully service customers across diverse industries. We support over 100,000 small to large businesses in optimizing their underground operations, including global multinationals like Coca Cola and Cargill. This is a 15% increase, compared to the previous quarter. Our success across our diverse customer base continues, ensuring our low customer and industry concentration risk. [Highlights of the] Karooooo Investment. Innovating through an entrepreneurial approach that prioritize customer needs, utilizes hands on experience and skills, and being adaptable in both planning and execution, offering a strong value proposition, proven track record of delivering value enhanced solutions and passing on cost savings to customers through successful execution while maintaining prudent capital allocation. Having a strong financial foundation, the ability to control prices and maintain higher operating profit margins, solid unit economics and a history of sustained growth at scale, our strong management, intraperitoneal culture, and vertically integrated business model puts us at a significant advantage by inspiring ownership and practically creative thinking throughout the business. This has been a leading contributor to our proven track record of growth and profitability in varying macroeconomic headwinds across multiple regions. Karooooo is using data to improve operations, and we are at an early stage of a large growing opportunity with over 40% of global GDP based on the underground operations. Mobility is the key to solving customer challenges, and crew is leading the way in this area. The platform is well-positioned to leverage this opportunity as it continues to grow. In South Africa, over 10% of all vehicles are connected to the Karooooo platform. Karooooo has a large untapped network effect generated from its platform with over 120 billion valuable data points generated monthly. Customers are benefiting by personalizing their experiences and provided with tools to improve decision making and increase their efficiencies. Predictive analytics of historical data are not only leading to improve customer loyalty, but allow us to develop new products and services. Thank you, Richard. I will now talk through Karooooo's financial performance for Q3 FY 2023. Please note that all comparisons are against Q3 FY 2022 unless otherwise stated. As expected, after substantial investment for future growth in all segments, earnings per share for the period was ZAR4.70. Year-to-date earnings per share increased 20% to ZAR14.59. Our cash generation continues to bolster our quality balance sheet. Free cash flow increased by 27% in this quarter and by 42% to ZAR434 million on a year-to-date basis. These robust earnings were achieved despite the group's strategic investment for expansion, brand building, and custom acquisition, a testament to our resilient business model that is highly cash generative. Supported by a high customer retention rate, Karooooo continues to grow at scale with a 14% growth in subscribers to 1,678,606 and 29% growth in revenue to ZAR930 million. Our growth remains organic and we continue to be prudent with capital allocation, focusing on deploying capital in key opportunities that will drive short and long-term value. Karoooooâs success is largely attributable to our innovative and customer centric culture, which has led us to become an operational technology partner that offers high customer return on investment through our end-to-end all-inclusive IoT operations cloud. Even with our large scale, our vertically integrated business model empowers us to remain agile and adaptable with full control over infrastructure, advanced internal systems, and our expanding distribution network. We have a proven ability to execute and achieve strong growth at scale. Our profitable SaaS business model continues to bolster cash flow generation with net cash on hand up by 2% at the end of November 2022 at ZAR819 million, despite paying a cash dividend of US$18.6 million in the period. Debtorâs turnover days improved to 31 days. We have strong unit economics, robust operating margins, a quality balance sheet, and strong cash position and have consistently beaten the Rule of 40. We report performance by our three key business segments: Cartrack, Carzuka, and Karooooo Logistics. Karooooo's total revenue increased by 29% to ZAR930 million at the end of Q3 and ZAR2.6 billion on a year-to-date basis. Cartrack grew its revenue by 19% to ZAR804 million, and operating profit by 7% to ZAR222 million in the quarter. Cartrack's adjusted EBITA was comparably unaltered in this quarter. Cartrack's year-to-date operating profit grew by 19%, EBITA grew by 17%, and EBITA margin is at 48%. This is in-line with Karoooooâs planned investment for future growth and management's guidance for 2023. Carzukaâs steady expansion justifies our belief in the sustainability of its agile, data enhanced, and highly scalable business model. Carzukaâs revenue grew to 72 million from 24 million in the prior year. We continue to invest in infrastructure, brand building, and improving our processes. Similarly, we are mindful of the losses and are being pragmatic in our spending to ensure good return on investment. Karooooo Logistics delivered strong growth generating ZAR54 million in revenue and an encouraging operating profit of ZAR2 million in this quarter. Its focus on delivery as a service continues to gain momentum. We will now focus on Cartrack, the largest underlying asset of Karooooo. Cartrackâs low cost of acquiring a customer, high customer retention rate, strong cost benefits derived from economies of scale and healthy ARPU result in attractive unit economics and a high customer lifetime value. Our lifetime value to cost of acquiring a customer is over 9. Our gross profit margin on subscription revenue is a healthy 72% and our operating profit margin is 28%, whilst we remain prudent with our capital allocation, we are well-positioned to materially increase investment for growth. We saw record net subscriber additions of over 78,000 this quarter as compared to any other historical quarter. This was largely supported by demand from small to large enterprises, reflecting the demand for customers to digitalize their businesses as to become more efficient, compliant, and competitive. Cartrack continues to have great visibility of future revenue with SaaS revenue up 16% to ZAR771 million and total revenue up 19% to ZAR804 million in the quarter. On a year-to-date basis, total subscription revenue remains 97% of total revenue. Our track record of execution extends over a decade, and we have a proven ability to scale in varying market conditions. Total subscribers grew by 14% to 1,678,606, and our operating profit grew 6% to ZAR222 million, despite significant investment for growth. Cartrack continued to expand in all geographies. In South Africa, despite adverse economic factors, subscribers still grew by 13%. In Asia, the Middle East, and USA, subscribers grew by 27% as the pace of Cartrackâs expansion into Southeast Asia moves ahead. Southeast Asia presents the greatest opportunity in the medium to long-term as we continue to focus to grow the region. Europe saw healthy growth of 14% and we aim to allocate more resources to the region in FY 2024. Africa, although is gaining some traction and increased subscribers by 9%. In this quarter, Cartrackâs ARPU was a ZAR157. We are focused on offering a strong value proposition to our customers, while retaining pricing power. Cartrack has robust operating margins and our current trends are in-line with the long-term financial goals set out upon our listing in NASDAQ in 2021. Research and development as a percentage of subscription revenue remains at 6%, in-line with our long-term targets of 4% to 6%. We expect to increase capital allocation into sales and marketing to drive growth whereby we expect sales and marketing as a percentage of subscription revenue to increase from the current 14% to be within our long-term target of 17% to 19%. Despite our continued investments in G&A, we expect that as a percentage of subscription revenue, G&A will drop to 12% to 16% in the long-term. As expected, our adjusted EBITDA as a percentage of subscription revenue was at 45% in the quarter. Our targets for the long-term are 50% to 55%. We are content with the progress we have made year-to-date and we will retain Cartrackâs outlook for FY 2023. Number of subscribers between 1.7 million and 1.9 million. Cartrackâs subscription revenue between ZAR2.95 billion and ZAR3.1 billion and Cartrackâs adjusted EBITDA margin between 45% and 50%. Carzuka and Karooooo Logistics continue to scale and positively impact Karoooooâs revenue growth. Both segments showed good progress with strong quarter-on-quarter growth of 11% and 32%, respectively. In combination with its intuitive e-commerce platform, in this quarter, Carzuka has made significant progress by expanding into its second physical showroom and continuing to grow the brand presence. We will continue to steadily add strategic hubs across South Africa and build Carzukaâs brand. Karooooo Logistics continues to integrate into Cartrackâs platform to support Cartrack customers. Karoooooâs year-to-date earnings per share grew 20% to ZAR14.59, despite being impacted negatively by Carzuka. We remain focused on managing Carzukaâs losses, while pragmatically investing in this segment. We are content with the results so far. I would like to thank everybody for joining us today and we'll now open the floor to Q&A with our Group CEO and Founder, Zak. Thank you very much. The first question is from [indiscernible]. What was the long-term gross margin and adjusted EBITDA margin targets for Carzuka and Karooooo Logistics? We're looking at gross profit margin for Carzuka in the region of 10% to 12%. We're not quite there yet. We've got quite a few store prices that we need to iron-out. And we're expecting over the long-term that we'll get probably in the region of 5% to 8% EBITDA margin or operating profit margins. There will be very little depreciation in Carzuka. On Karooooo Logistics, we expect the gross profit margins in the region of about 25% and we expect operating profits, which would be similar to EBITDA as thereâs very little depreciation as well. And that we expect to be in the region of about 7%. Weâre close to 5% at this point in time already. Next question from Alex. Question number 1, here, D&A was noticeably down quarter-on-quarter, but operating income was down as well, can you [relate] [ph] the OpEx line items to a higher degree of cash investment and if this is recurring? I think there was quite a lot of OpEx that we expensed during this year. And, you know, one of it was foreign exchange losses. And we don't see this as recurring, but clearly it could happen. And substantial amount of that was actually increasing headcount. One in Southeast Asia given the growth that we want to drive and in existing more mature markets like South Africa, as well as we continue to drive higher growth into the future. We are looking at containing this spend as we grow sales. Second question. Free cash flow conversion is very strong, should we think about the working capital improvements and lower capital intensity [indiscernible]more timing related? I think it's more timing related as we see stronger growth. In other words, we only had a 14% subscriber growth. And clearly, when the subscriber growth is lower than itâs been in the last two or three years, then obviously free cash flow becomes substantially stronger. So, if we start growing faster than the 20% or 25%, 30%, then the free cash flow will obviously be less. Another question from Alex. Within the record subscriber growth, are you seeing any challenging growth retention churn? What is the right long-term growth retention outlook? I think our retention is quite solid. We did see, especially in Q3, a better retention rate than we had seen in the first two quarters, but I also believe the first two quarters were still suffering from the impact of COVID. So, we certainly saw a better retention rate. In other words, less customers' churning. So, I expect it to be better at these levels. A question from Matthew from William Blair. Did this [subscriber movement] [ph] from the third â continuing into December and January? Matthew, traditionally, our fourth quarter, which is December and January, is quite a weak quarter. It's one of our weakest quarters because if you take our biggest geography in the segment, which is South Africa, I would say that three quarters and probably half of January. The business activity is very low. And that obviously causes a tradition for the fourth quarter to be weaker than the third quarter. But I think if we factor that into it, we continue to see the same strength into the fourth quarter. Matthew, weâre currently in Poland, Spain, and Portugal, as you know. I'm off to with Richard to Europe next week and [indiscernible]. And we certainly believe that there's still a long way to go in the current three countries we're in, but we're certainly going to now start the expansion and we would like to go into France as our next country, but fundamentally, we need to â we've got a lot of work to do to get real momentum in the countries weâre actually currently operating. Next question from [Kaul] [ph]. Can Karooooo make any comment on the degree which [load shedding] [ph] effect in demand either positively or negatively? In addition, any effect on traffic patterns, generally that you are able to share either in terms of accidents or increased transit times? What we see, obviously, we're not in [Ireland] [ph]. Our business in South Africa continues to be very strong. Clearly, the load shedding is affecting us on our cost structure. The ability to run the business is become more expensive. It also, in many respects, we become at times less efficient, but fundamentally, I think it's affected more our customers than it's affected us. And we see a very negative impact in the economy. And I think we're very lucky that our business â thereâs is always demand irrespective whether thereâs a negative economic environment, [a positive evolution as seen] [ph] at [indiscernible] catastrophe, we believe we will continue to see momentum. In terms of traffic patterns generally, we haven't seen the Eskom or the load shedding affect the traffic, except obviously when the traffic lights are out, that obviously affects a longer congestion. So, I would have to go look at it with more closely to answer this question, but I think in terms of kilometers driven, I think that people are doing the same kilometers. But clearly, we probably find that our customers are using more fuel given how many [traffic lights] [ph] are out for a long period of the time. A question from [Roy Campbell] [ph]. Can you talk through what you see in terms of inflation through the regions? Also, can you update on your access to inventory given recent supply chain challenges? We clearly are seeing inflation run to all the region, whether it's Europe. I think Europe probably being the region that we see with highest inflation. Asia, we also see inflation and clearly we're also seeing it in South Africa and in Africa. We keep quite a large portion of inventory and that, you know, as part of our PPE, we've increased our inventory. We've continuously been increasing our inventory for quite a long time. And given the shortage of components, that's increased even more. So, we haven't seen any shortages. Our developers have redesigned our telematics devices to be able to deal with parts that were short in the market. And that we do have [inventory] [ph] to be able to acquire more customers. We are not out of inventory. A question from [indiscernible], [Isaac] [ph], it's actually, say, it's from [indiscernible]. Have you experienced any direct or indirect impact from the recent load shedding? I think that's all for the day. I want to thank everybody for attending the presentation, and should anybody have any questions, you're welcome to email us. Thank you very much.
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EarningCall_1262
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Great. Good morning, everyone. My name is Jess Fye. I'm the large cap biotech analyst at JPMorgan, and we're delighted to be continuing the conference today with BioNTech. [Operator Instructions] Yeah. Thank you for joining us today, and thank you for the JPM team for inviting us here. It's a pleasure to present here. So first of all, the usual forward-looking statements and some safety information about our vaccine. I would like to start, again, as always, with our vision. Our vision is to harness the power of the immune system to fight human diseases. And in the last three years, we were encountered with a terrible pandemic and we were able to respond despite to this pandemic with a life-saving vaccine. We were in this privileged situation based on 20 years of research based on preparedness and it shows what technology, science and working together does. And by being able to respond to this pandemic, our company was transformed. We are now in a situation, in a historic situation where we can shape the future of medicine with new technologies, with new approaches. And we see that as a new chapter in our journey to act in a responsible way to address really to use this chance, the ability that we have built to contribute in a most effective manner to save individual lives, but also medical needs worldwide. 2022 was a great year. I would like to thank our team for a number of accomplishments. And I would like to highlight just a few of them on the helicopter perspective. With regard to the commercial success, we were able to bring the first variant vaccines. We delivered more than 2 billion doses, and we were able to keep our market leadership with a broad label (ph) and with delivery of vaccines worldwide in more than 60 regions on the planet. With regard to the execution on the scientific program, we have proven proof-of-concept for our first cell therapy product, for our next-generation immunomodulators, and we were able to start seven first in-human clinical trials (ph) for immune-oncology and free in infectious disease. And we continue to build our company, we built our capabilities. We're able to deliver the first COVID-19 variant vaccine within two months after announcement. We started new collaborations. We broadened our pipeline. We broadened our team and we ended the year financially strong. So what are the key strategic priorities for 2023? Number one, to build and strengthen our COVID-19 franchise by variant adaptive vaccines, by adding new technologies and by combination vaccines. In the immuno-oncology, we want to advance to our first registrational studies, starting clinical trials in various programs. And in infectious disease, we want to use the learnings of our COVID-19 vaccines to enter new clinical trials and continue with the already started. So how are we going to accomplish this? I would like to talk a little bit about our capabilities and our network. So in the meantime, BioNTech has more than 4,500 employees from more than 80 different nations. We have sites and collaborations now on five continents. And we announced last Friday a collaboration with U.K. I will go later into that showing that we are building now a global company with multiple sites, multiple continents with teams on all relevant places to execute our vision. We want to harness the power of the immune system. For us, this means, in principle, excellence in five pillars, deep understanding of the immune system, target discovery, multi-platform innovation engines, digital capabilities and manufacturing and automation. Today, I would like to touch a little bit deeper into our multi-platform engine and our digital capabilities. Personalized medicine is about delivering treatments for any kind of targets and any kind of conditions. We have a technology agnostic approach. We are extremely strong in the messenger mRNA technologies, but this is not the only thing that we do. We have cell and gene therapies. We are developing monoclonal antibodies, bispecific antibodies, and we have small molecules in clinical testing. And we are not only focusing on the modular aspects of these technologies, but we are focusing on the interface between the technologies. Great progress often happens if you bring in two technologies together, for example, cell therapy and mRNA technology. We have now approaches allowing us to empower cell therapies by vaccines, and we will go into approaches that we use the combination, use mRNA applications for engineering T-cell therapies. The idea of having this modular platform is the ability to have complementarity, but also to enable synergistic treatment and thereby enable individualization. Why we are doing that? Why we are so bold? At the end of the day, cancer is a devastating disease. And the greatest challenge in cancer is that every patient has a different type of tumor. That means we are getting more and more information about the genomics profiles of tumors, but the applications that we have are still based on the concept of personalization using single targets. Individualized medicine means that we can get the sequence of tumor signals of patients, engineer therapies according to the genetic profile of the patient, use of the shaft trucks (ph) and tailored on-demand therapies to adjust the entire individual variability. This type of new medicine has two aspects. We need to bring in new technologies, for example, AI technologies to ensure that these approaches can be done in an extremely fast fashion. And we have to implement a patient centric way in dealing with clinical trials as well as in a patient centric way in drug development. To address that at scale, we announced on Friday a collaboration with the U.K. Government. It is a collaboration with -- in a broad fashion with the U.K. health system, with clinical centers with genomic sequencing, sequencing partners. The goal of this collaboration is to deliver 10,000 personalized therapies by end of 2030, allowing us to do clinical trials with our portfolio of immunotherapies, mRNA vaccines, cell therapies, target therapies, small molecule modulators in multiple clinical indications, in multiple settings, early-stage and late-stage therapies. By this collaboration, our aim is to use the power of our pipeline and combine it with the logistics that allow us to do faster clinical trials. One key aspect for personalization is the ability to dissect data, clinical data, to dissect genomes, to understand how to identify mutations, how to deliver new products. And for this, we are using, since the beginning of BioNTech and even earlier, digital tools, machine learning algorithms, and we are now reaching a stage where the progress in the world of AI must be connected to the competencies that we have on drug development. And for that, we had started three years ago a collaboration with InstaDeep for connecting really cutting-edge AI technologies and solutions to the cutting-edge platform solutions that we have. From this collaboration, we came up with a number of solutions. So InstaDeep, today we announced and our plan to acquire InstaDeep. A few words to InstaDeep. InstaDeep is a leader in artificial intelligence, located in London with multiple sites in Cambridge, Paris, in Africa and in the East. InstaDeep has implemented deep AI technologies, collaborations with AI leaders and has a team of more than 240 engineers. And the plan is to acquire the company until end of Q1, so that this team and the capabilities are becoming part of our competencies. In the last three years, we developed a number of projects successfully, which already showed how important the integration of AI technologies in our existing business is, for example, the early warning system to identify COVID-19 variance in an extremely quick fashion, allowing us to reduce the turnaround time for vaccines or design of mRNA backbones to further improve the potency of our vaccines. Our goal is with the acquisition to integrate AI seamlessly in all aspects of our work from the target discovery, lead discovery as well as manufacturing and delivery of our products. So coming now to the results and goals that we have in 2,000 -- expect in 2023 for COVID-19. We have -- in 2022, we have accomplished to deliver two variant vaccines. We delivered more than 500 million doses shipped at worldwide. We have now the broadest label. And we not only manufactured and delivered the vaccines, but we did comprehensive research to understand how these variants evolve, what are the logic behind the mutations and how the immune system responds. And these learnings are extremely important for future design of the vaccines. We have created a database, safety database of more than 1.5 billion individuals, and we have built the capability to deliver vaccines in an extremely short time. How does this connect to 2023? So we know that the pandemic is not over. Yeah. We know that the virus is continuing to evolve. In 2022, more than 250,000 people died in the U.S., and we have similar numbers in Europe and this virus will stay with us for the next years. We are better prepared to address severe disease. But even severe disease, if the last immunization or the last infection is -- has a longer distance is getting a higher likelihood. So that means there is a need for variant adapted vaccines. And for that, it is important to quickly identify when a variant adapted vaccine is needed, and then we can continue to deliver the existing vaccines. What is also important is understanding that these mutations circumvented the recognition of the virus by antibodies. On the right side, you see in red the reduction of epitopes recognized by the existing immune responses, and we have left at the moment, less than 8% of epitopes on the surface of the spike protein, which is recognized by the antibodies created by the existing vaccines. This is the bad message, and this will continue to become lower in the next weeks and months. The good message is, is that there is a second protection layer. This is the T cell protection layer, and it is extremely difficult for the virus to overcome this layer. Still 80% of epitopes of the spike protein are conserved. But we believe that we can make the T cell response even more potent. We have now a T cell vaccine in clinical testing. And this T cell vaccine is designed in a way that all conserved epitopes from multiple of the Coronavirus proteins are addressed. We have about 99% conservation of this T cell stream epitopes in all strains. And we believe with this combination of a spike protein vaccine with a T cell vaccine, we can even further improve the quality of the response that we are getting from vaccination. And we will, of course, continue also this combination vaccine, not only the combo of flu with COVID-19, but also other combinations. In the infectious disease setting, we have started several clinical trials in 2022, including our malaria type trial and HSV-2 trial. We will continue with these trials. For malaria, we plan to evaluate multiple targets with additional studies in 2023. We will start our first tuberculosis vaccine and shingles vaccine trial in the next few months, and we plan to add additional pathogens in our infectious disease pipeline in the next six to nine months. Coming to oncology, our key aim in oncology is to accelerate the high priority programs towards registrational trials. We have at the moment 19 clinical programs in 22 ongoing clinical trials, and I will touch on a few of these programs, which are suitable for Phase II studies or for registrational studies to be decided in the next few months. We have, on the one side, our mRNA cancer vaccines. We have two platforms. We have the FixVac platform where we take non-mutated shared tumor antigens combine that in a disease-specific fashion. And we have the iNeST platform, which allows us to design mutation based vaccines configured in an individualized fashion. For both of the vaccine platforms, we have shown clinical activity data. For the iNeST platform, we have shown data, particularly in the adjuvant settings, strong immune responses, prevention of metastatic relapses in the adjuvant setting. We have data in melanoma, triple negative breast cancer, pancreatic cancer. For FixVac, we have shown objective responses in patients who had relapsed or progressed under PD-1 treatment, where for both approaches running Phase II clinical trials and one of the Phase II clinical trials that is of special interest is depicted on the next slide. It's iNeST trial that we have started in end of 2021. It's in the perioperative alterative session. Patients with colorectal cancer have labs relapse rate of about 30% after surgery. And if they have relapse, the prognosis of the disease is really bad. So we have -- we are identifying these patients who are going to relapse using a ctDNA assay and these patients are then randomized into standard of care with chemotherapy or standard of care plus personalized vaccination. This trial is screening more than 3,000 patients with colorectal cancer, and we will recruit more than 200 patients for vaccination. And we believe that this is one of the ideal setting for a personalized vaccine to reduce the relapses after surgery. In other programs, I would like to touch on our collaboration with our partner, Genmab. Here, we are developing immune modulatory antibodies, bispecific antibodies and engineered multivalent antibodies. We have two programs, which are now reaching Phase II with one program combining checkpoint blockade with agonistic 4-1BB approach and one program 1042/BNT312 combining to immunostimulatory aspect agonistic activities. We believe by bringing agonistic activity into cancer immunotherapy, we can increase the response, particularly in patients with cold tumors. We have seen exciting data, particularly for BNT312, which is an immunostimulatory antibody of CD40 and 4-1BB, for example, in head and neck cancer patients where we have in a small group of patients, 80% of patients showing objective -- deep objective responses with head and neck cancer. There are several expansion costs now running, and we will report about the progress of the study and how to continue with potentially registrational studies in 2023. In the cell therapy field, we started our first clinical trial with CAR-T cells. We are targeting a new molecule CLDN6 for solid tumors expressed in ovarian cancer, testicular cancer, many other tumors. This trial is still in dose escalation phase, but we are seeing encouraging objective responses particularly in testicular cancer, deepening over time with the first complete response now being stable for more than 12 months. The plan here is to proceed to Phase II clinical trial in testicular cancer and evaluate further trial opportunities in ovarian cancer and other type of cancers. This is, by the way, a combination of a CAR-T cell treatment with an mRNA vaccine. So with these approaches, we have a number of milestones expecting us in 2023. This is a selection of milestones encompassing a new clinical trial starts, data read outs from existing clinical trials as well as start of several Phase II clinical trials. The list is incomplete because we have a number of collaborations, and we still need to align in the next weeks with our partners what kind of clinical studies we are going to announce in 2023. So our vision remains the same. We want to advance the development with realization of our vision. Our goal is by 2030 to become a multiproduct, global biotechnology leader who is addressing medical need for individualized cancer patients as well as in multiple other indications with disruptive technologies. We have a good position for that with both pipeline of products and technologies now progressing towards registrational studies. I would like to thank our team, our partners and our investors, and thank you for your attention, and we can now have a discussion. Great. So just as a reminder, if you would like to ask a question, you raise your hand or you can send it to me on the portal. Nobody has done that yet. So I will start. Maybe first, recognizing you're not providing sort of near term guidance today. How do you think about the long-term COVID-19 revenue opportunity as the world moves toward dealing with it as an endemic disease? And when might we be able to anticipate more of a steady state for COVID revenue? Yeah. Thanks, Jess. Thank you, Jess. I'll start that, and I think Ugur, I'm sure can chime in. So I think our starting point here has been that there really is no perfect analog for the long-term COVID-19 vaccine market. We think this is a new pathogen. There's still a lot that we don't know. And while we expect that there -- the market could share some similarities with the seasonal flu market, it's not identical. So the seasonal flu market is about a 400 million to 600 million dose per year global market from a volume perspective. I think when we look long-term, we think that COVID-19 will stay with us, and those volumes might be the best analog, but probably aren't perfect. But I think there's a couple of features that are different between COVID and flu. And just to name a few of those, I think flu is highly competitive market. You do have a leading brands. But here, we have a more concentrated market. Ugur talked about our market share being about 60% and having grown over the last year so that's a difference. We have a generic component to the flu market here. We don't expect that. So when we look long-term, we see a double-digit billion market opportunity. I don't know, Ugur, if you want to add to that? Yes. I think what is really important is, we can't make predictions about volumes, but we have to really open our eyes and understand what is going on. People are seeing -- it is very clear that virus is continuing to mutate. And it is really mutating in a clever fashion. And the burden -- genomic burden of this virus worldwide is so high that it will not disappear. So of course, we all want that this goes away, but it will stay with us, okay. And we have to get used to a new normal. And what is the new normal? This virus is not only coming in a season, it is coming really in an unpredictable fashion. And we have two types of mutations. We have the mutation where we have a variant like Omicron, where there are [indiscernible] coming up. And then we have this unexpected completely new variants, which comes with multiple new mutations and whether where we have to say, okay, this is a really new variant and this will continue to happen. What is also not comparable to flu is it is not just an infection, which is then over after acute phase. Many people suffer from chronic symptoms. And there are more and more data that infected people were positive for eight, nine, 10 months. So this is a different beast, and we have to be aware of that. We have to communicate that and we have to find ways to deal with that. I believe one trend will be still not only focused on severe infection, but think about how can we develop vaccines and approaches that prevent infections or symptomatic disease. Well, I think, again, we don't have clear visibility. But when we look at the structural, some of the structural features that we would expect. We're already starting to see in terms of the evolution of the virus, likely requiring sort of seasonal or regular updates, and from a variant perspective, potential for combination vaccines, et cetera, yes. So talking about total market, best guess, we don't know, but I think best guess, we do think that this is likely to be a more attractive market than seasonal flu. So I think that's -- I think that's the key point over the coming years and longer term. Thank you very much. BioNTech has announced unprecedented investments in industrial structures in Africa, soon the most populous continent and systematically underserved by those companies who normally present here. Would you elaborate a little bit on BioNTech's plans? Should I take that, or do you? Yeah. So one of our goals is really addressing medical need worldwide. And with the mRNA technology, of course, we have now the opportunity to address infectious diseases, which were neglected or which were quasi neglected for where there is a huge medical need. So we just got an approval of malaria vaccine is the first malaria vaccine, but we still believe that malaria is an infectious disease with extremely high medical need, when mRNA vaccine, a highly effective mRNA vaccine can help eradication. The same is to for tuberculosis, and the same, even much more difficult to address is true for HIV. So we want to bring our technology, use our technologies for this high medical need neglected diseases. And we have started now our malaria trial. We are going to start a tuberculosis trial. And our goal is really the data look good to continue to develop these vaccines and get them to the market. This is the first aspect, addressing medical need. The second aspect is providing access to technology and manufacturing. So one of the learnings of the pandemic was that, at least in the first nine months when vaccine rollout were there, and poor countries didn't get vaccine doses. And this will not change even in the next pandemic because it is very clear if we have a pandemic situation, where vaccines are produced, they will be the first served, okay. So the question, how can we change that? And the only way to change that is to implement manufacturing technology, for example, in Africa. And this is not an easy task because it takes many years and huge investment to get these manufacturing facilities. And therefore, we came up with a new concept, which we call BioNTainer concept. This BioNTainer concept is more or less a plug-in manufacturing technology, which allows with a containerized system to produce up to 60 million in the second phase up to 100 million doses of vaccines in container-based, automated, digitally controlled factories. And our first factory will be implemented or we had the groundbreaking this year, and it will be implemented the first manufacturing facility will be there in 2023, and we plan to produce the first mRNA vaccines on the African continent in 2023. So this is in Kigali, Rwanda. We have identified other sites, for example, in Senegal. We are thinking about South Africa. So by this modular system, we can make technology accessible. And by this, we could get true independence by access to technology, and we will combine that also with a collaborative approach, getting access to talents, training the people there, so that they can really manage these new technologies by their own. So that's our plan. You have a great COVID-19 vaccine, but this vaccine is not available in China. Do you think price negotiation is part of reason in that case, can you help? Yeah. So I think your question just to make sure I understood was that are the price -- is pricing negotiations, the roadblock to approval in China, right? Yeah. So I think the short answer is not really. No. I think it's a broader roadblock. You're right that we don't yet have approval in Mainland China. We have been distributing our vaccine actually for well over a year in Hong Kong, Macau. We've distributed to Taiwan. We actually had quite good uptake in Hong Kong Macau and very recently, Chinese nationals were able, if they travel to Macau, to get access to our vaccine. I think we've not been able to -- so far to get approval in Mainland China. Over the last couple of weeks after a meeting with Chancellor Scholz in Germany and his counterpart in China, we did have a sort of mini breakthrough whereby our vaccine was made available for German nationals in China. But I think, at this point, so far, China has not authorized any foreign vaccine for the broader population. And I think we don't yet have visibility on when or if that policy will change. Yeah. Thanks. You mentioned that you didn't expect the COVID vaccines to go generic anytime soon, but we've heard Peter Marks mention that he does expect them to kind of follow in the footsteps of the flu in that sense. So I guess can you offer a little more color around that and talk a little bit? Yeah. So I think the flu market, we've seen room for both branded products -- successful branded, blockbuster products, but also the long tail of much lower priced generic products, and then there's a whole bunch of products in between. I think here, my point was that we have a much more sort of consolidated market with a couple of big players globally in the key markets. Obviously, we're in a good position in that regard. And so I think over the next couple of years, I do think that there's going to be a stronger branded character to the market relative to flu, if we just want to compare. And I think that's unavoidable. That's not to say that there couldn't be, on the margin, new entrants. But we've built up such brand equity and our safety database that, for example, sort of such a broad base of the population that have been vaccinated now, in many cases, several times with the vaccine, I think many people had a good experience with that. And I think that, that counts for something as we think about the likely shape of the market over the coming years. And I think innovation will continue to add to that, too. I think -- Ugur talked about some of the next-gen vaccines, the T-cell strain vaccine, potentially the next variant adaptive vaccines. So we're going to continue to invest in the franchise. We look at this as a sort of multiproduct franchise. And I think that core part of the market will likely continue to be, let's say, branded because it will be based on continuing innovation. There have also been some headlines, I think, about potential list prices for co-vaccines in the U.S. as we move to a commercial market and recognizing that you have a partner here, how should we think about whatever the net price for commodity (ph) ends up being in the commercial setting in the U.S? Well, so I think it's -- our starting point here was a very low price. On any sort of health economic basis, the price -- we started off at $19.50 in the U.S. The prices come up to a little over $30 in the booster phase of the pandemic. But if you compare that to other innovative vaccines in a sort of normal market setting, that's just orders of magnitude lower. So that's the starting point, and of course, that reflects the situation that we were in with massive volumes and a global public health need that we felt was important to address. I think as we transition now towards the next phase of the market, we do expect prices to come up in the commercial setting. We and Pfizer have guided to a price per dose gross of $110 to $130. We're not in a position yet to talk about net prices and gross to net ratios. But I think even that price, we think, is certainly more than justified on a health economic basis when you look at the lives saved through vaccination, the hospitalizations avoided and the overall benefit from a public health perspective. Maybe with just a little more time here. Switching to your oncology pipeline. Moderna recently top lined some positive data for their PCV program. Is there any read-through that you see from an approach like PCB to your own oncology programs like iNeST? Yes, I believe what we all expected, and this is not surprising is that cancer vaccines, personal cancer vaccines will be particularly effective in the adjuvant setting. The reason for that is a biological reason. There is much less tumor cells. There's more time to build an immune response. And in all kinds of experiments, we have seen that vaccines are ideally suited to prevent outgrowth of metastatic lesions, and that is what is observed in Moderna's trial. We have published similar data from single-arm studies in melanoma, in pancreatic cancer. We are seeing similar observations in triple negative breast cancer. And this, of course, calls for randomized registrational studies in the adjuvant setting.
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Good day, ladies and gentlemen and welcome to the General Electric Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] My name is Liz and I will be your conference coordinator today. If you experience issues with the webcast slides refreshing or there appears to be delays in the slide advancement, please hit F5 on your keyboard to refresh. As a reminder, this conference is being recorded. I would now like to turn the program over to your host for todayâs conference, Steve Winoker, Vice President of Investor Relations. Please proceed. Thanks, Liz. Welcome to GEâs fourth quarter and full year 2022 earnings call. I am joined by Chairman and CEO, Larry Culp and CFO, Carolina Dybeck Happe. Keep in mind that some of the statements we are making are forward-looking and based in our best view of the world and our businesses as we see them today. As described in our SEC filings and on our website, those elements may change as the world changes. As a reminder, GE completed the separation of our healthcare business this month. GE Healthcare will report separately on January 30. So while included in our 2022 results, we are focusing todayâs commentary primarily on GE Aerospace and GE Vernova, our portfolio of energy businesses. Our remarks will also be simpler and shorter today, reflecting the company we are now and we will move more quickly to Q&A. Steve, thank you and good morning everyone. 2022 marked the beginning of a new era for GE, following 4 years of strategic and operational transformation. We successfully separated GE Healthcare in a spin-off, distributing approximately 80% to GE shareholders on January 3. We strengthened our foundation, retiring an additional $11 billion of debt, bringing our total debt reduction over $100 billion since 2018. We continue to improve our operations, further embedding lean and decentralization to better serve our customers. And today, excluding GE Healthcare Services, which are both higher margin and more resilient, represented even larger part of our portfolio about 60% of revenues and 85% of our backlog. We finished the year strong, delivering revenue growth, margin expansion and better cash generation. GE Aerospace led the way as we executed on an unprecedented ramp. Within GE Vernova, power delivered with continued stability at gas and we took significant actions to position renewable energy for future profitability. External catalysts like U.S. climate legislation and the European focus on accelerating electrification are increasing investment in new decarbonization technologies. This progress has positioned us to create industry leading investment-grade independent public companies. Thanks to our teamâs high-quality work, our plans to launch GE Vernova and GE Aerospace are progressing well. We are filling key leadership positions for both and we are preparing for two standalone businesses. We will share more details with you, including our ongoing progress and timeline for the planned GE Vernova spin at our investor conference in March. I could not be more proud of how the GE team managed through a challenging external environment to deliver for our customers and partners in 2022, my thanks to everyone. And before I turn the call over to Carolina, a moment of reflection. Just two weeks ago, I, along with many of our leadership team attended a memorial service for our exemplary GE Board member and former U.S. Secretary of Defense, Ash Carter. Ash was a remarkable leader, incredibly humble and clear headed. We miss him and his stage counsel. Thanks, Larry. Turning to Slide 3, I will speak to the key drivers of our performance. I will do it on an organic basis and including GE Healthcare. In the fourth quarter, top line momentum continued as orders grew significantly across all segments. Revenue was up 11%, with services up 13%. By segment, revenue at Aerospace, Power and Healthcare was up double-digits, driven by market demand, price realization and improving delivery. This was partially offset by renewables largely due to lower volume resulting from U.S. PTC lapse and our heightened commercial selectivity. Adjusted margin expanded 290 basis points. Power was particularly robust, offsetting renewables. Overall, our price and cost-out actions outpaced inflation. Revenue and profit growth resulted in over 50% EPS growth. Free cash flow was $4.3 billion, primarily driven by strong earnings and improving working capital. All accounts were a source of cash, except receivables, which as expected, was a use from revenue growth. Moving to the full year, orders were up 7%, with 22% growth in Aerospace and 13% growth in Power. Total services orders were up 12% supporting profitable growth in 2023. Revenue was up 6%, largely driven again by Aerospace, up 23%. More broadly, higher margin services were up double-digits, while total equipment revenue decreased 4%. Collectively, supply chain headwinds and macro pressures impacted our performance by about 4 points. Importantly, margins, EPS and free cash flow, all significantly improved year-over-year and finished in line or above the most recent outlook we shared in October. Adjusted margin expanded 160 basis points led by Aerospace and Power. Robust services growth, pricing has almost $1.5 billion of cost out actions drove improvement. This was partially offset by inflationary pressures especially at our shorter cycle businesses and pressure from renewables. Operating profit growth and debt reduction drove EPS up more than 50% for the full year. Free cash flow was $4.8 billion, up over $2 billion or over 80% improvement, driven by earnings and reduced debt. In 2022, working capital was a source of cash as accounts payable, progress collections and contract assets all contributed to the solid performance. Now, a moment on corporate. In 2021, we ended the year with $1.2 billion of costs. We continued to reduce cost in 2022, including a few hundred million dollars of market-driven favorability. We now have a smaller, linear cost structure. And in 2023, we expect costs of about $600 million or roughly half of the 2021 sales line. Free cash flow, we expect to improve significantly given our progress with debt reduction and lower costs. We continue to execute our restructuring plans and reduce our cost structure post the healthcare spin, setting up fit-for-purpose, standalone structures for GE Aerospace and GE Vernova. Stepping back, we are encouraged by our improved volume and pricing and our significant cost-out actions exiting the quarter. This will help us drive continued growth in 2023. Carolina, thank you. Starting with Aerospace, I am 6 months in leading this business and my conviction is even higher today that we have a premier franchise with highly differentiated product and technology positions and leading positions in attractive commercial and military sectors. Entering 2022, our priority was delivering on the significant growth across both engines and services, where stability and predictability are critically important for our customers. This starts with the right team. We have a balance of unparalleled experience and fresh perspective with nearly half our leaders new to their roles this year. We are also driving two major operational changes. First is accelerating our progress with Lean to improve operating rigor and delivery. Take supply chain, where we have seen real improvements with more to come. Our team in Terre Haute produces lead turbine center frames and started â22 with about 50 pieces delinquent. Working through multiple kaizens, implementing flows, standard work and daily management, the teamâs Lean actions increased output over 20% and improved productivity by about 10%. And today, they are on schedule. With our 2023 demand, we will need to continue to use Lean in this way to deliver for our customers. The second is decentralization. For example, in our commercial engines business, we are increasingly running our product lines as their own P&Ls, in line with how our customers work with us, more cross-functional collaboration in real time closer to the customer helps make us better. Turning to the quarter, both orders and revenue were up over 20%. Equipment orders were robust, now with almost 10,000 LEAP engines in backlog. Commercial services and equipment revenue grew about 30% and military revenue was up about 20%. And services internal shop visits were up 25% and external part sales were up more than 20%. In equipment, commercial units were up nearly 30% with LEAP units, up almost 50%. Looking sequentially, both internal shop visits and commercial units were about flat, but military units were up 10%. While material availability continues to be a challenge, our output across engines and services, we are using our Lean tools to help accelerate sequential improvement, a key for us this year. Fourth quarter margins were above 18%, slightly better than we expected, although down year-over-year. Higher volume and price were more than offset by negative mix driven by increased commercial equipment shipments, continued investment to support the business growth and other cost pressures. While still net price cost positive, we expect inflation will continue to be challenging in 2023. For the year, revenue was up 23%, driven by commercial sales with internal shop visits up over 20%. Profitability and cash were solid. Margins were 18.3%, up 440 basis points year-over-year. Services growth and positive price costs more than offset the impact of increased investments and negative engine mix from higher LEAP deliveries. Free cash flow of $4.9 billion was driven by earnings and working capital. As we shared last quarter, total in-year AD&A flow came in close to zero versus last year, $0.5 billion of pressure. Looking ahead today, GE and CFM departures are close to 90% of â19 levels and we expect to be back to â19 levels later this year. In â23, internal shop visits are expected to grow about 20% and external spare part sales are expected to increase. With commercial engines growing at about 20% and services at high-teens to about 20% plus military growing at a high single-digit rate, we expect total aerospace revenue to be in the mid to high-teens and we expect LEAP engine deliveries to grow about 50% in â23. We also expect to deliver profit of $5.3 billion to $5.7 billion and higher free cash flow. Aligned to current airframe or aircraft delivery schedules, AD&A is expected to be about $0.5 billion outflow in 2023. We are laser-focused on supporting our airframers, airlines and lessors as they ramp post pandemic. Today, that means providing stability and predictability for our customers keeping our current fleet flying and growing our new fleet, all the while continuing to invest in technologies that will define the future of flight. Notably, we are encouraged by the momentum at military with our next-generation technology, including the XA100 engine for the F-35. The XA100 offers cutting-edge capabilities needed to ensure continued U.S. air superiority. The Adaptive Engine Transition Program received a strong show of support recently from nearly 50 bipartisan members of Congress who wrote in support of continuing the program, which includes our engine with $286 million of funding included in the 2023 Omnibus Appropriations bill. Overall, GE Aerospace is an exceptional franchise with a bright future as the standalone industry leader. Turning to the GE Vernova portfolio, power delivered a solid performance this year and we are making real progress running a similar strategy at renewables. While the demand dropped due to the PTC lapse significantly impacted our renewables results in 2022, the Inflation Reduction Act is a real game changer for us and the industry going forward. In fact, we began to see a rebound in demand this quarter, with renewables orders up 7%. Onshore orders in North America more than doubled a very encouraging sign. But unlocking the full potential of the IRA will hinge on how quickly the administration moves through implementation. Meanwhile, lower volumes and inflationary pressures continue to weigh on our performance. Fourth quarter revenue was down 13% due to onshore and margins contracted as inflation and lower volumes offset pricing and productivity gains. Full year free cash flow declined over $0.5 billion due to lower earnings. So, while we await clarity on the IRA rules, Scott and the team are controlling the controllable, taking action and we saw progress in that regard this quarter. Grid, a business that lost close to $400 million in 2021 was profitable for the first quarter since 2018, reflecting our restructuring and selectivity efforts. Orders also grew significantly. At onshore, we are executing a restructuring with our headcount decreasing almost 20% sequentially, which will deliver savings in 2023. Our strategic sourcing actions that are onshore and our focus on reducing product variance will improve product costs despite continued inflationary pressures. Across the businesses, orders and sales pricing continue to improve with our selectivity strategy yielding a more profitable backlog and pipeline. Service orders and revenues, excluding repower, grew. There is certainly more work to do and the next 6 months will remain challenging, but we are acting with urgency. In 2023, we expect mid single-digit growth, significantly better profit and flat to improving free cash flow. Taking it by the businesses. Onshore, we expect more than 50% orders growth in North America this year. And based on the orders we have in hand, we are confident of delivering over 2,000 units globally with North American volume more than doubling in the second half versus the first half of the year. We also expect a significant step up in profit driven by lower warranty and related reserves, better price and restructuring benefits. With this significant orders growth comes roughly $3 billion to $4 billion of cash down payments this year. This includes $0.5 billion of cash linked to large tech selects we have won, which we expect to convert to orders later this year. These are strong customer commitments, but given the project size and complexity, timing could shift somewhat across quarters. In offshore, we expect to more than double revenue from about $0.5 billion in 2022. However, our margins on the first tranche of Haliade-X projects will be challenging between typical new product margins and inflation resulting in rising losses. Associated with the delivery growth and limited down payments, we also expect cash will be significantly pressured in 2023 in offshore, mostly a timing dynamic. And at Grid, given our robust orders growth, we expect continued growth. The actions weâve taken on price are expected to offset inflation pressures, and we continue to make progress, including our small â our smaller cost structure and productivity. Taken together, this will enable grid to deliver a modestly profitable year in 2023. Overall, Iâm confident weâre seeing operating improvements throughout the year in renewables and key external catalysts like the IRA will help improve our longer-term economic profile here. Moving to Power. Weâve significantly improved power is demonstrated by our continued profit and cash growth. Weâre well positioned for continued services growth with our expanded HA fleet. To date, weâve now shipped 110 HAs with roughly 80 units COD, providing a reliable source of cash growth in the future as our highest utilization assets in the fleet. Looking at the quarter, power demand remained robust. Orders grew in all businesses and revenue was up double digits, largely driven by continued aero derivative momentum at Gas Power. Services were also solid with orders and revenue up again driven by gas transactional services. Margins expanded over 700 basis points driven by significant gas volume, favorable price cost and productivity gains. Similar to Aerospace, we expect inflation will remain challenging through 2023. Moving to the full year, orders were up double digits, but importantly, weâre not taking our eye off selectivity with disciplined underwriting. In line with our outlook, revenue was up low single digits led by services. Margins expanded 300 basis points, enabling power to achieve high single-digit margin for the year, and our free cash flow improved significantly across both gas and steam. At gas service, billings were strong as fleet utilization grew low single digits. Looking to 2023 for Power, we expect low single-digit revenue growth driven by Gas Power services. Equipment revenue will grow as we deliver more HAs despite the new build wind down at team, and we anticipate [Technical Difficulty] year-over-year. At gas, both equipment and services volume as well as productivity gains and price should help offset rising inflation pressure. We expect lower free cash flow year-over-year, continued earnings growth and strong services collections are offset by disbursements, but we expect free cash flow conversion to remain solid. Stepping back, our existing technologies in the GE Vernova portfolio will play an important role in the energy transition. Itâs the strategic imperative to electrify and decarbonize the world is a challenge these businesses with their vast installed bases were made to meet. Letâs turn now to the overall GE outlook for 2023. Weâre expecting organic revenue growth in the high single-digit range, $1.60 to $2 for adjusted EPS, which includes about $4.2 billion to $4.8 billion of adjusted profit and a range of $3.4 billion to $4.2 billion for free cash flow. Underpinning this outlook is a higher services concentration in our portfolio as well as our confidence in the strength of GE Aerospace is the worldwide commercial aviation industry, airlines and airframers like continues its post-pandemic recovery. We also anticipate military revenue growth, thus yielding significant profit growth for GE Aerospace in â23. For GE Vernova, we expect low to mid-single-digit growth and profit of negative $600 million to negative $200 million, including improvement at both businesses. On cash, we expect flat to slight improvement. This is driven largely by better profitability and planned down payments in onshore where timing could shift across quarters with some offset from offshore increasing deliveries. Across GE, we expect continued operational improvements to deliver higher earnings and improved working capital management. In turn, this will help us drive higher free cash flow for GE in â23. We are looking forward to sharing more during our March 9 Investor Conference at GE Aerospace in Cincinnati by then, hopefully, home of the Super Bowl Champion Bangs, where youâll hear more detail from our leadership teams about both GE Aerospace and GE Vernova. Please come to see us. To close on Slide 8, I hope you see what I see: strong results, a simpler story and an exciting future. GE Aerospace continuous improvement is our mantra, and our results reflect our team, our technology and our portfolioâs unique positioning is the industryâs largest and youngest fleet. At GE Vernova, Power is delivering solid earnings and cash, while weâre setting up renewables to drive longer-term profitable growth. Weâre moving forward with our plans to launch two independent investment-grade industry leaders that are well positioned to create long-term growth as we shape the future of flight and lead the energy transition. And Iâm confident that we will unlock greater value for our customers and our shareholders in the year ahead. Thanks, Larry. [Operator Instructions] We ask that you please save any GE Healthcare questions until their earnings call next week. Liz, can you please open the line? Yes. So my question is really going to be focused on this free cash flow bridge for 2023. And specifically on the segments, Iâm curious you talked about Aviation free cash flow being up versus 22%. I know that you threw out the $500 million impact in AD&A, but did the rest of GE Aviation free cash flow grow consistently with earnings in 2023? And then my kind of second question on the segment is just around renewables. And what are you anticipating for the large payments in the second half of the year and what impact that has to the free cash flow in 2023? Thank you. Okay, Joe. So a couple of questions. So let me start with the free cash flow guide for 2023 for the whole company. So if we look at our 2022 numbers that we just printed 4.8%. New jumping house point, excluding healthcare, is $3.1 billion. So basically, we are assuming that the midpoint of our guide, we will improve free cash flow with about $700 million. And the majority of that comes from growing of profit. Midpoint is about $1.3 billion of improvement in op profit. You add to that lower interest, a couple of hundred million of tailwinds and then some working capital improvement despite the high single-digit growth. A couple of things that are partially offsetting that, the headwinds for AD&A that you mentioned, about $0.5 billion, we have a restructuring cash out as well as higher cash tax since we made more money. So taking all together, we expect earnings to be the biggest driver of the improvement. We continue to benefit from our working capital management. And overall, thatâs what leaves us confident in our total free cash flow guide. You also asked about the segments specifically and on aerospace. So if you look at aerospace, clearly, the improvement in profit is a big driver in aerospace improved free cash flow. When it comes to working capital, mind you, what Larry said about the really strong growth that weâre expecting to see. So of course, working capital will be pressured receivables and also partly inventory from that kind of growth. But we do expect that the combination of profit growth, working capital management will more than offset the AD&A headwind of $0.5 billion. So we will improve cash also for aerospace. And then if you look at the Vernova businesses, as Larry said, we basically expect it to be flat to slightly improving on cash as well. And here, you have power would be slightly down where we expect renewables to improve. Down payments, Joe that you were asking about, I think we said in our formal remarks that should be in the $3 billion to $4 billion range. Some of those are four orders as they progress and orders to come, many of which we have been selected for. But again, the timing here until the finalizes the rules, the tax rules for developers could have a little bit of movement, and thatâs what we were trying to flag in the formal remarks. So it will be back loaded in that regard, but we will have much greater linearity in aerospace as Carolina suggested. Larry just wanted to follow-up here on renewables. It looks like there is some profit improvement, not maybe all the way back to what folks were perhaps expecting. Just wondering if you could parse whatâs getting better like selectivity or grid or price cost versus whatâs still kind of a more material headwind this year? Josh, good morning. No, I think if you look at renewables, we think profitability will be significantly better. If I break it down, at grid, weâre really encouraged by the improvements the team has put in place. I think thatâs what yielded the profitable quarter here in the fourth, but more importantly, sets them up to be profitable in 2023, right? This is a business that people had given up on a few years ago. And particularly in Europe, weâve seen tremendous interest really across the grid portfolio in line with this accelerated electrification thatâs underway. So I think thatâs all good and they begin to contribute in the new year. I think from an onshore perspective, a little to Joeâs question a moment ago on cash, the same thing applies to profitability. I think the first half is going to continue to be challenged much in the way that 2022 has. But as we work our way through the year, we would expect to see volume. We will see higher quality volume as a function of that selectivity, and we can really see better pricing in our order book compared to our revenues and our test selects compared to our orders and in our pipeline. Weâve talked about that before. I think that really is a sign that the industry is transitioning in anticipation of the IRA to one where volumes may be â capacity may be challenged by demand, and that will be good overall. But there is a whole host of things that we need to do operationally. I think we talked in the last call about improving our producibility and the robustness of what we do in manufacturing. At the same time, we have taken some structural cost actions really the only place in GE where thatâs the case with nearly 2,000 of our associates in transition here as we look to get the renewables business onshore in particular, in better shape for what lies ahead. And then for offshore, because we arenât going to double revenue, weâre going to need to recognize the losses that go with the Haliade-X early on here. So grid much better, onshore wind and transition, a bit of a timing dynamic with offshore, and you put that together, and thatâs really what gives you the renewables guide for â23. Hi, good morning. Just wanted to ask about cash flow sort of through the year and also the uses of your cash, thatâs something maybe refreshing to talk about for the first time in a few years, but on the cash flow through the year, when we think about the seasonality, I think you had sort of free cash was minus $900 million first quarter a year ago. How do you see the sort of the cash flow moving this year? It sounds like renewables may be a very big headwind in the first half and then swings in the second. So any color on the GE firm-wide free cash as we go through the year? And then maybe more for Larry, sort of thoughts on capital deployment there is starting to be some optionality now for GE partly because of the improving cash flow. Itâs mostly been debt reduction understandably for a few years, but maybe just help us understand your priorities on cash use? Julian, let me take the first part of that question on seasonality and on how we see that happening through the year in 2023. Maybe let me just start with the first quarter. We are expecting an EPS of $0.10 to $0.15 in the first quarter. So actually better linearity than weâve seen before in 2022. On cash, we still expect cash to be negative also in the first quarter. The new jumping off point is a negative 1.2. So we expect it to be significantly better than that, but still negative as is typical for our seasonality. And seasonality, in general, I would say we donât expect material changes to our seasonality. We are still sort of heavy second half loaded both on revenue and profit and on cash, actually even more back-end loaded now that we are excluding healthcare. So expect lower volume in the first half and ramping in the second half. sort of renewables sequentially growing through the year â sorry, aerospace sequentially growing through the year, renewables significant for the first half to second half ramp and power more the typical outage seasonality where youâd see sort of large 2Q and even larger 4Q and we also have equipment deliveries in the second half. But I would finish by saying that improving operational linearity is a key priority for us and clearly more to do. Julian, I would say with respect to capital allocation, youâre right. The boardroom conversations are fundamentally different than they were just a few years ago, right? Weâve now reduced our debt loans by $100 billion. Really pleased with the way healthcare is and has traded here. You can look at that effectively is a $30 billion dividend to shareholders. So we have a lot of options. And I would say all options are on the table. However, job one remains the completion of what we announced, the transformation back in November of â21, right. We want to make sure more than anything that we are setting up both aerospace and Vernova in the way that we described them. So, as we work through a number of, if you will, more tactical considerations, that overarching strategic objective will continue to be foremost in mind, but no doubt about it. Itâs a different conversation and itâs a much more enjoyable conversation to have than where we were back in â18 and â19. Just a couple of questions, I think on Vernova, First, I think there is a lot of sort of talk in the industry about â on wind to structurally change the contract, right, because overall industry is just not in particularly good shape. So, question one, where are we in conversations with large customers who seem to want more capacity, yet sort of the contract terms are not really helping the industry make any money? Where are we in structurally renegotiating the contract structure? And I hand the second question just on power overall, more traditional power, but focus is on profit growth, not revenue growth. What are the key levers you are focused in â23, guidance seems to suggest modest margin expansion? Are there any headwinds in gas and services that you are facing in â23? Thank you. Andrew, I will take the first part of that. Carolina, perhaps can jump in on the second part. I would say that you see, I think in the press more discussion offshore than you do onshore relative to renegotiation given that some of the PPAs that are in place in the wake of the inflation that has run over every part of our economy makes those more challenging arrangements. We are just really starting in our offshore business. So, we see a little bit of that, but frankly, not a lot given our relatively small position. I think the way you see those dynamics playing out for us, again, in the wake of the IRA in particular here in the U.S. is that customers really want what we refer to as workhorse products. I think the technical specmanship, the arms race is a thing that is quickly â a dynamic thatâs quickly fading here and customers want to make sure that they know they can get units onshore in particular, over the next several years that they can count on, both in terms of performance and delivery. And I think that, in turn is leading not to renegotiations. Thatâs not the nature of the business. But as we look at new business, right, the reason we are seeing better pricing. I think that the industry is going to need to work it, work through that so that there will be a new equilibrium the carats offered by the IRA are incredibly helpful in that regard, at least we anticipate that they will be once the IRS rules are finalized. And that in turn, is why I think you will see us step up in volume over the next several years and presumably convert these better â sold price levels into real margins and real cash. To the power, I have to just start by saying looking at where we landed the year and what the team delivered, $1.2 billion of profit and 7.5% of op margin, really getting to high-single digits, thatâs quite an achievement. And building on that for 2023, for power, we have a couple of positives. We have more CSA outages. We talked about â22 being a low-CSA outage year, â23 will be higher CSA outage year, so thatâs good. We also have aeroderivatives growing. But we do expect to have a tough mix equation with equipment deliveries as well as inflation. So, price cost for power, having had a big price impact in 2022 when you lap that in 2023, being pressured by the inflation coming through in the P&L being such a long-cycle business. So, overall, we expect earnings growth and on the cash side, also strong services collections, but offset by distribution, so down slightly on the cash side, but still a very high cash conversion number. Hi. Good morning. Just went â my line just went there. First of all, thanks for all the details. We have covered a lot so far. I did want to go back to the offshore losses and cash outflow in â23. Just wondering how do you see that curve developing? I donât know if you want to quantify it in â23 in terms of the headwinds facing. But how do you see that progressing in â24 or â25? And maybe just given the magnitude of the losses in â23 for renewables in total, are we still confident in the bridge back to â24 profit? Nigel, I donât know if we got all of that. Let me speak to the offshore dynamic. I think what we are going to see in â23 is pressure. We talked a little bit earlier about the doubling of revenue, the dynamics with the Haliade-X being new and how that rev rec will lead to op profit pressure. From a cash dynamic, we will also see disbursements as those projects move forward. We should see some milestone payments, some of which will be back-end loaded as well. And they too have a little bit of timing variability around them. We need to execute in order to see that in â23 as opposed to â24. But as we look forward, I think what we have gotten from customers is a lot of good feedback relative to where we go next with the evolution of the Haliade-X. And thatâs where our product teams and our engineering teams are focused. I think the timing of when we see the next tranche of orders is such that itâs going to be potentially more a â24 than a late â23 dynamic. And that too will create some of that pressure that is not atypical for a business that is effectively in startup mode. I wish it were otherwise, but again, I think given what we are seeing in grid and what we should see in onshore once we have clarity with the IRA, that will help buffet us in many respects. But when you look at Vernova overall, for that free cash flat to slightly improving guide, thatâs really what we are referring to. I think with respect to no change in expectation, right. Again, if we get the volume that I think everyone anticipates coming here in the North American market, our best market, where we are seeing healthier pricing, coupled with better execution from a manufacturing, from a cost perspective, grid being profitable and onshore or offshore rather coming along, we should do that in â24. We need to do that next year. And when you see that cash â that profit will then turn into cash and then also the timing that we have talked about on working capital with the progress down payments and more of that happening in 2024. Alright. Good morning. Just sort of a multi-parter for me, if I could, I am sorry. But just first on renewables. I just do want to confirm that the free cash flow guide includes the expectation of this $3 billion to $4 billion of payments. But my larger question is really how we think about normal conversion going forward, kind of the implied free cash flow conversion on the guide here today for â23 is 180%, 190%, 200% or so relative to net income, right? So, how do we expect that to normalize over time? And maybe you could provide just a little bit more color on that bridge from net income to free cash flow. Carolina, you started walking us through the delta a little bit, but still just kind of that absolute difference between the two would be interesting to bridge? Thank you. Sure, Jeff. So, to start with, you are right. As Larry mentioned earlier this morning, in our guide for renewables, we are expecting the $3 billion to $4 billion of payments in the free cash flow. When we talk about free cash flow conversion, and you know me, I always talk about cash, but itâs important to see where it comes from. So, broadly speaking, we do expect to operate at more than 100% free cash flow conversion for the next few years. And why is that, a couple of different parts. First part, depreciation and amortization being higher than CapEx. And then I will talk more about the working capital opportunities and timing as well. But with the depreciation and amortization, an important distinction. We expect depreciation to be largely in line with the CapEx to basically continue to invest. Itâs really the amortization that makes the difference. And now that we are excluding healthcare, itâs about $600 million of difference, and we would expect that to continue for years. And on working capital, I would say there are a couple of different parts here. We do continue to see opportunities in improving our working capital management, especially after the year with the pressure that we see on the supply chain. So, we see opportunities both to improve to so and inventory turns on receivables and inventory. But also when we look at progress and contract assets, we expect both to be sources given where we are in the cycle. Finally, on AD&A, itâs not working capital, but itâs also a driver. And this year, we are expecting negative $0.5 billion of flow and we have had a couple of years with positive flow from AD&A. So, for the next couple of years, we can expect that to be pressure. But over time, we would also see that normalizing. So, overall, we do see opportunity to continue to improve and we will continue to work that. But for now, we are focused on growing earnings. Thank you. I wanted to turn the conversation over to the aerospace business and specifically margins. I understand the general flat lining of margins in 2023, given the mix towards equipment. But I guess my question is, how long should we expect these mixed headwinds to persist? Should we model margins higher coming out of 2023? And is there anything keeping the segment up from returning to that 21% level achieved in 2018, 2019? Thank you. Well, we are delighted to talk about aerospace. So, let me jump in. We had a very strong finish, as you saw margins up to nearly 19%. But Chris, as you know, this LEAP dynamic and frankly, mix overall will be a pressure for us in â23. I think as we look at margins next year, rather this year, we would expect they would be flat, but the revenue growth will give us an opportunity to drive profit growth up, call it, 15%. I would call out two things in â23. One, we do expect new units to grow more rapidly than services, thatâs a headwind in and of itself. And then the LEAP dynamic, both within services and within new units will create the mix pressure that I suspect will remind folks about through the course of the year. That said, I donât think we look at 18% as some sort of ceiling that we cannot pierce. We continue to have, I think a lot of optimism about the LEAP program and the opportunity to improve margins both with new units and in the aftermarket as we go forward. The program is still very much a young one. I think at the same time, we know price-cost hasnât been as challenging, but it has been challenging at aerospace. We will do a better job, I am sure as we go forward. And our lean efforts, I think very much is an intendancy. You will see that both in the P&L and I think in the cash flow statement. So, I donât think this is necessarily a â23 and done dynamic. That said, our expectations would be as we go forward, all in to continue to drive top line growth, profit dollar growth and margin expansion at aerospace. First is a follow-up to Jeffâs free cash flow question. Larry, when you joined GE, you talked about an initiative to kind of smooth out the free cash flow cadence for the year, trying to avoid that historical hockey stick. And look, there are still some seasonal impacts. You canât get away from like scheduled outages that will impact the fourth quarter. But has there been progress? Is that still something thatâs an initiative here in terms of smoothing out free cash flow? And then I had a follow-up macro question. I would say that there has been progress. There is still a lot more to do. And we talk about it, when you hear us use the word linearity, right, it gets back to Lean 101. We just want to make every hour of every day count, every day, every week, every week of every month. And there is still a bit of a dynamic. Some of this is us, some of this is our customers, where we migrate towards quarter end, we migrate towards year-end. So, I am encouraged by the progress. And I think more people today understand how we can be more linear. If you look at just the reviews we have had the first three weeks of this year at aerospace, right. We are looking at how we have started this year, how we have started this month, vis-Ã -vis, December, vis-Ã -vis, January a year ago. Those are the sort of operating cadences, which really help us in that regard. So, pleased, but we are not done. Appreciate that. And then just given the uncertain macro, can you cite any changes, any meaningful changes in demand indicators that you are looking at, whether itâs quote activity, front log, anything that you could share here this morning. Well, we are looking at just about everything that we can. Obviously, in aerospace, we are watching not only departures, bookings and everything that can precede that. The only thing that we have seen, and this is in a proprietary view, Deane, is obviously, freight has softened here as the short-cycle economy has done the same. I think with respect to for Vernova, we look at utilization in gas and when we can see whatâs happening in real time. Even in Europe, we have been encouraged, I think by the utilization of the gas fleet. That said, we donât want to suggest that we are immune with 60% of revenue now and services tied to those real-time dynamics we are watching carefully, but we wouldnât be guiding a high-single digit top line number this year if we werenât confident that our positioning both with the aerospace recovery and the energy transition sets us up to do well here in â23. Steve, we have covered a lot of ground here this morning. I would just wrap up with the group saying that 2023 really, I think was a historic year for â22 rather the historic year for us, we finished very strongly. The plans, the spends are advancing. We couldnât be, I think, more thrilled with how things have played out for healthcare. But more importantly, we are excited about what lies ahead. Certainly appreciate everybody taking the time today to join us, your interest in our company and your investment in GE. And again, we hope to see many of you in March in Cincinnati.
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EarningCall_1264
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Ladies and gentlemen, welcome to the SmartFinancial Inc. Earnings Release and Conference Call. My name is Glenn and I'll be the moderator for today's call. [Operator Instructions] Thanks Glenn. Good morning to all of you and we appreciate you joining us today for our Q4 2022 earnings call. We're excited to be on the call this morning to visit with each of you about our bank. We've continued to make great progress on all fronts, execute better every quarter and deliver quality shareholder returns. We thank you for the interest that you all have in our progress, and it's important for us to hear your questions, comments and feedback. Joining me on the call today are Billy Carroll, our President and CEO, Ron Gorczynski, our CFO, Rhett Jordan, our CCO, and Nate Strall, our Director of Corporate Strategy. Before we get started, I'd like to ask each of you to please refer to Page 2 of our deck that we filed yesterday evening for the normal and customary disclaimers and forward-looking statements, comments, please take a minute to review these. Q4 was a fantastic quarter for our company and we're very proud of what we were able to accomplish for the quarter and for the entire year. Our year-over-year increase in earnings for the bank was strong and I also believe we executed much better than most of our competition for the quarter. I'm proud of the team for their focus and continued improvements we made during 2022. Thanks Miller and good morning everyone. This quarter was a great way to close out the year. As you'll see from the results we continued to focus on growing both revenue and earnings per share. We had discussed our plan for 2022 on prior calls, and these results show how we are executing on transitioning this company in the one that has a very solid core foundation and earning stream. I'll open my comments referencing our 2022 year in review slide on Page 3 of the deck. This slide details the results of the work our team has been doing. Looking at the compound annual growth rate of these key areas, shows why we have been and believe we'll continue to be a great company to invest in. Looking at our fourth quarter performance on Slide 4, you'll see very nice trends in our areas of key performance. We had great operating EPS for the quarter of $0.76, and Ron is going to dive into those details more in a minute. We had nice expense control coupled with another record revenue quarter. Our loan growth continued to be outstanding coming in at 17% annualized for Q4. There was a slight contraction in deposits as we let some rate sensitive non-core balances roll out of the bank as some competitors pushed rates higher than we wanted. We felt like there was no real spread advantage in keeping those deposits, but we did however, defend our rate sensitive core balances. Ron will discuss our betas in more detail, but we felt good where we entered the quarter on funding and related costs. Holding our loan to deposit ratio at 79% has allowed us to be selective on where we're increasing those funding costs. Our efficiency ratio trends are again positive coming in at 61% and I would also like to note the momentum in our non-interest income, especially given the drop in mortgage revenue. We're excited to see growth in many areas of these lines, including treasury fees, wealth, insurance, and capital markets. Credit remains outstanding within NPAs holding steady quarter-to-quarter at 10 basis points and our ROA and ROE were solid at 1.10% and 16.5% respectively. The next couple of slides detail our markets. I'm not going to spend a lot of time here other than to say we were able to open our Franklin, Brentwood, Tennessee office allowing us to continue our expansion into the Nashville MSA. All of our markets continue to show steadiness. Our company like others continues to watch the economy closely as rising rates will slow some areas, but we continue to be cautiously optimistic even with elevated rates. I'll speak more to our outlook in my closing comments, but now let me flip it over to Rhett and let him go into a little bit more detail on lending and credit. Rhett? Thank you, Billy. As Billy mentioned earlier, solid loan growth continued throughout the year as we ended 2022 with quarter-over-quarter net organic loan and lease growth at a 17% annualized pace excluding PPP loans. For the full 2022 year, the bank saw total loans and leases outstanding grow a little under 20% over year end 2021 with diversification in the types of loans generated, as well as solid geographic dispersion of that growth. As you can see on Slide 7, loan and lease balances outstanding grew over $130 million for the fourth quarter, putting the portfolio total at just over $3.2 billion. The loan portfolio mix has continued to be stable as well and average loan yields continued to rise through the latter half of the year. Improved interest rates on new loan production and renewals as the year progressed generated gradual increases in portfolio yield with our largest increase happening in Q4, pushing that average yield up 46 basis points quarter-over-quarter, just over 5%. We finished the year on a continued strong trend as December monthly origination average yields were over 6%. Slide 8 shows a balanced and diversified commercial real estate portfolio as well. Our largest segment concentration is in the hospitality sector, driven primarily by positions in our bank's strong tourism markets in east Tennessee and the Florida panhandle market areas. We feel very comfortable with our positioning in the CRE space as we believe the risk profile of our finance projects, historically conservative underwriting methodology and the market experience of our clientele in this space has us poised to sustain a minor correction in the sector with very little disruption in performance should such an event occur. And while national economic forecast still indicate a higher probability of recessionary pressure nationally for 2023, we believe the continued population growth and corporate relocation trends happening in our footprint will serve to minimize the impacts of those pressures across our bank's market area compared to other parts of the country. Even with this relative optimism and our market condition outlook, like many others in the industry, we took some additional steps to implement even more precaution than normal in our credit underwriting procedures throughout 2022 in efforts to more aggressively battle potential impacts of a challenging interest rate environment, continued supply chain disruption and sociopolitical challenges on our client base. However, despite those hurdles, we still saw solid performance being reported by our commercial clients throughout the year, strong traffic and demand in our heavier tourism markets and a continued sense of general positivity and optimism for 2023 being expressed by our clientele. As the next slide indicates, our portfolio of credit quality continued to be a strong in Q4 as it has been all year. Slide 9 shows continued stability across all of our core asset quality metrics. NPAs, past dues and classified loans to total loans are all stable quarter-over-quarter and right in line with our metrics throughout 2022. Our CRE portfolio saw a slight decline quarter-over-quarter, and we ended the year just below the regulatory targets in both total and C&D segments. Overall, our 2022 loan production and credit quality metrics saw extremely strong results due to some very hard work on the part of a great team of associates across our company. Thanks Rhett and good morning everyone. Let's move forward to Slide 10, our loan loss reserve. During the quarter, we recorded a $788,000 provision related to our strong loan growth. At quarter end our allowance to originated loans and leases was at 73 basis points, and our total reserves to total loans and leases was at 1.13%. Looking ahead to the first quarter of 2023, we adopted CECL on January 1st. While we cannot forecast the economic environment ahead, we are estimating our allowance for credit losses to be approximately $32 million or close to 1% of ACL to total loans. On Slide 11. Similar to other financial institutions during the quarter, we experienced a decline in deposits. As some of this was anticipated due to our high liquidity position we additionally had customers deploying some of their excess cash into higher yielding security instruments. These deposit outflows as many financial institutions experienced, caused significant pricing competition throughout our footprint, causing rates to increase quickly as our less liquid competitors rushed to shore up their balance sheets. As we stated during the last few quarters, our goal is to be judicious in our approach to raising deposit pricing, but not at the expense of losing good customer relationships. As a result of defending these relationships, our total deposit costs increased 40 basis points to 0.85% for the fourth quarter and was 1.06% for December. We do anticipate this upward deposit pricing pressure to continue for the next few quarters. Our loan to deposit ratio increased to 79%, up from 72% in the previous quarter. Despite this increase, we've remained below our historical loan to deposit ratio levels and are comfortable with both our liquidity deposition and the composition of our deposit portfolio. That said, we do anticipate some mixed shift in the composition of our deposit portfolio over time as clients elect to move cash into higher yielding account types. Onto Slide 12. During the fourth quarter, we deployed much of our excess cash to fund new loan production and cover our deposit outflows. Our overall liquidity position, which includes cash and securities, remains strong at approximately 22% of total assets. Our fourth quarter margin was 3.51%, representing a 22 basis point quarter-over-quarter expansion. Our yield on interest earning assets increased by 62 basis points, primarily driven by a 46 basis point increase in our loan portfolio yield, which included 18 basis points of loan accretion. Our loan portfolio yield less accretion for the fourth quarter was 4.87%, and for the month of December it was 5.08%. Our interest bearing liabilities increased 57 basis points driven by increases in our interest bearing deposit costs. Our interest bearing deposit cost for the fourth quarter was 1.18%, and for the month of December was 1.45%. At quarter end our cumulative deposit beta during the cycle was roughly 23%. However, given the previously discussed market environment, our increase in this quarter's beta is estimated to give us a cumulative beta for this rate cycle of 35% with our total cost of deposits for the first quarter in the 1.3% to 1.35% range. Giving margin guidance is difficult in this uncertain rate environment, but with that said, we anticipate our margin for the first quarter in the range of 3.3% to 3.35%. During the quarter, operating revenue increased $1.7 million for an annualized quarter-over-quarter increase of over 15%. When comparing to the fourth quarter of 2021, our operating revenue increased $7.9 million or over 21% year-over-year. As operating revenue is one of the primary metrics by which we judge our performance, we are extremely proud of our SmartBank associates ability to consistently grow revenue despite the various ongoing economic challenges. On Slide 13, you'll find some interest rate sensitivity information. With the sharp rise in interest rates and the deployment of our cash liquidity during the year, our balance sheet has shifted from a modestly asset sensitive to a general and neutral position at year end. Looking ahead, we anticipate that any small increases or decreases in short-term rates will generally have a limited impact on our net interest margin and net income. As we move into an uncertain 2023, the company continues to focus on strategies to protect income and both in up or down rate environment. On Slide 14, for the fourth quarter, our operating non-interest income increased to $7 million versus $6.2 million in the prior quarter. Our insurance revenues increased due to the acquisition of Sunbelt Insurance, and we also benefited from $700,000 of revenue from our capital markets group. Looking ahead to 2023, we will continue to focus on building steady recurring fee income streams. Our non-interest income forecast for the first quarter is in the $7.5 million range. Onto Slide 15. Our continued efforts to create operating efficiencies to manage expenses resulted in a fourth quarter operating efficiency ratio of 61%. As we continued our steady downward trajectory, we expect our efficiency ratio for the first quarter to be similar to those of the previous quarters, then in the later part of 2023, getting back to the low sixties range. Our operating non-interest expense was $27.5 million, a 1.2% increase over the prior quarter. This increase was primarily attributable to increases in technology related expenses and professional fees. As we continue to upgrade, invest in and future proof our organization, we fully expect ebbs and flows in various expense categories. That said, we always remain ready to tighten our belt to ensure we head our income targets and deliver on our goal to create shareholder value. For the first quarter we are forecasting the expense run rate of $28.2 million range, an increase from the prior quarter, primarily stemming from our salary and benefit expenses of $16.8 million. Onto Slide 16, capital. During the quarter, our capital benefited from strong earnings and positive momentum in our AOCI position. As we move forward into 2023, we anticipate building capital at a rate sufficient to fund future growth and continue to build our capital ratios. At quarter end our tangible book value was $19.09 per share; however, excluding the temporary impact of our unrealized security losses, our tangible book value per share was $21.18, representing a quarter-over-quarter increase of 3.7% and a five-year compound annualized growth rate of almost 9%. Thanks, Ron. As you can see we're really hitting a nice stride, and as Ron mentioned in his guidance, we continue to be well positioned. I do feel that we will see a slowing of loan growth a little as we start the year, particularly for us as we had some clients accelerate some closings into 2022 that we had to pay for Q1 2023. With that said, I feel our loan growth outlook is still solid, but in the current environment, I'm more comfortable with a mid-to-high single digits growth in the loans from a forecast standpoint for the year. We're also positioning to handle this rate environment with a heightened focus on non-interest bearing and low interest bearing deposits. We've ramped up our treasury platform and resources and continue to make this area an emphasis for the bank. Now that we've digested the lift-outs from late 2021 and early 2022 that added six new markets to our bank, we're looking for more opportunities to add talent to our team. We're in continued conversation with bankers that can add balances to both sides of the balance sheet and feel good about our prospects to bring on more sales team members in the coming quarters. I was very pleased with the performance and growth of both our Fountain Equipment Finance Group and their SmartBank investments wealth platform. We are expecting continued upside from these groups in the coming year. This coming quarter we're also merging our two insurance agencies and excited to watch this company take off in 2023. Again, a very nice upside for revenue generation as we get its foundation set. We continue to make investments that are accretive to growing our value and are staying focused on those singles and doubles that will create a great core franchise. To close, again, a very successful year for our company and a big thank you to our SMBK team. Our group continues to execute while building an outstanding culture. It's a great time to be involved in this company, so I'm going to stop there and open it up for questions. I wanted just to first appreciate all the guidance as usual. I wanted just to start on the balance sheet. You obviously have been able to use your liquidity to fund the loan growth in the past year. Maybe any thoughts just on how much liquidity you think you might have left on the balance sheet now, the balance sheet grows from here, I would assume we kind of pivot from the balance sheet growing more in relative to the past few quarters? Yes Brett, I'll let Ron kind of dive into a little more color on details, but yes, you're right. I think we've kind of gotten to the spot where we're holding the liquidity that we feel like we need for a bank our size right now. So that's kind of our comments on the growth that we see from here, we feel pretty comfortable about being able to fund that and increase those deposit balances accordingly as we see the loan growth opportunities. But Ron, you got any, you want any additional color you want to add to that? Yes, in the near-term, I think, well cash and securities will probably remain stable and we will fund much of our loan growth with our deposit growth. No real wholesale changes until we probably get into 2024. We do have quite of amount of $250 million of treasuries that will be maturing during the first six months. So we may have some strategy to deploy some balance sheet strategies or ideas, but up until now we're kind of going to keep, I think we are looking to remain stable where we're at today. Okay, that's helpful. And then I wanted to just talk about commercial real estate. I think a lot of investors are kind of concerned about it and maybe loans that were made at lower rates and as the market re-prices those, what those will look like? Can you give us any color on how you're looking at commercial real estate and just what you've done to maybe insulate your portfolio from any of the challenges that folks are talking about? Thanks. Yes Brett, I'm going to let Rhett kind of dive into that, but just kind of anecdotally, I mean, it's something we talk about a lot and then we've been watching and obviously do quarterly reviews, annual reviews for clients looking at that, during some shocks, and we still feel extremely comfortable about the quality of our loan portfolio, even with a little high rate environment. But obviously it's changing. It's obviously changing the way we're looking to underwrite newer credits. It is, it's probably looking for a little more cash into certain deals today, a little more equity in some of these just to kind of hedge against potential up rates. But Rhett, you want to maybe kind of dive into kind of how you're walking through that analysis with the team? Yes, I mean we are probably similar to a lot of others in that. Last year especially as rates began to increase at the pace they were, we -- to Billyâs point, we started doing additional rate shocks kind of above where we historically had done rate shocks on underwriting, on new opportunities coming in the door. And then as we progressed into the year, we also started a process of looking out six months to a year on transactions that were coming up for renewal, looking at projects that, to your point, had been financed in earlier years with lower interest rate cost to just see how those were going to perform. But again, to Billyâs point, historically, weâve always been pretty conservative when it comes to equity requirements on the front end of a project, stress testing interest rates on the front end of a project, making sure that they could sustain both an increased interest rate and/or a reduction in OI side. So we still feel very good from the conversations weâve had with clients about where rent rates are even at the elevated interest expense with the majority of the portfolio, we feel very good about where weâre going to be as we go through the year. Okay, thatâs great color. Maybe if I could sneak in one last one on the margin, you mentioned, obviously tough to project here. But just with the balance sheet is more neutral to rates than the Feds. The Fed stops here, would you expect the margin to stabilize and kind of remain flattish from the first quarter subsequently or would you give us any other color around that? Yes. Weâre expecting it to -- we -- from where we are, because weâre a little bit elevated for Q4 because of additional accretion, we should see that 330, 335 range pretty much at this point throughout 2023, where again, weâre probably seeing our margin to be flat, not seeing, at this point, not modeling any more contraction. So weâre, again, just stable as we go forward. Yes, just back on deposits, it sounds like you guys have enough securities rolling off to help fund most of the loan growth throughout the year. But just for the rest of the loan growth, are you guys looking at any CD specials you might be running just to help with the deposit growth? I hope youâve run any yet. And then you also leaned on FHLB borrowings during 4Q a little bit. Do you see yourselves doing that anymore throughout 2023? Yes. We didnât have FHLB borrowings. We didnât have any for the fourth quarter. And we donât see -- letâs get the wholesale funding, we donât see the use of FHLB or broker deposits at this point or the need to. We are running promotional CD specials, and we are doing exception -- more exceptional pricing. We have done some overall lift on our sheet rates, but again, weâre trying to stay focused on the good relationships and individual pricing as we go forward. No. I was just thanking for the clarification on the securities there. And then my other question is just on your initiatives you set for 2023, the customer pricing software, the implements on the enhanced risk and fraud solutions and then you're improving the treasury management system. Can you just give us an idea of the benefits youâre seeing there and then if thereâs any allocated costs to that, that we should be thinking about? They are embedded in our guidance at this point, yes, will be in our noninterest expense on that. We are targeting all those projects starting it for the first quarter. The benefits of pricing is obviously -- I donât really have to get into that one, but a lot of fraud prevention software. It allows us to go through a lot more data where weâve been a little bit more manual in the past. Itâs definitely in this time frame, something that we see the benefits of. A lot of savings, so we donât have losses in our deposit side of the house for the transactions. Other than that, weâll gradually see all this being implemented throughout 2023 and it will be in our guidance. Let me just add a little bit of color too, Thomas, yes, to Ronâs point. Obviously, weâre no different than any other bank right now with obviously with -- thereâs a lot of fraud going on in our industry. And so we think this is just a prudent investment to try to kind of help mitigate potential losses on that side. So hopefully, it saves us some expense dollars on that front. The treasury piece, weâre excited about. Weâve got a very robust treasury platform, but weâre also looking to continue to enhance that. Thereâs some upgrades that weâre going to look to put in to kind of allow us to maybe have a few more bells and whistles with some treasury clients. Especially with the client, a lot of clients that weâve added, theyâre very sophisticated treasury users, and so we want to make sure that weâre keeping tabs on that and being able to grow. So we think that will enable us to hopefully continue to grow and really as a result, help to grow that lower cost deposit base. Thank you, Thomas. We have our next question comes from Graham Dick from Piper Sandler. Graham, your line is now open. So I just want to hit on the NIM maybe in a different way as it relates to your loan growth guidance and the balance sheet from here. So I know you guys are saying mid-to-high single loan growth. If you see demand for loans and growth surpass that guidance maybe into the 10% range or low double digits, would you expect the margin to remain in that 3.30% to 3.35% range you talked about or do you think that incremental funding pressures may push out a little bit lower? And I guess the second part of that question is, what would you be funding that new loan growth at in terms of the cost on CDs or I guess, your NOW accounts? Yes, Iâll start and guys you'll add any color that you want. Yes, I think youâre accurate, Graham. I mean, for us, weâve kind of given the markets and the teams and our projections, we feel very comfortable being able to fund that kind of that mid-to-high singles just internally at kind of our rates at normal course. If we do get some outpaced growth, and not saying that couldnât happen as we get into mid part of the year, we would probably fund that at more -- probably a little bit more of a market. So it might cause a little bit of additional pressure on margin if we didnât want to go ahead and push some of those loan growth totals a little higher. Go ahead Ron. You had a comment⦠Yes. We do anticipate if we do have heavier loan growth, we will run more specials. We do anticipate us to be self-funded. Obviously, we could go back to the wholesale market, but weâre still, even with the spread weâre getting, I still think itâs probably not going to hurt our margin at all. So⦠Okay, thatâs good to hear. What are I guess, on your interest rate sensitivity side, what kind of drove the move to liability sensitive here? Is it just the deployment of excess cash from here? Okay. Thatâs kind of what I figured in what weâve seen over the last couple of quarters with that slide. But if I can sneak in one more in here on the expense side, I think you said $28.2 million, right, in 1Q, and then it sounded like the efficiency ratio should improve from there. Are you kind of hopeful or guiding towards maybe some flattish expense growth after 1Q? Iâm just trying to get a sense of what the full year might look like from an expense standpoint. Yes. I think for the expense side, we have -- it will go up incrementally, not in big amounts, but Q1 is kind of our -- traditionally our worst quarter. Weâre faced with some of the reset of taxes, some wage increases and catching up on our deposit beta. I think as we go forward, you get some more leverage with loan production and deposit rates stabilizing, our expenses will remain relatively stable going through that time. So pretty much that $28 million, $28-ish million range is what weâre focusing on. Graham, Iâll just add. When you -- as we kind of forecast out that noninterest expense line for the year, we feel really good about controlling really all those areas. Obviously, with salaries, weâre -- as everybody, weâre in a competitive wage environment, so we want to make sure that weâre continuing to retain great staff members, and weâre going to look to make sure that we can do that. And so we may have a little more budgeted into some of those increases than traditional or what weâve seen in the past few years. But overall, we feel pretty good about our ability to hold that expense line. As you said and as Ron kind of alluded to a little -- probably a little more on the expense side and then itâs flattening out, probably cause that efficiency ratio to edge up a little bit, but then works its way back down. We still think kind of moving down to that 60 number and getting sub-60 is the goal for our company that we could achieve in a relatively short period of time. Thank you, Graham. [Operator Instructions] We have our next question comes from Feddie Strickland from Janney Montgomery Scott LLC. Feddie, your line is now open. So your noninterest income guide is a pretty healthy jump from the fourth quarter. Is that driven by any fee income line in particular, whether itâs insurance or Equipment Finance? Just curious what the drivers are there. Well, third quarter, we were down on capital markets and obviously, as Billy mentioned, the mortgage revenues were down. As we go into fourth quarter, we have a full quarterâs worth from our insurance acquisition, the revenues generated from there, and we also have picked up on our capital markets side. So we donât -- we didnât have anything really new hit. We just had some of the segments that kind of had a down Q3 pick up some steam for Q4 and we project that steam to going into 2023. Got it, that makes sense. And then just moving to deposits, a lot of your tenancy neighbors have had a good bit more pressure on their deposit costs than you guys are seeing at SmartBank. Do you feel like your footprint in Alabama and Florida is a big part of that? Has that helped you to kind of mitigate some of the deposit cost pressure? Yes. I think some. I do think the geographic diversification that we have helped some of that, so we can price. And I think weâve really worked hard over the course of the last couple of years, Feddie, building that kind of that more solid core funding base and I think thatâs showing a little bit now. Not that weâre immune from rate pressures and weâre going to continue to still have to defend, as Ron and I both said in our comments, weâve got to continue to defend those core rate-sensitive deposits. But I do think it helps. I think it allows us to kind of take a look at pricing in other markets. And if we need to adjust one market versus the other, it allows us to do that. So I think overall it helps, but doesnât make us immune. Itâs, to your point... To your point, weâve -- a lot of our competitors, especially here in the great State of Tennessee are pushing some of these rates a little higher than weâd like to see. But thatâs just -- thatâs part of it. Weâll continue to defend it. Got it. No, thatâs a great point on the investments you guys have made on the deposit side. Thereâs certainly not a whole lot of banks that can let some of the higher stuff -- higher rate stuff walk away. But just one last question from me, just can you talk through what youâre seeing in that area just outside Nashville? How much opportunity do you think that you have on the loan side there? And how much growth do you think we could see in that market over the course of the year? Obviously, Nashvilleâs MSA is arguably one of the best in the country. A lot of competition. I mean, when you got a market like that, itâs an extremely competitive market. We know that. But it kind of goes back to the team you got and the talent you have. Weâve got some great folks in our Middle Tennessee group. I do believe that weâll have some nice opportunities to grow Nashville. Weâre looking strategically and looking at how we want to expand in that zone. We think that is a zone that we can and want to grow in. And so as far as how much growth for us, itâs kind of tough to say. It will be a function of really kind of the strategies that we want to execute this year. But thereâs a good upside there for us and looking forward to watching this Nashville team grow for our bank. I just want to throw it back to the margin and I think about loan yields. I know you gave the December loan yield was 5.08%, I think, is what you said. And so as we think about the piece of the variable rate of your book that resets over the, what you call the longer term, that $561 million that resets over three months, whatâs the kind of pace that you see that happening? And maybe as you think about where you see loan yields going over the kind of the course of the year, how would you think about peak loan yields or beta or the re-pricing opportunities from that piece of the loan book? Yes, Iâll start. I think for 2023 like, for instance, Q1, we have about $25 million of -- thatâs not resetting that will reset and that today that rate is 4.87%. With our new loan production and this resetting, weâre projecting our loan yields to be in the neighborhood of 5.35%, 5.4%. So -- and then ratably going through, weâll have about $25 million a quarter for 20 -- for the remaining quarters 2023, that will come due. And theyâre all about the high 4s, about 4.8%, 4.9% in terms of weighted average yield, so that will be resetting into the current rate. So we feel pretty comfortable that our loan yields will continue to ratably go up as we turn into 2023. Great, thatâs really helpful. And so do you think then is that -- as that plays out, do you think the margin kind of hovers in this 3% to 3.35% range for the rest of the year or do you see directionally kind of upside or downside from there for the year? Itâs a function of deposits. I think right now, we feel like -- youâll continue to see a little bit of pressure on that deposit side. So basically, what we make up on the loan side, it gets, it's eaten up a little bit on the deposit side. Weâre hopeful maybe that we could have a little -- widen some of that spread. But yes, I think from what weâve seen in the markets today, we feel more comfortable with kind of that's hovering of our NIM for the next little bit. Thank you, Catherine. [Operator Instructions] We have no further questions on the line. I will now pass back to the management team for closing remarks. Thanks, Glenn. Again, in closing, thanks again to each of you for joining us today. As always, please reach out directly to any of us if needed, with additional questions. We appreciate your time today, and have a great rest of your week. Thank you. Ladies and gentlemen, this concludes todayâs call. If you have missed any part of this call and would you like to hear it again, our recording will be ready shortly. Thank you for joining todayâs call. Have a lovely day.
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EarningCall_1265
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Ladies and gentlemen, thank you for standing by. Welcome to the Columbia Banking System's Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session. Instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Clint Stein, President and Chief Executive Officer of Columbia Banking System. Please go ahead. Thank you, Justin. Welcome, and good morning. Thank you for joining us on today's call as we review our fourth quarter and full year 2022 results, which we released this morning before the market opens. The earnings release and accompanying investor presentation are available at columbiabank.com. It was another exceptional year for Columbia. Our bankers entered 2022 with tremendous momentum on the heels of a record 2021, and they were successful in capitalizing on opportunities, winning new business and providing the necessary capital to allow our customers to grow and expand. We extended our footprint into Utah and Arizona during the year, all the while nurturing our existing client base in an interested rate environment unseen in well over a decade. That weren't enough, teams across the bank were simultaneously involved in integration efforts for our merger with Umpqua. And during the first quarter of 2022, we completed the core conversion for our Bank of Commerce Holdings acquisition. Notwithstanding these competing priorities, our bankers delivered outstanding full year results: annual net income exceeded $250 million for the first time in our history; full year EPS expanded by 15% to a new high; loans rose by 11% during the year, after adjusting for PPP runoff; and our operating efficiency ratio fell below 50% in the fourth quarter. Although it took longer than initially expected, on January 9, we announced we had received approval from the FDIC clearing the last regulatory hurdle for our merger with Umpqua. I'm happy to report that we completed the first of the branch divestiture sales this past weekend, with the second scheduled in February. Consequently, we expect the merger with Umpqua to close February 28 and we are still planning for the systems conversion in March. It's an understatement to say I'm proud to lead such a talented and committed team. Associates across the company had done an outstanding job over the past 15 months remaining externally focused on all of our stakeholders in addition to preparing for our merger with Umpqua. Our bankers focused on sustaining and growing our normal business activities while simultaneously supporting integration efforts and conversion planning. I want to thank them for their commitment for rising to the challenge as we work towards creating one of the premier banking franchises in the Western U.S. On the call with me today are Aaron Deer, our Chief Financial Officer; and Chris Merrywell, our Chief Operating Officer. Following our prepared remarks, we will be happy to answer your questions. I need to remind you that we may make forward-looking statements during the call. For further information on forward-looking comments, please refer to either our earnings release or website or our SEC filings. As Clint noted, full year net income of $250 million and EPS of $3.20 were new annual record. Our performance was a reflection of strong loan growth and rising interest rates combined with solid fee income, well-controlled spending and thoughtfully-managed credit. Excluding costs related to the Umpqua combination and Merchants acquisition of $19.1 million, pre-tax pre-provision income was a record $326 million, exceeding the prior record set in 2021 by $58 million or 22%. Fourth quarter earnings of $68.9 million and EPS of $0.88 represented a linked-quarter increase of $4 million and $0.05, respectively. Quarterly pre-tax pre-provision earnings increased by $1.9 million to $90.9 million due to continued expansion of net interest income. The core increase was actually larger, but we had higher sequential merger costs, and recall that we had a non-recurring gain of $3.7 million on the building sale on the third quarter. The balance sheet funding mix shifted during the quarter and was supported by an increase of $986 million in short-term borrowings, as deposits declined by $1.2 billion to $16.7 billion. The overall mix of deposits remained superb and our liquidity position remains very strong, providing us with continued deposit pricing flexibility. The loan-to-deposit ratio at year-end was 69%, which remains at the low end of the five-year average preceding the pandemic. Total loans were essentially flat linked-quarter after accounting for $76 million of loans moved to held for sale in preparation for the divestiture of 10 branches as a condition of the Umpqua merger. Excluding this, new loan production exceeding $400 million was essentially offset by contractual prepayments -- rather contractual payments along with an uptick in early prepayments and seasonally lower line utilization. Early repayments were $190 million in the fourth quarter versus $157 million in the third, as more borrowers are choosing to use their liquidity to pay down debt that is repriced to current market rates. The investment portfolio decreased $156 million to $6.6 billion, as paydowns and maturities were partly offset by fair value movement related to the available for sale book. The portfolio was split 31% held to- maturity and 69% available for sale as of year-end. The overall investment securities yield was essentially unchanged at 2.05%, while the duration decreased slightly to 5.2 years. Our net interest margin continues to benefit from rising rates, increasing 17 basis points linked-quarter to 3.64%, predominantly driven by higher average loan rate and a stronger earning asset mix. Partly offsetting this, our cost of deposits rose relatively modest 8 bps to 18 basis points. Our overall cost of interest-bearing liabilities rose 36 basis points to 58 basis points due mostly to higher FHLB borrowing, though our exceptional deposit base continues to support a favorable overall cost of funds. New loan coupons in the fourth quarter were at an average rate of 6.16%, which compares to 3.57% in the fourth quarter of 2021. Notably, the vast majority of our loans moved above their floors in the latter half of 2022. Noninterest income decreased $3.3 million linked quarter to $23.3 million. After adjusting to the property sale gain I noted earlier however, noninterest income increased by approximately $400,000, mostly due to BOLI gains of $354,000. We continue to see solid deposit account and treasury management fees with strength in financial services and trust revenue offsetting lower loan revenue due to weakness in mortgage banking activity. Excluding merger-related expenses in the third and fourth quarter, noninterest expense decreased $2.6 million sequentially to $95.6 million, primarily due to lower compensation and benefits expense that we had [good] (ph) cost control across the board. Combined with our strong revenue, operating efficiency dropped to 48% for the quarter. Meanwhile, the effective tax rate remained at level of 21%. Lastly, credit metrics improved during the quarter, reflecting continued industry-leading asset quality. Nonperforming assets decreased slightly with NPAs at year-end representing just 7 basis points of total assets. And we reported net recoveries of $1.2 million. Despite these favorable trends, we recorded a $2.4 million provision, reflecting a less optimistic economic forecast. As a result, the allowance as a percentage of total loans rose to 1.36% at year-end compared to 1.32% as of September 30. As Aaron mentioned, solid loan production of $402 million was in line with previous fourth quarters and drove full year production to a new post PPP record of $2.2 billion. While quarterly loan growth was tempered by a normal seasonal reduction in line utilization, loan balances grew to $11.6 billion, representing an increase of 9% during the year and 11% when adjusted for PPP paydowns. Production during the quarter was predominantly split between CRE and C&I. Overall, line utilization fell 2 basis points during the quarter to 47.5%, but was up from 43.3% a year ago. CRE remains well diversified across multiple industries and is well balanced with 54% income properties and 46% owner occupied. We're very proud of our bankers and our C&I portfolio continues to reflect their disciplined relationship-based approach. The quarterly production mix was 49% fixed, 41% floating, and 10% variable. The overall portfolio now stands at 54% fixed, 32% floating and 13% variable. PPP loans are no longer a measurable part of the portfolio at only $10 million as of year-end. The geographic distribution of our loan portfolio stands at 48% Washington, 29% Oregon, 10% California, 5% Idaho, with remaining 7% in other states. Deposits fell by $1.2 million -- excuse me, $1.2 billion during the quarter and the outflows were due to a variety of factors, including normal seasonal activity and a reversion of excess client liquidity back towards historical levels. Clients use funds for a variety of purposes to include year-end bonuses and distributions, paying down debt, making investments and moving cash to higher paying alternatives, including approximately $200 million to CB Financial Services during the quarter and almost $800 million during the full year, with the majority of that coming in the second half of the year. The deposit mix shifted slightly during the quarter, with 59% of our deposit sourced from businesses and 41% from consumers as of year-end. And the ratio of noninterest-bearing demand deposits improved from 49.1% at the end of 2021 to 50.1% at the end of 2022. On the fee income front, our wealth management group had yet another record year with over $17 million in revenue. Our retail, commercial and wealth management teams continue to work together in an effort to bank the entire relationship across our clients' life cycles. Our regular quarterly dividend of $0.30 was announced this morning. This quarter's dividend will be paid on February 21 to shareholders of record as of the close of business on February 6. This concludes our prepared comments. As a reminder, Chris and Aaron are with me to answer your questions. And now, Justin, we'll open the call for Q&A. I'd kind of like to follow-up maybe on the deposit front. Maybe you touched on some of the competitive dynamics there. I was wondering if you could maybe help quantify maybe some of the surge deposit outflows versus seasonal dynamics and versus client utilizing cash to pay down higher cost debt. And then, I guess from a competitive standpoint, are you seeing certain geographies maybe more competitive? And do you think we're through the surge deposits? Just curious on some comments on that front. Sure. This is Aaron. I'll start, and let Chris clean up for me. But we certainly have seen some revision of excess client funding kind of revert back towards normal levels. I think there's probably still a little bit more of that to be seen, given some of the analysis we've done on that front. But I think if you look overall through the pandemic, we saw outsized inflows relative to a lot of our competitors. Even after the outflows that we saw this quarter, we continue to run ahead of most of our peers. And so, we're still feeling very good about the -- what the deposit flows have been and the mix. And we've just continued -- and I think a lot of that just reflects our continued discipline in terms of pricing. And I can let Chris talk a little bit more about that. Sure. Thanks, Aaron. David, yes, you mentioned the part of that is it more competitive in certain markets, and I would tell you it's -- all markets are competitive and it's different competitors in certain markets, but you're seeing lots of deposit specials, things of that nature, really happy with the team and how they're working with our clients to find out what the purpose of the funds were, trying not to become interest rate sensitive when we don't have to, and utilizing the tools that are available through wealth management and such. But the reality is there are some pretty significant specials that are out there. We've used our exception pricing and the discipline around that to keep our costs from going up on that. But there are some folks that have chosen to pivot into a treasury bill or a CD special or a money market special in another bank. But we're not seeing that we're losing the relationships. We're just seeing a pivot for some -- put it more into the hot money category, but we're really comfortable with the relationships we still have with those clients. And, David, also, if you look at the composition of noninterest-bearing as percentage of the total, that continue to be very stable. In fact, it actually ticked up just a little bit sequentially. And just in terms of the loan deposit ratio, if you look back to where that stood, as I mentioned in my opening comments, over the five years preceding the pandemic, it basically ranged between 70% and 85% and we're still down at the very bottom end of that. So, we've still a lot of flexibility. Yes, absolutely. And if you do see some more of those surge deposits outflow, is FHLB advances the primary way of funding those versus security sales or CDs or anything like that? Okay. And maybe a question on the growth side. And somewhat of a seasonal slowdown in originations. Just curious how much of that is your appetite for credit diminishing somewhat just given the economic backdrop versus demand for credit in the market slowing or competitive dynamics maybe even fewer attractive deals coming across the desk. And just curious where -- what segments are still attracted to you and still coming up -- bringing good risk adjusted returns at this point in the cycle. Well, David, as always, you pack a lot into a question. So, feel free to circle back if we don't fully address each aspect of that. I guess, I'll start off and then hand it over to Chris. From an appetite standpoint, we're very comfortable with all the different verticals that we've historically been in. We're committed to remaining throughout the cycles to our clients and to our bankers within those verticals. And then, when we look at our pending merger with Umpqua, there's not any portfolio concentration issues that get created as a result of that. In fact, it actually gives -- on a combined basis, gives us more room to run within those verticals that we do have expertise in. I think the key part of your question though is -- I'll paraphrase, can we quantify what we stepped away from because of either underwriting, I don't really call -- I guess you could say it's competitive dynamics. I think I just call it people that are still very much focused on putting up loan growth number as opposed to really looking at where we might be heading from an economy or economic standpoint, and then, realizing that, all right, the risk return isn't there. And so, from our perspective, we would rather pass and protect shareholder value and let somebody else take that deal. And there was quite a bit of that during the quarter. Okay. Thanks. Yes, David, the dynamics during the quarter of what we were tracking as we saw rates coming in and what the requests were, it approaches a couple hundred million in deals that we simply looked at and said that it is not in the shareholders' best interest to put that on the books. And we were seeing rates that frankly were below the 10-year treasury and it just doesn't seem prudent to put that type of business on at this time. Now, if there was something that was a relationship or something like that, as we've mentioned in the past, we certainly would be flexible with that type of pricing. But when you look at some of the new business that we would normally attract throughout the year, that's where we chose to walk away from those types of deals. That makes sense. And then, last one maybe for me. You guys talked about having the first mock conversion and a readiness review with the upcoming systems conversion. Just curious how that went, and maybe what you learned from that? And then, as we think about this whole conversion process, it's kind of unique opportunity. From the integration management office standpoint, they've been looking at this for a long time. Is there any anything while we're going through these opportunities or other investments or upgrades as we go through the conversion and integration that maybe we can accelerate? Just curious from the conversion standpoint, your thoughts around that. Hey, David, this is Aaron. Yes, the mock conversions went very well. Of course, there's always some lessons learned and we're figuring out ways we can make sure we do things better. But we're having a tremendous amount of client communication right now that's going out to make sure that when we do get to the actual conversion that it goes as absolutely smoothly as possible and we want it to be a seamless and experience for the customer and for our associates as possible. So, we're spending a lot of time there. IMO, obviously, is leading that effort. And as we've gone through this, we've had a principle of not introducing new risk to any of this process. So, we haven't necessarily been actively looking to build in new products as part of this process. Certainly, we're continuously looking at the competitive environment and speaking to our clients about what their needs are and making sure that we're staying ahead of that and anticipating that. And so, there are things that we will be looking to do in the year ahead to make sure that all of our treasury management capabilities continue to be a leading edge, but there's nothing that we're trying to implement through the integration process. The one thing I'll add to that is we've spent a lot of time over the past 15 months talking about the complementary nature of Columbia's business activities and Umpqua's business activities. So, we think that there's a lot of opportunity for upside with existing capabilities between the two organizations. So, for example, our healthcare book leveraging impacts capabilities, some of those types of things. Umpqua has got a more sophisticated and broader product set on the treasury management side that existing Columbia customers will instantly get the benefit of those expanded offerings. So, I do think that there's plenty of opportunities already existing. And then, to Aaron's point, try to minimize the number of moving parts as -- to the extent, we can at these critical moments of conversion and integration. But with the conversion scheduled shortly after we close, I think we'll be able to quickly pivot in the back half of the year towards looking at, are there things that have emerged that neither bank has that we think long-term would give us an advantage. And so, I think it will be a quick turn, but I think we're set up very, very well day one to meet -- not only meet the needs, but exceed the needs of most of our customers and continue to grow with them. And thank you. [Operator Instructions] And our next question comes from Jeff Rulis from D.A. Davidson. Your line is now open. Just wanted to narrow in on the -- maybe if I could, the core noninterest expense and fee income lines. I got it around 96 in, call it, '23, '24. So, I wanted to first see if those numbers align with what your thoughts are on core? And then, if you have any thoughts about how that transitions outside of seasonal influences, but look at for kind of growth rates for the year? Thank you. Yes, Jeff, those are pretty close. If you want, I can give you the specifics behind the underlying merger costs in terms of what lines those hit, if that's helpful to you. But I think I would echo the comments that Ron made on the earlier Umpqua call in terms of expectations for first quarter typically you're going to see an uptick in expenses related to FICA and that sort of thing. And then, shortly after that, you get the kind of annual merit increase impact. But a lot of those seasonal costs that hit in the first quarter then trail off through the year. So, I don't think you're going to see anything outsized or abnormal related to that, of course, the exception of our two institutions coming together. So⦠Aaron, expectation of growth in the -- outside of that -- let's just exclude the cost saves, but just standalone Columbia, are you in kind of a 3%, 4% or 5% kind of growth for '23? Okay. Got you. Okay. And then, I guess, similarly looking at growth -- loan growth that is and understood on some of the puts and takes competitively and within customer movement, your own appetite, also if you layer in, I don't know if you've got visibility on payoffs or paydowns, but kind of where you budget on a 2023 growth expectation for the Columbia standalone? Yes, Jeff, this is Chris. I think the visibility to it, there's always payoffs, paydowns, there's normal amortization, et cetera. Just put it in the kind of normal course of business right now with the interest rate environment where it is, your unforeseen payoffs are less likely. You may still see some business sales or some things like that, but we're pretty comfortable where we are on it. I would look at overall low- to mid-single digit. I don't know that I would go much over 5% on that as far as the mid. But you're in that space kind of with the market dynamics where they're at and what we're looking at. But again, our bankers are seeing lots of opportunities and it's just a matter of which ones make the most sense to put onto the balance sheet. But low- to mid-single digits is, I think, a comfortable spot to be. And thank you. [Operator Instructions] And our next question comes from Jon Arfstrom from RBC Capital Markets. Your line is now open. Hey, I don't know if you'll answer this one, but I'll give it a shot. On Slide 30 of your presentation, the last bullet shows core expense run rate communicated. And if you go back to your original deck, you talk about $135 million of full run rate savings with two-thirds of it in '23. How do you want us to think about the timing of the cost saves given that your systems conversion is going to occur at the same time than you originally planned? Yes. It's a great question. Just given the passage of time with the protracted approval, we've identified the full $135 million. Typically, the timing of when those are realized is some immediately at close, and then usually there's another wave of those somewhere between 30 and 60 days post systems conversion and integration. So, we're shooting for a clean run rate for fourth quarter of '23. So, we would expect that all $135 million is fully implemented sometime within the third quarter. Kind of how that flows between first quarter, second quarter? I don't have that in front of me. I don't know if Aaron does specifically. What I will say is that we've had some of that has actually been realized just as some of the attrition that we've had from an employee standpoint, where centered-in positions that will not go forward. And so, there's a little bit of that that's already in the run rate, I'd say. No. I just think -- I mean, the thing that's changed is maybe the order or the timing of when the various saves are realized. But in terms of the end date of when we expect to hit a good run rate, as Clint said, that expectation of hitting that by year-end remains. Okay. That's actually very helpful and what I was looking for. And then, just to follow-up on the margin question, actually, it's kind of impressive when you see your earning asset yields up like they were, but your interest-bearing liability costs were up about the same amount, and that's outperformed most of the other banks that I've seen. Just philosophically when you think about those -- the direction of those two interest-earning asset yields and interest-bearing liability costs, is there more pressure on the liability side at this point? Or do you feel like you can kind of keep pace with asset yield expansion that maybe matches your exceeded viability cost expansion? That's a good question. Because the -- you are seeing an acceleration here through the year on the liability side, but I think if you look at where the new asset yields are coming on, and then continue to see a little bit of mix shift as we utilize those cash flows coming off the investment securities portfolio, I think we should see them at least be matched if we're not seeing continued expansion overall between the two. Okay. That's helpful. And then, I guess, one more follow-up. You may have kind of answered it before, Chris or Clint, but any of the big picture themes that you laid out when the merger was announced, have they changed at all in your mind positive or negative? And in terms of the revenue synergies, I know you don't really want to lay them out at this point, but any other opportunities that you found as you've kind of played this waiting game for approval? Thanks. It's -- so big picture. The world is completely different than what it was when we announced this thing, what, 16 months ago almost. But in terms of what our expectations were and what we thought that we would achieve on a combined basis or be able to achieve on a combined basis, nothing has changed there. In fact, just with the passage of time, probably more firmly entrenched in our beliefs that we're going to be able to capture those revenue synergies. I think we did a fairly robust analysis of some of these things through the diligence process. But then as you start to truly understand the depth of talent that Umpqua Bank has in some of these areas that would be additive to Columbia standalone revenue streams, it's hard not to get excited waiting for March 1, so we can hit the ground running. So, there's nothing that we expected that we now today are thinking that we won't be able to accomplish together. Yes. I think that the piece around now having a firm date sticking with our conversion is, Jon, honestly, it's what we've learned over all this time about the expanded capabilities and what our bankers are going to be able to take to market. They now have that point in time where they know what's coming and we get right back out there and get to taking advantage of those capabilities. So, big picture, I don't think things have changed, but I think there's been a little bit more excitement created because of the length of time. And only because we now have a finish line to it that we'll be often in working on that aspect of it. But yes, the world has changed. Rates are, obviously, different. Mortgage market is different, and things of that nature. But our bankers are still out there looking and prospecting. And then, now with that finish line in sight, I think it's really exciting actually. Great. Thanks. Just a question on credit. Obviously, you guys have unbelievable credit numbers. One of the conversations that's taken a lot of our time as analysts recently is just office? So, I was hoping you could speak to kind of your thoughts on that portfolio. It looks like it's about 10% or 11%. Maybe some characteristics, the underwriting statistics, anything you're particularly concerned about, that would be great. Thank you. Good morning, Chris. I'll start, and we'll take maybe a team approach to answering your question here. I'll start by saying our metrics you saw in the release continue to remain pristine. I think this is the first -- probably the first earnings call in 18-plus years that Andy McDonald hasn't been. On Andy is skiing someplace in Idaho right now. So, I think, that in itself is a testament to how we're thinking about credit. Specific to the office space, some of the -- a lot of the kind of urban core downtown-type office buildings, that's not really the type of things that we have in our portfolio. And so, I think there's a little bit of a significant difference between what you're seeing in, let's say, Downtown Seattle and Portland and some of the other areas that we're in from an occupancy standpoint. Sure. Chris, you mentioned in our underwriting sense of that nature, it hasn't changed. I mean, we've always been fairly conservative by nature. We've talked about that in the past. What's changed is when you look at the portfolio and you stress-test it towards higher rates, we're very comfortable with what we're seeing there in the credit side. And anything new that's coming on to you, being stressed at even higher rate. So, when you look at the ability of a borrower to withstand potentially if rates were to go up further, values were to come down, we're working on lower loan to values overall, certainly in the portfolio, never been a max proceeds lender on anything new, and, again, stressing the portfolio to those higher rates, we're not seeing anything. And as Clint mentioned, we're not really in the markets where you're seeing the headlines of businesses pulling out, turning back-office space and things of that nature. That's really not our niche. Okay. Thanks for that. Aside from office, I mean the wall of worry is high, I guess, broadly on the economy. Where else would you be spending more time just stress-testing within your portfolio? Well, actually, everything that's stress-tested. Not seeing any -- I mean, there's not any early warning signs that we're seeing. I think from conversations with Andy, there's an eyebeam kept on it. When we do our provision with Aaron, we're certainly looking at economic indicators and the unemployment and things of that nature. But I guess you would say we're keeping an eye on what may happen with some of these large companies and doing some downsizing and some layoffs. But again, when you hear some of those numbers, these are companies that are not only across many states, but they're multinational. And so, it doesn't mean it's all affecting an area right down the street from us. But we are looking at those types of things. Haven't seen anything that's popped up yet in any reviews or any of our testing. The other thing I'll add is that it really comes down to our bankers being proactive in managing their portfolios. We talk a lot -- and a lot of banks probably do this, talk about relationships, but that's really the value of having a relationship is that there's ongoing two-way communication so that you're operating under the premise of no surprises. And that's part of that is, if we, through that process, it sort of does well for the 30 years that we've been in business, you find a borrower that maybe isn't as forthright or isn't communicative is what you would think. Well then, those are the types that we prune out just on an ongoing basis and trying to make sure that we have the best clients possible or the best portfolio within each vertical possible that we can. And so, one area I'll mention just specifically would be our builder banking area. That's something that as part of our ongoing management was early 2021, that really started communicating with each of their clients about, what's your plan if rates go up? What does it look like? How is your inventory going to hold up? What's your exit strategy for projects. And as a result, those portfolios are performing very well. There probably was a little bit of pruning that occurred in late '21, early '22 as a result of those conversations. But the vast majority of those relationships are intact and part of the great metrics that you see. It also leads into other things that you see in the balance sheet. Now these are smaller portions of that dynamic. But, for example, our builders are putting more of their own money into their projects. So that lowers their deposit balances, lowers their line utilization. There's different things that kind of come into play that you can see at a macro level as you look at our financials. Maybe just to start, Aaron, on the FHLB borrowings this quarter, were all of the FHLBs added? Were they overnight funding? Or was there any term to the borrowings? Yes. Okay. And then, maybe just bigger picture, if I think about the balance sheet on a pro forma basis throughout the year, you will have marked the securities portfolio after the deal close, so that's reflected in pro forma capital. Do you feel like that gives you maybe philosophically just greater flexibility to roll or sell a greater portion of the bond book, either to fund loan growth or maybe reduce the borrowing position throughout the year? Yes. I mean, once marked, obviously, that arguably gives you more flexibility. That doesn't mean that's going to be the decision. And obviously, those cash flows on those marks come back and supports capital levels. But it's -- I mean, that's going to be a decision dependent upon what the rate environment is and what the balance sheet trends are going forward. So -- and -- so I'm not going to presume just what that's going to be just yet. Andrew, the one thing I'll add there. And you were on the Umpqua call just before this, and I think Ron fielded a similar question. We're not going to give our playbook out because there's a lot of folks besides just our investors that listen to this call or listen to the playback of it. But it does present an opportunity for us to start thinking about just how we manage downside risk, the following rate over the intermediate term. And Ron and myself and the rest of the go-forward executive team have started having those conversations. And so, we're not going to say anything about what exactly the details are, but we do have flexibility and, I think, more flexibility than most of the banks in our peer group will have to put some protection on the balance sheet for following rates and that could be part of that -- the component of that strategy. And thank you. [Operator Instructions] And our next question comes from Matthew Clark from Piper Sandler. Your line is now open. Hey, good morning. Thanks for the questions. First one just on the -- your updated thoughts around your pro forma deposit beta through the cycle. I think in the deck, you guys showed 28%, it seemed to be your base case. Is that kind of what you're managing to as Umpqua comes on board and with only a couple more rate hikes allegedly from the Fed? No. I mean it's -- I wouldn't say we're managing to a deposit beta per se. Obviously, you've seen our deposit costs start to come up here in the last quarter of the year. But the -- but to date through the cycle, our deposit beta on interest-bearing is only 9 basis points. So, overall, it's about half of that 9%. So that's going to continue to rise. Whether or not that exceeds what we saw in the last cycle is to be determined. I think there's a decent expectation that it's a bit higher than that just given the rate rising pace has been more aggressive and longer lasting. So, there's going to be more follow through than what we saw during the last cycle. But what that ultimately is, is going to depend on what we see in terms of just deposit flows, loan demand, and as Clint kind of alluded to in the prior question about what we might do with the balance sheet overall. Yes. Okay. And then, if you had the spot rate on interest-bearing deposits or total deposits at the end of the year and the average NIM in the month of December? Okay. I'll follow up with you on the monthly. Maybe just last one around M&A. I know you guys have a lot on your plate with the integration with Umpqua. But what are your general thoughts around additional kind of M&A to the extent something comes available, that's high quality in Northern California? Well, our highest priority is getting to February 28 and getting our merger closed and then assimilating the two companies. And we're both very experienced at that. And I think the work that we've done, we haven't let the protracted closing process go to waste. We've got a clearly defined combined culture. We've put a few thousand of our associates from both companies through training on that. So, I think that the process of, what I'll say, the systems piece, that's all scheduled. I think social aspect of integrating two large companies is well underway and has been for quite some time. And so, as we emerge from the back half or into the back half of -- approach the end of '23, that's where we'll refine our combined strategy and strategic plan in terms of what we -- will be our primary focus over the next two to five years. M&A, I envision, will be a part of that. The challenge, frankly, that we'll have is at $50-plus billion and with the growth capabilities, organic growth capabilities that we have today -- I mean, if you look at what the two banks have done in the midst of all this uncertainty around when the closing would be, the expansion in the de novo markets, the production that those teams have had, there's, I would say, a short list of quality franchises that would meet our hurdle from an M&A perspective. But we have more work to do on that. We have to get the work at-hand done first and then we'll turn our focus to what targets might be a good fit for us and make a meaningful difference in terms of the size of the combined organization. And thank you. And I'm showing no further questions. I would now like to turn the call back over to Clint Stein for closing remarks.
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Good day, and thank you for standing by. Welcome to the Concentrix Fiscal Fourth Quarter, 2022 Financial Results Conference Call. At this time, all participants are in 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. I would now like to hand the conference over to your speaker today, David Stein, Head of Investor Relations. Please go ahead. Thank you, Leanne, and good morning. Welcome to the Concentrix fourth quarter, fiscal 2022 earnings call. This call is the property of Concentrix and may not be recorded or rebroadcast without the written permission of Concentrix. This call contains forward-looking statements that address our expected future performance and that by their nature address matters that are uncertain. These uncertainties may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements as a result of new information or future events or developments. Please refer to todayâs earnings release and our most recent filings with the SEC for additional information regarding uncertainties that could affect our future financial results. This includes the risk factors provided in our Annual Report on Form 10-K. Also during the call we will discuss non-GAAP financial measures, including free cash flow, non-GAAP operating income, adjusted EBITDA and adjusted EPS, as well as adjusted constant currency revenue growth. A reconciliation of these non-GAAP measures is available in the news release and on the Concentrix Investor Relations website under Financials. With me on the call today are Chris Caldwell, our President and Chief Executive Officer; and Andre Valentine, our Chief Financial Officer. Chris will provide a summary of our operating performance and growth strategy, and Andre will cover our financial results and business outlook. Then, weâll open the call for your questions. Thank you very much, David. Good evening, everyone, and welcome to our fourth quarter and fiscal year 2022 earnings call. I would like to start with a quick review of 2022. We made progress across several fronts that we believe continue to position us as a leader in the customer experience industry. For the full year, revenue increased over 13% on an as reported basis. On an organic constant currency basis, revenue was up over 8%. On a non-GAAP basis, our operating margin â operating income increased more than 20% and our operating margin was up 90 basis points to a record 14%. Free cash flow was up 26%. In addition to this profitable growth, our operational performance continued to be strong in 2022, once more delivering the highest customer satisfaction and innovation scores since we started our surveys over a decade ago. Our investments in new technologies and innovative services have also allowed us to capitalize on new opportunities with clients as their priorities have shifted going into 2023 from helping to support their growth, to reducing their operational costs. As a reminder, earlier in the year, we introduced our new Concentrix Catalyst Group, successfully integrating the PK acquisition, to allow us to deliver deeper CX Technology Solutions at scale. In July, we augmented our B2B revenue generation capabilities and footprint with the service source acquisition. Throughout the year, we have rolled out multiple technology platforms for our operations that have helped increase our profitability and security such as Recruit CX, Connect CX and CXQI. We have also increased our operational footprint with new countries and additional locations in Europe, Latin America and Asia. In 2023, we have additional footprint investments in the works, as well as continued focus on building platforms that will help us be more efficient and deliver a compelling offering for our clients. We believe all of this is helping continue to build our pipeline of opportunities around more complex work and higher value services. Turning to the fourth quarter, I'm pleased to report that despite the challenges of a tough macroeconomic environment in the back half of the year, we delivered strong revenue growth, profit improvement and cash flow generation. Our revenue of $1.64 billion represented an increase of 12% compared with last year on a reported basis. Revenue increased approximately 6% on an organic constant currency basis. Non-GAAP operating income of $248 million was up 22% and adjusted EBITDA increased 20% to $285 million. Free cash flow increased 32% to $193 million compared with last year. We did experience volume softness primarily in late October and November with clients in the consumer electronics and retail e-commerce areas. Clients in these areas as a whole were flat to down year-over-year without their traditional seasonal uptick in volumes related to consumer spending they expected. While the base business remained solid, volumes were below what these clients had forecasted for their Double 11 shopping event, Thanksgiving and Christmas pre-sales. Although we adjusted quickly, our fourth quarter profits were impacted by initial staffing levels to meet clientsâ forecasted demand. The rest of the portfolio performed very well with several of our key verticals posting double-digit revenue gains that Andre will go through. Our catalyst business continued to build a strong pipeline of new opportunities of integrated solutions with our CX Operations clients, as well as expansion work within our existing catalyst clients. Within our Catalyst business, we did experience a few ramps progressing slower in the quarter than we expected, primarily based on clientsâ ability to coordinate change in their ecosystems. This is typical with larger projects and we expect to be on pace within our second quarter. From a sales perspective, we signed business with two dozen new logos in the quarter. Our wins provide a full spectrum of services to clients across our vertical service. Two interesting examples include providing business to consumer sales and integrated sale propensity analytics to improve conversion rates for a large European service provider, which was delivered by our new business-to-business sales team, and in our catalyst business providing advisory services for cloud based data management, quality assessment and assurance to reduce costs on an operational process for a new economy company. In addition to these wins, our pipeline of single systems integrator and solution operator opportunities, which combine the capabilities of our Concentrix Catalyst, core CX operations and our B2B team increased during the quarter. We believe this expanding pipeline shows that our investments to align our capabilities and services to designing, building and running the future of CX is resonating well with existing and new perspective clients. We use these capabilities to broaden and deepen our relationships by optimizing business processes, consolidating volume and reducing our clients cost. Going into the New Year, demand from enterprise and new economy perspective clients remain strong. Existing clients are recalibrating volume expectations and we are seeing positive discussions that we expect will lead to the consolidation of client volumes with us. As a result, we expect choppiness in the first two quarters of the year as these discussions are finalized. We expect year-over-year growth to accelerate in the second half of the year as a result of large deals we have already signed, underlying base business and consolidation of volumes from smaller suppliers. We do not expect and are not factoring in large seasonal volume at the end of 2023. As a reminder, historically, we have done well in both good and more challenging economic times by helping our clients meet their goals. In times like these, our clients need to continue to drive revenue, do more with less through automation and retain customers by ensuring the best possible experience. We are having the right conversations about all these areas with our clients. From an operational perspective going into 2023, challenge with staffing new technical problems have eased and the labor market has become stable and more predictable in most regions. The pricing environment for solutions also remains stable. In summary, 2022 was a successful year where we took significant steps to build our offering both organically and inorganically focused on transforming everything CX for our clients and their customers. We're optimistic about what we can deliver in 2023. We have confidence in our strategy to grow faster than the market with margin expansion, relentlessly innovating with new solutions and expanding into emerging markets, building strategic key relationships and selectively pursuing strategic acquisitions to drive superior returns for our shareholders. Finally, I'd like to thank our exceptional staff for their commitment to execution, our clients for their trust and our talented Board of Directors for their support and mentorship and our investors for their confidence in Concentrix. Thank you, Chris, and hello, everyone. I'll begin with a look at our financial results for the fourth quarter and then discuss our business outlook for fiscal year 2023. We delivered solid revenue growth, impressive margin improvement and strong cash generation in the fourth quarter, despite some impact from lower client volumes and slower project ramps than we expected going into the quarter. Revenue in the fourth quarter was $1.64 billion as reported, up 11.9%. The improvement in reported revenue includes a 5.1% negative impact from foreign currency fluctuations and 11.2% impact from acquisitions. Organic constant currency growth was 5.8%. In terms of client verticals, on a percentage basis, revenue increases of healthcare clients led the way in the quarter, growing approximately 23%. Revenue grew 13% in the technology and consumer electronics vertical, with technology clients driving the growth. Our retail, travel and e-commerce clients grew by 12% with travel clients driving the growth. Revenue from banking, financial service, and insurance clients grew by 10% in the quarter. Communications and media client revenue grew 9% with all of that growth driven by the contribution of the catalyst acquisition. Revenue from our other vertical grew 5%, with growth from acquisitions more than offsetting an organic decline in that vertical. Organic growth in the quarter was driven primarily by increases with clients in the technology, travel, banking, healthcare and automotive industries. New economy clients generated growth of 13% year-over-year and represented 22% of fourth quarter revenue. We generated modest growth across our enterprise clients on an organic, constant currency basis. While we grew with 14 of our 20 largest enterprise clients, softer volumes with a handful of consumer electronics and communications clients were a headwind for this grouping of clients in the quarter. Turning to profitability, non-GAAP operating income was $248 million in the fourth quarter, compared with $203 million last year. Our non-GAAP operating margin was 15.1%, up an impressive 120 basis points from 13.9% in the fourth quarter last year. Adjusted EBITDA was $285 million compared with $238 million in the fourth quarter of last year. Our adjusted EBITDA margin was 17.4%, up 120 basis points from 16.2% in the fourth quarter last year. This impressive margin progress reflects profit flow through on revenue growth from existing and new clients. Contributions from catalyst in our B2B revenue generation business, productivity improvements and increased pricing, partially offset by investment in new program ramps and wage inflation. Non-GAAP net income in the fourth quarter was $157 million, compared with $158 million last year. Non-GAAP EPS was $3.01 per share compared with $2.99 per share last year. GAAP results for the fourth quarter of 2022 included $42 million of amortization of intangibles, $19 million of expense related to acquisition integration and $10 million of share based compensation expense. Our non-GAAP tax rate was 32.5% in the fourth quarter. This was higher than expected due to the change in geographic mix of our income, which increased our exposure to U.S. BEAT and guilty taxes for the full year. Our non-GAAP tax rate for the full year was 27.3%. Turning to cash flow, our fourth quarter cash generation from operations totaled $236 million, and capital expenditures were $43 million. This resulted in free cash flow of $193 million in the quarter. Fourth quarter free cash flow included approximately $19 million of integration costs, primarily related to the service source acquisition. We are on track to deliver our year one cost and revenue synergy targets for this acquisition. For the full year, free cash flow came in as expected at slightly over $460 million. We continue to expect free cash flow to approximate 85% of non-GAAP net income over time and for capital expenditures to approximate 2.5% of revenue. Turning to the balance sheet, at the end of the fourth quarter, cash and cash equivalents were $145 million. Debt outstanding was $2.224 billion and net debt was $2.079 billion. We achieved the commitment we made at the time of the PK acquisition of reducing our net leverage to under 2x pro-forma adjusted EBITDA by year. We did this despite an active capital program, active program for capital return and the service source acquisition. Speaking of capital employment, we maintained our balance approach in the quarter, including capital return, investing in the business and debt repayment. During the quarter, we paid a quarterly dividend of $0.275 per share. We also repurchased 106,000 shares of our stock for approximately $13 million. Repurchase in the fourth quarter were made in the average price of approximately $120 per share. For the full year, we paid $53 million dollars in dividends and used $121 million on share repurchases. As of today, we have $354 million remaining on our share repurchase authority. Our near term priorities for free cash flow, are our dividend and debt reduction with modest antidilutive and opportunistic share repurchase activity as well. At year-end, our liquidity remained strong at nearly $1.3 billion, including our $1 billion line of credit, cash on hand, and the additional capacity on our AR Securitization. Our strong balance sheet and cash flow generation provides significant flexibility for the future. Now, I'll turn to our business outlook for the first quarter and full fiscal year 2023. As Chris mentioned, the current macroeconomic environment presents both challenges and opportunities for us. While growth is slowing in some verticals, and we're experiencing delays with some project ramps, we also see opportunities to gain share with our client base through the consolidation of volumes from smaller providers. We also see opportunity for new outsourcing volumes as our clients seek to make more of their cost structure variable and drive efficiencies using our design, build and run approach. On balance, we now expect to see constant currency revenue growth in the first half of 2023 in the low to mid-single digits with stronger growth in the second half of the year. We're also taking steps internally and making investments to drive further efficiency and reduce costs, as well as grow faster in emerging markets, Latin America and Europe, across our entire set of capabilities. For the first quarter we expect organic constant currency revenue growth to be in the range of 2% to 4%. Based on current exchange rates, we also expect a 2.4 point year-over-year headwind in the first quarter. We are expecting the timing of our 2022 acquisitions to contribute approximately $80 million of incremental year-over-year revenue growth in the first quarter. Based on these assumptions, we expect reported first quarter revenue to be in a range of $1.61 billion to $1.64 billion. Our profitability expectations for the first quarter include non-GAAP operating in a range of $210 million to $220 million. This equates to a non-GAAP operating margin of 13.2% at the midpoint of the range, an increase of 10 basis points over the first quarter last year. We expect interest expense in the first quarter to be approximately $35 million, with an effective tax rate of 26% and a weighted average diluted share count of approximately 52 million shares. As is typical in our business, we expect first quarter free cash flow to be approximately breakeven. Moving now to our outlook for the entire year, we expect 2023 constant currency organic revenue growth to be in a range of 4% to 6%. Based on current exchange rates, we expect almost no-FX impact on our reported revenues for the full year â23. We expect the timing of our 2022 acquisitions to contribute, approximately $160 million of incremental year-over-year revenue growth for the full year. This equates to reported full year revenue in a range of $6.715 billion to $6.865 billion. These expectations include a continuation of the general economic softness we have seen in recent quarters throughout the year, including muted seasonal volumes in the fourth quarter of 2023, consistent with 2022. Based on our discussions with clients regarding their recalibrated volume expectations for 2023, we expect to grow faster in the second half of â23 than in the first half. Despite the challenging macro environment, several factors give us confidence in our forecast for the year, including increasing contributions from the two large deals discussed on our last earnings call, a growing pipeline with discussions with clients to consolidate more volumes from smaller providers, and passing the anniversaries of the offshore movement and downturn in volumes last year from our Crypto currency clients, which occurred in the second quarter of 2022. Our full year profitability expectations include non-GAAP operating income in a range of $950 million to $990 million. This equates to a non-GAAP operating margin of 14.3% at the midpoint of the range. We expect full year interest expense to be approximately $140 million and effective tax rate of approximately 26% and a weighted average diluted share count of approximately 52 million shares. We expect another strong free cash flow generation year, with free cash flow growing by over 10% to over $500 million in 2023. This would position us to further reduce our net leverage to under 1.6x adjusted EBITDA by year end, if we assume no further acquisitions or share repurchases. Our business outlook does not include acquisition related impacts or transaction and integration costs associated with any future acquisition. Also not included in the guidance are impacts from future foreign currency fluctuations or future share repurchases. As I close, I want to say that we had a successful year with strong revenue growth, margin expansion and free cash flow generation. We believe our unique customer experience offerings will keep our business resilient through business cycles. Our vision for the future of the business presented at our Investor Day last January is unchanged, despite the near term challenges in the economy. This includes faster than market growth through 2025, with meaningful margin expansion, strong free cash flow generation and the ability to be a leading consolidator in the space, leveraging our strong balance sheet. Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Vince Colicchio of Barrington Research. Your line is now open. Yeah, good afternoon Chris. Can you talk a little bit more about how demand patterns are changing for a more labor intensive work? Are you seeing demand for a bigger offshore piece? And are you seeing some existing engagements shift more towards catalyst type work, for example. Hey Vince. So first on the labor part, we are seeing as we kind of talked about in Q3, a continuation of when people are looking to outsource for the vast majority, they are looking at outsourcing offshore versus near shore and onshore to begin with and that's primarily driven by sort of the cost environment that people are looking for a larger reduction in their run costs. And so we are seeing that, but we're not seeing sort of a difficulty to supply to those demands or changes in sort of the pricing environment relatively stable for sort of the higher value work that we do. You are correct; we've made a concerted effort over the last year, just really focus on more in-depth and integrated complex offerings with our catalyst business. Obviously, it takes some time to ramp those up and we had some constraints on the technical talent at the beginning of the year in 2022 as we mentioned, those constraints of sort of cleaned up or cleared up. And so we are seeing a much bigger pipeline of those more integrated offerings going into 2023 which we're excited about. It sounds like a good amount of the consolidation related revenue you expect in the second half will be signed in the first half. I'm curious in terms of confidence level with signing that business. Are you dealing largely with existing clients and to what extent are these clients that have consolidated business with you in the past? So you are correct, the vast majority are existing clients that we're having the conversations with. A big chunk, we have consolidated volume within the past through COIVD, as well as from other areas where they might have seen different changes in their growth pattern and we are predominant providers in those areas. And so we have a high level of confidence with what we think we can sign from a consolidation perspective in the first couple of quarters. And then Andre, if I look at the midpoint of your adjusted operating margin expectation for fiscal â23, it looks like a slight increase. I'm just wondering if you could review the puts and takes to that. Sure, Vince, happy, too. Your right. The midpoint, thatâs 14.3%, which is up 30 basis points versus what we delivered in the past year. We think the drivers of our margin growth remain what they have been, which is certainly more complex, higher value offerings, more technology in our offerings, using technology, including some of the platforms that Chris alluded to in his prepared remarks to make ourselves more efficient and leverage on our G&A as we grow. I think the somewhat more modest margin progression this year versus last year and a couple of prior years would largely reflect that the growth rate is down a bit, and so less leverage on G&A, more investment frankly upfront in some of the program ramps. So including those large programs that we talked about on the third quarter earnings call, and let's see. I think we've talked about the pricing environment and our ability to pass through cost increases, but being a major contributor to our progress in the margin in 2022. I think we'll keep pace with cost increases and pricing, but probably not be playing the game of frankly catch up that we are playing in parts of 2022, catching up from some wage actions that frankly started in mid-2021 for us. So those are kind of the puts and takes, as I think about the margin progression. We're very, very proud of the margins progress that we've made, really since, if you go back to when Concentrix acquired Convergys moving from where it was at roughly 10% non-GAAP OI to being at 14% this most recent year, and we still think all those factors I talked about before give us the confidence that we can drive to 14.3% at the midpoint of our guide this year and keep going. [Operator Instructions] Our next question comes from the line of Ruplu Bhattacharya with Bank of America. Your line is now open. Hi. Thank you for taking my questions. Chris, I mean, my first question relates to your revenue guidance for the full year as well as for the first quarter. Looks like you know fiscal 1Q revenues will be down seasonally and you're guiding for a low single-digit organic growth in constant currency. The full year you're guiding mid-single digits, so that implies a healthy growth in the back half. I know you've said that you're getting some consolidation, volumes consolidated from other providers and you have these two large deals, but if I look at your business, about 50% of your business is tied to end markets like tech, consumer electronics, retail, travel and e-commerce, which are exposed to consumer spending and macro slowdown. So what happens if there's a recession? What have you factored in in terms of a recession either in the first half or second half. And is there a way for you to quantify like off the mid-single-digit organic growth you're expecting for the full year. How much do you think is coming from the large deals versus the consolidated volumes you are getting? I'm just trying to understand the risk associated with a macro slowdown in the second half and what you're factoring in for that. Thank you. Thanks, Ruplu. So let me kind of break up apart the question from this perspective. When we look at our 2023 plan and what we are seeing as our growth drivers, clearly our clients have kind of recalibrated their volume based on what we experienced during the fourth quarter and what they experienced during the fourth quarter. And how we've looked at that is basically you continue to do it in those specific areas that you mentioned about consumer electronics and retail through sort of 2023 regardless of additional changes in the macroeconomic as we muted that down fairly significantly. We then layered on where we have discussions already going ahead and where we think weâll be successful from the consolidation perspective and how those get layered in. They are not instantaneous over a 30 -day period. They kind of get phased in over a quarter or four and a half, two quarters, hence we kind of talk about the first two quarters being choppy. The third thing that we layer on, is net new wins and the net new wins, as we talked about in Q4, we want a significant number of new logos. Those are at muted volumes. Those are at the new volumes that we're seeing that are coming through and so they will continue to progress and will add on to our growth. The next layer is the elements of, and verticals that we continue to do well in that are not so bound by macroeconomic locations. You saw the health care vertical grow, BSSI grow. Some of the work that we're doing in those tends to be more resilient to sort of shaky economic times that we're seeing. The next layer down from that is we have some regions that are somewhat isolated from what we're seeing around the globe and spending a lot of time working with them to see what growth opportunities we have in those, and so those have performed sort of on forecast, if not a little bit better and so they are layering on. Then we get into the bigger deals that we've already signed, that come through and we've seen progress as we expect. One deal is ramping a little slower primarily to the client. Itâs a big change for them and so they are kind of taking a little longer to kind of mix some coordinated changes in their ecosystem, but we've already started and weâll get back to pace in Q2. And then we're also seeing sort of net new pipeline of opportunities that we're talking about with both our Catalyst and CX operations that are clearly tied to sort of what we're seeing in the economy where clients are asking us, prospective clients are asking us to sort of transform what they need to drive cost out of the business. And if you look at what our win rates are against those deals and sort of the push those clients, prospective clients are making in order to get them in place. But we feel confidence around what we think we can close over the next quarter or two, which will impact our revenue through the back half of the year. And so we've spent a significant amount of time kind of putting all these layers of building blocks into our plan of what we expect to deliver, not only in the first two quarters, but also in the back half of the year, as we look at the business and the regions that we operate in. We also mentioned in the prepared remarks, we have and are making additional footprint investments. We're seeing some good traction in those, which expose us to some higher growth areas where we think we're under invested in. We primarily talked about LatAm and Europe in the past, as well as offshore delivery centers for our Catalyst business that allow us to be at a at a higher margin profile for that type of work and have more scale for that type of work. So we think we're building the right building blocks. We think we're being conservative on what we see. As we mentioned, we're not factoring in any large seasonal business within 2023. Weâre really just keeping a baseline business for that. So if anything bounces back in the back half of the year, thatâs fantastic, but we're not counting on it. Okay, thank you for all the details there, I appreciate that. For my follow up, if I can ask about the growth rate for the new economy clients. You know three quarters ago they were growing at 47%. I think you mentioned 13%. What are you seeing with respect to those type of clients? I mean, are they more hesitant to spend? When do you think - what do you think is a steady state growth rate for the new economy clients. And I was wondering if you can â if you've mentioned it, maybe I missed this. What was the revenue total contribution from, the new economy clients in fiscal â22 and what â in general, what growth rate should we expect from those clients going forward. Yeah, so I'll let Andre answer the total dollar figure for 2022. But just prior to that, you know Ruplu the New Economy Company as we've talked about a few times kind of replicate a lot of our verticals that we deal with. So we do have new economy companies within e-commerce. They tend to be feeling the same pain as traditional e-commerce players and some retailers where there's been less sort of disposable consumption within those areas. We've also seen as we've mentioned in sort of Q3 and Q4, where the new economy companies where they were focused at really growth and customer acquisition at any cost at sort of the beginning of 2022 to where they are, rightfully so being prudent about their investments and our, you know the services we're offering them tend to be more traditional services around with cost optimization, process consulting and then really a focus around where they think that they can drive higher returns for their shareholders versus just growth at any cost. We do expect that the new economy companies will grow at an elevated rate versus enterprise clients. Itâs just the nature of the beast that they are building the market where enterprise clients are optimizing their markets. But you know we are still expecting and we still continue to win net new deals in the new economy space that we think that will have the higher elevated growth rate. Yeah, so Ruplu the total contribution in fiscal â22 from new economy clients are about $1.45 billion overall. So right in that 22% to 23% of revenue that has been tracking at frankly each quarter here this year. Okay, thanks for that Andre, I appreciated it. If I can ask you one more question on capital allocation priorities. I think you mentioned dividend and debt reduction followed by modest share buybacks. Can you remind us what the target is for leverage and your debt? What leverage ratio are you comfortable with, what is the target? And then I'd like to hear your thoughts on M&A. Is the long term target still to get to the 10 billion in revenues by fiscal â25 and I think that entailed $1.5 billion of M&A. So in this environment in fiscal â23, your thoughts on inorganic growth. Yes. So I'll start with kind of the middle of your question. So the $10 billion is still absolutely our target for 2025 for this business and we're confident we can get there. You're right, it requires some amount of M&A in that $1.5 billion range and we still think that that is a good use of capital in this business. We think the industry will continue to consolidate. Clients want to have deeper relationships with less partners and therefore having that scale is important in terms of the capabilities, etcetera. Obviously, what weâll look for there, first of all, first and foremost the deals need to be accretive to our EPS. They have to hit our targets from a return on capital perspective and then we're not just looking for scale for scale sake. We're looking for domain expertise, for groups of clients that we think that we can grow more quickly and for technology capabilities. Those things really all remain unchanged. From a leverage perspective, we've said you know for M&A we are comfortable taking our leverage up as high as 3.5x, may be even higher and it feel that with the strong free cash flow generation of this business, as well as the acquiree, we would be in a position to delever very, very quickly, and get to â you know get very quickly under 3x and keep pushing down towards the low twos from a net leverage perspective. Right now, given the current interest rate environment, as we think about the strong free cash flow we're going to generate in 2023, you know obviously we're still looking for accretive M&A, that's a priority supporting our dividend. It's certainly a priority and then from a share buyback perspective, I think you'll see us be modestly active there. We do want to offset dilution from share issuances. So that will be a part of the program and then some amount of opportunistic share repurchase, perhaps after that. But right now, in the current interest rate environment, you know delevering, creating more fresh powder for accretive M&A would be a higher priority for us than what I would call kind of large-scale share repurchase. Okay, thank you for all the details. If I can just sneak one more in, Chris, can you talk about the sales cycle. You know is it lengthening, shortening; is it, as you would have expected in this environment and if you can make any comments on attrition rates, both in the catalyst business as well as in the base business? Thank you. No problem Ruplu. So just in terms of the sales cycle, what I will tell you is that discussions that clients feel a deal starting to form are taking a little longer, right. So clients are kind of going through this debate internally about do they outsource more, do they consolidate more. How is that going to look and what's their strategy based on what they're seeing from a volume expectation perspective? But once the decision is made to say, yes, we're going to do this, then frankly the sales cycle has not changed. It's actually maintained some of the speed that is coming through. On complex deals, which we're doing more of in the obviously the Catalyst business, it tends to be a longer sales cycle. We haven't seen that necessarily extend any further. It's just been â it's just a longer sales cycle because of more kind of moving parts and more integration into their IT systems and infrastructure that we have to deal with. From an attrition perspective, our catalyst attrition frankly is down fairly significantly. You've seen a number of companies kind of looking at resizing their technical talent opportunity. So that has really sort of somewhat cooled the market and driven a lot of stability within it. In a general attrition perspective in our operations business, itâs still lower than pre-COVID and it's starting to trend down a little bit more. It had trended up a little bit through the course of 2022, as the job markets have kind of heated up in a lot of different regions that we operate in. We're now seeing it sort of trending down a little bit, but still not back to where it was pre-COVID levels and so we're comfortable with what we're seeing, hence our common and prepared remarks about sort of a more stable labor environment and more predictable labor environment. One moment for our next question. Our next question comes from the line of Joseph Vafi of Canaccord Genuity. Your line is now open. Hello gentlemen! Good afternoon. Thanks for taking my questions here. I just thought perhaps we'd focus a little on the catalyst line of business a bit more. I know you signed up a large â a very large deal there last quarter. We get an update on progress there. I know you've cited it as a growth driver, but just a little more incremental color on progress on that and then a quick follow up. Yes, for sure. Thanks very much for the question. So we have started the project. We started it a little sort of mid-Decemberâish, early December when we kicked off and started putting, I'll call it feet on the ground. That is one of the projects that's ramping slower than expected, primarily because of the change. There's a number of things that decline is coordinating within their ecosystem with vendors that are leaving us, that are taking over some of that work and projects that they've got on play that are being kind of reorganized in terms of what we're taking on and doing. Based on what we're seeing, we're expecting that it will be back on pace with our expectations in Q2, but we're pretty happy with this going so far. The clients happy with what they are seeing and looking forward to kind of getting into more of the meteor stocks. As we mentioned originally when we announced the deal, it will start to contribute more meaningful to our revenue in Q3, Q4 and thatâs still frankly the plan and what we're seeing. Got it, thanks for that. And then maybe if there's any differences in the current demand environment for the kind of more complex IT solutions work right now versus some of the CX work. Iâd be interested to compare and contrast demand drivers given the macro right now. Thanks a lot. Yes, for sure, good question. So we are seeing a change in some of the demand from what I'll call as discretionary IT projects. Think of it as sort of you know rewrite of workflow or other things that might be more customer experience facing versus cost takeout automation. We are seeing a higher demand requests for more consulting and journey mapping around how we can take costs out, and then if it drives a different customer experience, then delivery on that. And so that has changed a little bit in terms of what we're seeing within our Catalyst business. From the larger infrastructure projects that we are dealing with, frankly they are tied to fairly significant ROIâs for the client and so there's been really no impact in those. They continue to come along. We continue to bid and win new projects within that space and so that seems relatively stable. Anything pure â I'll call them vanity projects for the lack of a better term. Those generally dropped out of the funnel in sort of the Q3 timeframe. Thank you. That's all we have time for today. Thank you for participating in today's conference call. This does conclude the program. You may now disconnect.
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EarningCall_1267
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Hi, everyone. This is Rachel Vatnsdal from the Life Science Tools, Diagnostics team. Today, I'm joined by Prahlad from the PerkinElmer team. And so as you've seen with the rest of these sessions, today will be a 20-minute presentation from Prahlad, followed by a Q&A session. We do have mic runners throughout the room. Please raise your hand if you have a question. Otherwise, for those of you joining us online via the webcast, you can submit a question via the Q&A portal. Good morning, everyone, and thank you, Rachel, for the opportunity to come and share our transformation story. It's good to be back in-person, as I call it at the disease [war] after three years. Before I begin, I wanted to attract your attention to our Safe Harbor statement and encourage you to visit the Investors website section for further disclosures on any forward-looking statements that are made here today. For those of you who are new to the company and for those who have followed us for a few years, I thought it would be a good point to reflect back as to what has transpired at the company over the past few years. Three years ago, I stood at this conference two weeks officially into my tenure as CEO of the company. COVID was not very well known outside of China at that point, and sort of we talked about four key areas of focus on our transformation journey. And these four key areas were realigning our portfolio into attractive end markets; increasing the percent of recurring revenue mix as part of our total product mix; increasing our presence from a revenue and an operational footprint perspective and attractive growth end market â geographic markets; and four, strengthening our competencies and capabilities from a competitive position in the attractive growth markets of life sciences and diagnostics. And if you've been following our company at all recently, I hope you will appreciate that we've done a pretty good job accomplishing this transformation, albeit in a more rapid manner than even we had envisioned when I stood and spoke those words here a few weeks ago. I think it's also pertinent to appreciate that we have accomplished this in a truly exceptional manner and with a very strategic focus despite the macro volatile environment that we have all lived through. So where we are today? Post the divestiture or the close of the divestiture of the Applied and Enterprise Solutions business towards the end of the first quarter, we will be a pure-play life sciences and diagnostics business with faster growth, higher margin and nearly 80% of our revenue coming on a recurring basis. Once we close this divestiture to New Mountain Capital towards the end of the first quarter, we will be 11,000 strong company, globally diverse, and as I said, expecting to exit 2022 with nearly $2.7 billion in revenue, roughly split half and half between Life Sciences and Diagnostics. And forward-looking, as I said, nearly 80% of our revenue coming from reagents, consumables, software and services. We will continue to share the PerkinElmer brand name with our Applied and Enterprise Solutions colleagues for a few months until we finalize the new company brand identity and name. Because it's not just about creating a new brand name for the company. For us, it is what are the cultural and core values of the new company going to be, what is the value proposition that we bring forth to our customers, how internally we and our employees act. And I think it's rarely you get a chance in your career to build a new company identity, a brand identity based on a solid foundation of a $3 billion revenue company, which is faster growing and is of high profit. And I'm excited to share that story over the next few months with you. Today, my objective is threefold. One, to give you an insight into how our focus is around science first and how we want to lead by innovation and breakthrough NPIs that we bring to the table; second, give you an insight into some of the key strategic priorities and operational imperatives for 2023; and third, give you a peek into when you put all this together, what does the company look like from a financial profile perspective. So to begin with, on the Life Sciences side of the business, we expect it to exit 2022, again, roughly $1.3 billion in revenue with nearly two-thirds of it coming from consumables, software, assays and services, ably supported by one-third of market-leading in imaging and detection instrumentation portfolio. As you know, we've put together a string of acquisitions that were strategically sought out over the last three years to bolster this business and put it on a growth trajectory, highly focused around reagents, instruments and informatics. And again, where we are sitting today is having a market-leading position in these three branches of that business. What I thought over the next couple of slides, I'll give you an insight into some of the key NPI breakthroughs that we are bringing to the marketplace and how we are leveraging the acquisition that we have made in this business. Starting with our all-in-one automated image cytometer and cell counter. The co-founders of this company are in the audience right now proudly looking at this. And when the Cellaca PLX was launched towards the end of September, this is the first-in-class product profile and NPI that allows our researchers to not only look at potential areas of interest, but also to assess the viability of those cells, leveraging our BioLegend reagent â proprietary reagents from the BioLegend side of the business. This is unique in not only that it increases the productivity of researchers and scientists, but also reduces their risks if they were to use their current traditional workflows. Again, this is something which is a breakthrough NPI and is really going to be something an exciting growth trajectory for us. Another example is around Pin-point base editing. Just like we had done with Vanadis, our intent with Pin-point base editing is bring it into the mainstream. Pin-point base editing is the next chapter in the CRISPR growth story. It allows scientists to not just accelerate therapeutic development, but also get a better preclinical understanding of functional genomics and the impact of changes in genes and proteins has on functions and biological interactions. We intend to â this is through our exclusive partnership with Rutgers University, and we intend to bring this technology to our customers either through licensing to our pharma and biotech customers or providing them with commercial products and tools or providing specialized services to customers that might not have that capability and competencies in-house today. Again, this is something that we'll continue to share progress on this in 2023 with you. The third one, some or if not most of you might have heard from me earlier, is our focus around GMP. While we've got a very strong position on the preclinical research and development side for the Life Sciences business, our intent is to provide our customers with GMP reagents, antibodies, cytokines that they might need so that we can continue to support them from their transition from research to clinic. This is going to be more of an organic investment play for us over 2023 and beyond. So hopefully, these few examples gives you an insight into where we are headed in the Life Sciences side of the business. Our focus will be to fuel our NPI engine, providing leading technology to our customers through novel contiguous solutions that helps accelerate their transition from the research to the clinic. This is what gives us the confidence that we expect our Life Sciences business to grow in the double digits in the future. Now moving to the Diagnostics side of the business. This is something that as some, if not most, of you know, the transformation journey of this began several years ago when I joined the company. It was primarily a niche reproductive health or a newborn screening business. In 2022, this will exit $1.4 billion in differentiated primarily reagents business, excluding the COVID revenue that this business generated, and the three areas being around reproductive health, immunodiagnostics and applied genomics. Obviously, we have a flagship position in newborn screening and autoimmune disease testing, but what COVID did is gave us a platform, not just to be able to show our innovation, but also to significantly increase our installed base through our liquid handling, nucleic acid extraction and microfluidics business. Again, to give you a few examples on how we think of our Diagnostics side of the business. Initially, our focus was around looking at it either from newborn screening or autoimmune. But sort of as you continue to evolve, our evolution here is to â we look at the whole human care cycle from a continuum of care perspective. Starting from the planning stage, we provide insight to families around whole genome sequencing, carrier screening, and as it moves into a pregnancy cycle for a woman, maternal serum screening is still prevalent in many markets where we have â we are a market leader. Pre-eclampsia is an excellent biomarker for preterm birth. And of course, Vanadis, our non-NGS based NIPT offering, which saw significant growth in 2022, and we expect it to continue to grow and be a major growth driver for our reproductive health business. Moving from the pregnancy to newborn screening. Obviously, our flagship position around newborn screening. We continue to be a major provider of cord blood and tissue storage and the informatics platform that goes along with it. But to give you, again, a couple of examples around NPI breakthroughs here. We recently announced the FDA clearance of the first SMA screening in newborns for spinal muscular atrophy screening. And whether it's around SCID, DMD or SMA, our network with key opinion leaders that has been established with more than three decades now has been really instrumental in that. Plus the fact that we have an in-house sandbox with a genetic testing lab that allows us to accelerate product development. But from a customer's perspective, it's really the full contiguous workflow that we provide them all the way from a dry blood spot cord to the informatics platform that provides the results back to the pediatrician or the health care solution from one single provider is what's value added, and that's really what has benefited us. Moving from postnatal to prime years of a human cycle. We've done a really good job of assimilating assays as we build this business from diagnostic â from newborn screening primarily to a comprehensive diagnostics portfolio. We again have market-leading position, as you know, in autoimmune through our EUROIMMUN, Tulip franchises, but also in allergy and emerging infectious diseases. The thing that we were lacking here really was a full contiguous platform of instrumentation to be able to test these assays. With the acquisition of IDS, that gave us stabletop, random access platform and the recent CE marking of our Excentis platform that was long awaited from EUROIMMUN, we now have a full comprehensive portfolio of instrumentation, whether it's for a small lab or a clinic atmosphere, to do small testing or for a reference lab that wants to do high throughput and large capacity screening. Going forward, our focus here will be how do we continue to fuel the pipeline of NPIs that go to this portfolio now. Another example of how we try to bring breakthrough NPIs into the mainstream, similar to what I have talked about Vanadis earlier, our Pin-point base editing. We just recently announced the launch of BioQule, which is an NGS library prep system, that really our focus is how do we make this mainstream by providing a low-throughput, benchtop solution for customers that might not have a lot of NGS experience, and it really provides a simplified user experience. And this is not just library prep for small labs, but even for large reference labs, if they want to do a small run to test something out, BioQule is an ideal product for them. So again, my goal here was to give you a bit of a peek into how our focus is around science first, and in the Diagnostics side, how do we intend to continue to build on our leadership position, whether it's around newborn screening or reproductive health, provide turnkey solutions for our customer so that it expands the reach into lab, not just in large reference lab, but also in a dissipated or a discrete point of care setting of benchtop solutions to our customers. Again, this is what gives us the confidence that the Diagnostics business will continue to grow into the high digits over the next few years. Switching to the second topic, really around what are our operational and strategic imperatives. Obviously, the team is quite focused on ensuring a smooth close of the divestiture towards the end of the first quarter. I talked about creating a new brand identity of the company. Outside of that, three main areas of focus. The one I talked about providing breakthrough NPIs and innovation for our customers. While we've done a good job with the acquisitions and integrating them over the past three years, there is still an opportunity to leverage more commercial and operational synergies with these acquisitions. And then post the divestiture, diligent deployment of the capital, whether it's for organic or inorganic investments. In addition to these, another area of focus and increased investment for us will be around ESG. We recently raised our reduction target emissions by 50% to align with the Paris Climate Accord and became a signatory to the United Nations Global Compact. This is an area which will see an increased investment for us, not because we have to do it, but it's because it's the right thing to do. So then the question comes, what does all this mean from a financial profile perspective? Again, this is not very different than what you have seen before, at least over the last six months that I've talked about. In 2021, when we gave our midterm outlook, we were essentially a mid-single-digit grower with nearly two-thirds of our revenue coming from recurring basis and operating margin target of about 23%. And our current midterm outlook is to â has taken us into double digits with nearly 80% of our revenue coming on a recurring basis and 30% plus operating margin and ensuring that there is 75 to 100 bps of operating expansion opportunity over the medium term that I talked about and an adjusted EPS growth in the mid-teens. Additionally, we'll have significant capital available to deploy to further support this outlook that I have given you. So the question comes, what does this all mean and where are we focused and where are we taking the company? It's really to ensure that we successfully execute on the transformation part, ensure that we drive innovation and are a science first-led company so that we can deliver value for our customers, our shareholders and our employees. And we ensure that â we will ensure that we drive this through the innovation, integration and investment pillars that I talked about earlier. Thank you. As a reminder, if you do have a question, please just raise your hand, and then one of the mic runners will come to you. So thanks, Prahlad. First off, can you just talk about timing of divesting some of these businesses? Why is right now the right time to divest the analytical food and enterprise services? And then can you talk about how does this really position you to become a life science and diagnostics pure-play going forward? And why is the timing right? Rachel, obviously, this was not opportunistic for us. This was thought out when â even before I came into my role â can you guys hear us? It's tough to say. Even when I â before I came into my role as CEO of the company, starting with â we first built out the Diagnostics business and took it from being a niche player to a more comprehensive Diagnostics portfolio. And then COVID gave us a very good platform to be able to demonstrate our innovation and how we were able to do that. Plus, it also gave us a very rapid â robust balance sheet that we immediately deployed to ensure that we had the â once COVID and once the pandemic went away, we had a revenue profile of high-growth, high-profitable businesses that compensated for the drop in COVID revenue, which I think we've done a pretty good job in. But I think consequent nearly when it came down to the point, once post the BioLegend acquisition closed, we were at a sort of a fork in our business profile, right? We were essentially two businesses, one with a high growth, high margin profile and one with decent growth but lower profitability. And I think that's when it became apparent that, I think, to create more value for our shareholders, it would be best to divest that business. And with New Mountain Capital, we found an able partner who gave us three things that weâve focused on: value, speed and certainty. And that was sort of the reason that we continued on that path of our transformation journey. Got it. Helpful. And then just maybe regarding that medium-term outlook slide. So when the divestitures were first announced, it looks like that was really 10% plus growth from that 2024 through 2026 time frame. Today, it looks like that is 10% in the midterm. So a few questions on that. What drove that shift? I know it's minor, but from 10% plus to 10%, and then is that guidance still through 2026? Or is that time frame kind of changing? And then last piece on that midterm guide is, how is capital deployment assumed within the guidance? It looks like that may be included in this updated guide from today, but just kind of walk us through the puts and takes there? Sure. I mean, I think the first thing is let's be cognizant, there are not many companies in our peer group that can come up and say that they have 10% growth. So guys, I think let's just start with that point. I think it's more around, as you appreciate the market conditions that are playing out, you need to be cognizant and see what it is. In the medium-term and it is the 2026 frame, just to make sure that it's there. I think 10%, and as if you all have seen our track record, we love to beat our numbers. And I think that's the way you should expect that to be. The second question of yours, Rachel, was around the medium-term outlook. So yes, the capital deployment piece, as I said, it further supports that outlook. So it's not that it's â whether it's in there. We ensure that it will continue to bolster that, if anything. Okay. And then maybe just from looking at the slide, it looks like it assumes a stable macroeconomic environment. So just kind of digging deeper on that shift from 10% plus to 10%. What happened â if it's assuming a steady macro environment, what shifted from today versus a few months ago where you have a little bit less confidence, understanding that you're one of the few that's growing in that double-digit range? No, I don't think there is any lesser degree of confidence, let me begin with that, right? And I think the â assumes a stable macro environment has been something that we have talked about on an ongoing basis. So it's not a new revelation from that perspective. I don't think materially anything has changed, but I think we've all read what's going on in China, and we've all seen what's happening with Europe with the energy crisis. So it's just being prudent, and that's all. There is nothing that we are bringing up or down. Our confidence and our ability to execute on the numbers that we have put forth continues to remain the same. Helpful. So then maybe shifting over to some of the assumptions within that guide for deals. You've been very active on the M&A front in recent years. And before that, that wasn't a huge part of the Perkin's story. So can you just talk about some of the deals that you've completed in the last two to three years and really how that's contemplated in that 10% guide going forward? And then how is the execution? How has the integration gone on those deals as well? I mean, I think you saw a couple of examples today around how the integration of these acquisitions are going with the example on Nexcelom's Cellaca and how they are leveraging the BioLegend reagents. I've talked earlier around how our liquid handling portfolio and Nexcelom's, again, cell counting capabilities are being used in Oxford's TB testing environment. So from â the commercial one was a low-hanging fruit. So that started earlier, but now we are seeing technological synergies coming out, other opportunities that I've talked about. So in short, the integration is going very well. And in terms of how the acquisitions are doing, and I think I have said this earlier, when I did the EUROIMMUN acquisition in 2017 fall, I had said that would be the best acquisition we would have done. I mean I'm eating my words right now. And then I think with the acquisitions that we did on the Life Sciences side, we've built a $700 million-plus reagent revenue business that is growing at double digits and spilling out great profit margins. Again, a very rare opportunity to be able to stand up and say that. Helpful. Maybe just shifting over to framework for 2023. So can you spend a minute just talking about COVID? You've talked about how the $600 million this year is going to shift over to about $100 million in 2023. Obviously, we've had an outpaced flu and respiratory season in recent months. So can you just talk about some of that roll off? And could we see upside given the current environment? And then how should we think about that margin roll off and the impact from that $500 million differential? So let me start with the last part of the question. The margin roll-off is assumed in our 30%-plus outlook. So it's already factored in. And as we've seen with our numbers in the 3Q, and we have said this that what we are focusing on COVID has been around PCR testing. And PCR testing has gone down rapidly in the U.S. And also, if you look at it in China, they have said that majority of the folks are not getting PCR testing. So I think when we had put that $100 million number out and that still stays, so nothing's changed there, just to start there, right? But I think what changes is the profile of it. One, majority of it was leveraging our increased installed base, especially from the capabilities that we would have around liquid extraction reagents that we would sell and services and all that. So that remains and continues. It just becomes tougher three-plus years going forward from the pandemic to be able to tell whether the customer is using that for COVID or for other NGS prep. The second piece is true, right? The PCR testing has gone down and most of our COVID direct revenue was from PCR testing. So while nothing has changed, I think what you will see is more the profile of how that revenue mix shifts. Helpful. You mentioned China. So I'm going to do a follow-up on that one. During 3Q, you expected China to drive a roughly 200 basis points headwind to RemainCo for 4Q and then totaling 300 basis points for the year. So can you talk about how that's trended given some of the recent lockdowns? It's like [earlier into] the discussion just some of the COVID headwinds there. So how should we think about China recovering in the near term, but then also returning to a normalized growth rate for you guys just given your exposure there? Sure. I think when we did our 3Q earnings call, I mean, specifically around 4Q, obviously, we'll talk about it a month from now. But I think our reagent â diagnostic reagents business, specifically in China, is on the non-critical side, right? And then I think as we've all seen what happened with China in December, life needs to return back to normal for people to go for autoimmune and allergy or infectious disease testing. And life has not yet returned back to normal for our purposes. But we still â as we've said, we still expect life â it to come back to normal in the second half of the year, which is the way it's playing out. Helpful. Maybe let's shift over to pricing. So historically, pricing hasn't been that meaningful part of the model for PerkinElmer. So can you talk about the pricing that you guys have seen so far this year? During 3Q, it was 200 basis points. So how are you thinking about that pricing shifting into 2023? And then after this transformation and some of the divestitures, how are you thinking about using that pricing lever going forward once you become that life science and diagnostics pure-play? Yes. So I mean, I don't think we've seen the full impact of the rollout of the pricing yet. So it's still going to be healthy, Rachel. We said a couple of 100 basis plus point in the third quarter, and I think I would say that we've also talked about the fact that we'll see at least 100 bps pricing impact in 2023 for us, which is higher than what we normally have. But I think what the question that you asked is more important is going forward, what does it look like? I think what we've done a good job is now with the portfolio that we've built around Life Sciences more specifically, we have a better opportunity to continue to leverage pricing and the impact that we will get out of it. So we are confident of that happening. Helpful. Maybe shifting over to margins for 2023. So can you walk us through that bridge from the 31.4% operating margin for continuing ops during 3Q into that 30% plus op end that you guys expect to hit 12 months post divestiture? And then how should we think about the margin roll-off from the COVID perspective, but then also some of the stranded costs that you guys have flagged as well? Sure. I mean itâs to some extent, it's apples and oranges, right? The 31.4% that we had in third quarter was more in terms of how you have to account based on GAAP accounting rules when you have discounts. So that's why you see that number there. I think we'll get a clearer picture post the close of the divestiture. But as we've said, over the next 12 months, we expect it to average around 30%, right? And that includes 1% to 2% of stranded costs that we have said earlier. I think and â but more importantly, it also accounts for the roll-off of COVID margins that we would have going forward. So that is accounted in the 30% that we have said in the first 12 months is for average. Helpful. And then maybe shifting over to some of the comments around excess inventory levels that customers that some of your peers have flagged. On the liquid handling, the microfluidics businesses, for example, what are you seeing with your customers? Have you seen any excess inventory in the channel? And then is there anywhere where you would expect destocking in the next few months? Sure. Again, Rachel, this is where the portfolio that we have now with 80% of our revenue coming on a recurring basis with differentiated reagents and a relatively short expiry shelf life, customers are not going to be stocking this, right? And the second aspect is that we do not have much of a commodity business even on the instrumentation side. $300 million of that is imaging and detection for Life Sciences. Even on the diagnostics side, what we do with our applied genomics portfolio is with chemagen, liquid handling and also around the automated systems that we sell for our customers, right, we have not seen any decline or slowdown, and these are not products that they will have â want to stash a lot of inventory. So there is nothing that â we are fortunate with the new portfolio that we have built, that it doesn't give us that impact. Perfect. Great to hear. So then maybe let's talk briefly about 4Q. You guys noted in your press release yesterday that you expect 4Q to come in above guidance expectations. So can you just dig a little deeper into that? What metrics do you think you came ahead on? And then were there any pockets of the portfolio that were even more outpaced than you expected? I had to try. So maybe can we spend a minute on Europe? Europe has been a big discussion this week, just given some of the headwinds from a macro standpoint, energy costs. So what are you seeing with your European customers? And what are the conversations look like there? I mean if you look until the 3Q, right, we were pretty much â Europe has grown in sync with our total company, right? And I don't think that has changed. I think what has changed is now a more keen awareness around the energy crisis that's going on, and I think we'll see what the impact of that will be going forward. But as of now, I would say, Europe is sort of growing pretty much in sync with our total business and other geographies. Helpful. So let's shift over now to the life sciences portfolio. Kind of kick it off here, can you walk us through that life sciences portfolio as you've added some meaningful additions in the last few years, Horizon Discovery, SIRION, BioLegend? You expect that portfolio to grow low double digits. So how should we think about the opportunities there and to grow beyond that low double-digit range going forward? And then last question, where are there gaps in the portfolio that you think that you would like to add to on this life sciences side, especially post divestitures? Look, I think, as I said, right, we'll have a $700 million reagents business growing double digits. We have a $300 million, $400 million, if you include services, instrumentation portfolio and $200 million informatics business around software, all of them being market-leading. I'm very happy with the double-digit growth forecast that we have. I don't think there is â we are â I would love to see others that have that kind of a growth profile, as I said, really. But coming back to the second half of your question, are there gaps in your portfolio that you would fill? Yes, I mean, we'll continue to bolster our reagent side of the business. We'll continue to bolster our position as we move from preclinical research to development. Our focus is not going on to the commercial side of GMP, but really from the transition point from preclinical research to our customers going into the clinical side. So that is an area where you'll probably see us doing both organic and inorganic investments. Helpful. BioLegend. So you flagged during your comments that the EUROIMMUN was going to be the best deal that you've done and then BioLegend has performed well so far. So can you walk us through how â as we lap that one year since close, how has that really performed relative to your expectations? And do you think that it can continue to drive that mid-teens growth? Or is there opportunity for upside there for BioLegend? Our total M&A portfolio grew double digits â has grown double digits, and we are very happy with the acquisitions. I think what â and I have said this earlier, rather than talk of specific acquisitions, I'll attract your attention to our total reagents business, which is $700 million plus in revenue and growing double digits, and BioLegend makes up nearly half of it, if not more. So really, it's the biggest piece of that reagents business, and it's doing very well. Helpful. So maybe shifting over to diagnostics then. To take a step back, you expect diagnostics to grow high single digits long-term, and you've continued to diversify that portfolio as well via the acquisitions. So how are you thinking about portfolio expansion beyond that for your current diagnostics portfolio to hit that high single-digit growth rate or above? Sure. I mean, I think if you â we have to break it down into the three pieces, right? With the reproductive health side, despite tough birth rates, we've done pretty well, growing amid single-digit, high single digits, and we expect to do that. Vanadis is a growth accelerator on that side of the business. I think what you will â we'll continue to sort of bolster the assay pipeline. Now as I talked about on the autoimmune side, we've built a very strong portfolio of instrumentation all the way from a tabletop through the IDS acquisitions and in homegrown products to Excentis, which, as I said, got recent CE marking. We now need to fuel that engine, and we need to fuel that engine outside of the differentiated assay offerings that we have from autoimmune and allergy with more reagents. So that's probably where you'll see us to make more investments. Helpful. Then shifting over just more to capital deployment given the part of the story that is. So how should we think about capital deployment priorities post divestitures and really how much firepower will the company have? And then as a follow-up, Perkin, you've been very active on deals for the last two to three years, but peers continue to roll up assets as well. So how do you see PerkinElmer positioning themselves to win in some of these competitive bids for companies moving forward? Yes. A great question, Rachel. I think two, three things, right? One, I want to make sure I don't forget because there are three questions wrapped in that one. We'll be very diligent with our capital deployment. We have $1.2 billion of debt that we have to ensure that we pay off, which we will be. I think the second and more important aspect is that we've got to â most of the deals that you see that we have done have not been one where we are in a competitive process. As you know, 90% of our founder, inventor, senior management for our acquired companies still stay with the company, and we hope to continue to partner and bring in companies into the PerkinElmer family because they are a good cultural fit in addition to the strategic fit and financial profile that we are looking for. So that's where we sort of â we have some differentiated ability to be able to attract those founder owners, and those don't go into a competitive process. So that's where we will be focusing our attention at the right time. Helpful. And then just as a follow-up, how quickly could we see you start to deploy some of that capital once you divest these businesses in the near future? And then where would you be comfortable from a leverage perspective going to, if it was for the right-size deal? I think we'll stay investment grade, which means that even though short-term, once the capital â once the divestiture closes, we'll be closer to 1.2 EBITDA. But I think, overall, we'll try â our focus is to stay investment grade and 3x. So that's where we'll be from that perspective. I think we'll be diligent in our capital deployment. We've talked about the fact that we have to repay debt. We've got some organic investments, whether it's around GMP, around e-commerce, and we look at that. And we'll continue to look for strategic opportunities. We've got an active funnel, and, at the right time, we will pull the trigger on those. Perfect. Helpful. We spent a lot of time discussing some of the inorganic growth opportunities here, but let's talk a bit about organic growth. From an R&D perspective, what areas of the portfolio are you looking at to spend most on R&D? And then are there any exciting things in the pipeline that we should be focused on? Yes, I think the benefit with â post the divestiture, it's a very simplified portfolio now, life sciences and diagnostics. I think you will continue to see us making organic investments in R&D around some assays or differentiated NPIs that we bring to the table. Overall, at the company level, I've talked about e-commerce, nearly 45%, 50% of BioLegend's revenue come from e-commerce. Only 5% to 7% of our total company comes from e-commerce. We have a great opportunity there to leverage an e-commerce platform. And that sort of not just is an efficient thing to do, but also a margin play. So that's where from an organic perspective, you'll see an investment in addition to the GMP facilities that I talked about.
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EarningCall_1268
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Good day, and welcome to the Southwest Airlines Fourth Quarter and Full Year 2022 Conference Call. My name is Chad and I will be moderating today's call. This call is being recorded and a replay will be available on southwest.com in the Investor Relations section. After today's prepared remarks, there will be an opportunity to ask questions. [Operator Instructions]. At this time, I would like to turn the call over to Mr. Ryan Martinez, Vice President of Investor Relations. Please go ahead, sir. Thank you, operator and welcome everyone to our fourth quarter and full year 2022 conference call. In just a moment, we will share our prepared remarks and then leave plenty of room for Q&A. Joining me on the call today is our President and CEO Bob Jordan; Chief Operating Officer Andrew Watterson, Executive; Vice President and CFO Tammy Romo, and Executive Vice President and Chief Commercial Officer, Ryan Green. A quick reminder, that we will make forward-looking statements which are based on our current expectation of future performance. And our actual results could differ from expectations. Also, we had special items in our fourth quarter results, which we excluded from our trends for non-GAAP purposes. And we will reference our non-GAAP results today. So please refer to our press release from this morning and our Investor Relations website for more information. All right. Thank you, Ryan. I appreciate everybody joining us this morning. Well, we're disappointed to report a Q4 net loss, as we were on track to produce a healthy fourth quarter profit prior to December 21. We provided an 8-K investor update earlier this month that quantify the preliminary estimate of the financial impacts, so a Q4 loss is likely not a surprise. But I would like to take a few minutes to talk about the operational disruptions. And first and foremost, I want to apologize again to our customers and our employees for the impact the operational disruption had on them and on their holiday plans. We are intensely focused on reducing the risk of repeating that type of operational event, again, like we had last month, and we are highly focused on our customers and our plan going forward. And customer refunds and reimbursements remain a top focus. While not proud of what happened, I am very proud of our people and all that they have done to take care of our customers and their needs. Well, in terms of the events themselves, we canceled more than 16,700 flights from December the 21 to the December 31. The first few days through December the 23 were specific to the winter storm, and we began to have additional disruptions in the operation on December the 24. As the largest carrier in roughly half of the top 50 U.S. travel markets, we were impacted by rolling storms to an extraordinary degree. We experienced gridlock and many of our largest airports along with a high frequency of short notice cancellations, which created urgent and repeating efforts to repair the aircraft routings and then our pilot and flight attendant schedules. Given the overwhelming volume of flight cancellations over multiple days, combined with manual workstreams, we determined that the best course of action to get back on track operationally was to reduce our December 27 through December 29 flight activity by roughly two thirds. And that allowed us time to reset the operation to normal flight levels beginning on December the 30. But based on what we know at this point, our processes and technology generally worked as designed. But we were hit by an overwhelming volume of close in cancellations, which put us behind and creating crew solutions, which in turn pushed us to manual efforts and solutions and Andrew will cover that in detail more here in just a minute. So we've got several streams of work underway. Immediately following the disruption, we move swiftly to put mitigation efforts in place to reduce the risk of future operational disruptions and to help fortify our operational resilience. We created an early indicator dashboard that closely monitors operational health and signals and alert if we approach predefined operational thresholds. We established supplemental operational staffing that can quickly mobilize to support crew recovery efforts at the first sign of a potential workload backlog. We enhanced our existing tools for crew members to communicate electronically to crew scheduling during irregular operations. And we're in the process of swiftly updating and upgrading our crew recovery tools and system to solve the backlog repair of crew member schedules, which was one of the key issues during the disruption. With these short term risk mitigation steps in place or underway, we're taking additional steps to review the events and determine any additional changes to our plans. We worked early on with our Board of Directors and they've established an operations review committee that is working with our management to understand the events and help oversee the company's response. We've engaged a third-party global aviation firm Oliver Wyman, for a third-party assessment of the event and help make recommendations of additional mitigation elements for us to consider. And that work will conclude here over the next several weeks. And with that assessment and our own, we will reassess our 2023 plans, keeping in mind that we already had a robust operational modernization plan in place for 2023 and Andrew will walk you through that in greater detail as well. I want to reiterate that Southwest has a very long history of innovation and continuous improvement. We've been investing up to $1 billion per year on technology, both recurring and investment [spend] (ph) included and we have implemented numerous large scale technology and business projects over the past five years, including things like the first implementation of the Amadeus Reservation System in North America, co-developing an innovative network planning system that's now part of the Amadeus product portfolio, ETOPS certification and processes for Hawaii flying, new aircraft maintenance systems, a DDS platform capabilities and connection to three other platforms, a new [pair] (ph) product, and automated ancillary services capabilities, and we're in the process of wrapping up the replacement of our revenue management system, which actually involves three RM systems simultaneously in production, which is an absolute technical feat. That list is not meant to be comprehensive, but hopefully it gives you an idea of what we've done and what's underway. We're also currently budgeted to spend $1.3 billion of our 2023 annual operating plan on investments, upgrades and maintenance of our IT systems, which is higher than what we spent in 2022. The recent disruptions will likely accelerate some of our plans to enhance our processes and technology, but I suspect that the operational modernization opportunities that Andrew outlined at Investor Day have largely captured the key workstreams and we will dedicate the capital needed to execute in a timely and efficient manner. We currently plan to stick with our 2023 growth plans. We were appropriately staffed for our 2022 flight schedules including the holidays and we continue hiring this year to be appropriately staffed for our 2023 flight schedules. Our plans call for adding over 7,000 new employees in 2023, which is actually a decrease of nearly 40% from 2022 hiring levels. We have the order book from Boeing that we need in 2023. And with the short-term mitigation elements that we put in place, we believe we are well prepared to execute our network restoration plans this year. Nearly all planned 2023 capacity additions will go to restoring the network and adding breadth and depth in existing Southwest markets. And that network restoration should significantly help our operational resilience efforts over the long term. Andrew will also cover that in more detail. Finally, we continue to work hard on labor agreements for our people. And I'm very proud of the fact that we were able to reach agreements with several of our unions recently, including our flight instructors, our facilities maintenance techs, our customer service agents and, just earlier this week, a tentative agreement with our dispatchers. We continue negotiations with the unions representing our ramp and ops employees and mediation with unions representing our pilots and flight attendants. And we intend, as always, to have competitive market compensation packages for our people. In closing, we still made tremendous progress in 2022. And despite some impact here in Q1, we believe we still have a solid plan for 2023. We are holding ourselves accountable to the plans that we outlined at our early December Investor Day, and it is still our goal to achieve the long-term financial targets that we outlined. And I know that our people are up to the task. I'm just extremely proud of them for their dedication to the cause that is Southwest Airlines, and they remain absolutely our greatest asset, the heart and soul the company and a tremendous source of pride for me personally. Thank you, Bob, and hello, everyone. I will focus the majority of my comments on the operational disruptions to provide some additional color to what Bob shared. We experienced a historic event with a combination of challenges we hadn't experienced before. However, as Bob mentioned, our crew scheduling software didn't stop working during the disruptions, but a combination of our processes and the technology couldn't keep up with the pace of cancellations at the height of the weather disruption. That forced crew scheduling into fully manual mode to develop solutions, and they simply couldn't keep up with the volume of changes. Based on what we know today, it appears that the last domino to fall was when we could no longer use our automation for crew scheduling. Automation works very well for us, but when a problem gets dated, the automation doesn't have the ability to look backward as it tried to solve future problems. To simplify, the decision support tool helps us solve two issues. One, repair the assignments of individual crew members; and two, solve crew coverage problems for individual flights by reassigning crew members and using reserve crew members. If a crew member's individual schedule is not repaired before the next assignment begins, then we aren't able to use the automation to repair the individual schedule. Consequently, without updated crew member schedules, the software can't reassign crew members to solve for flights with crew coverage issues. So the disruption uncovered a functional gap in our technology. However, this issue is in the process of being addressed. In terms of the moving parts of our point-to-point network, you can think of it in 3 buckets. You have the flight network, the aircraft network and the crew network. We feel very confident in the flight network and schedules we have published for sale, and we are very adequately staffed to operate our fourth quarter flight schedules. We feel very confident in our aircraft network, and we have a sophisticated technology product that we call the Baker that produces new aircraft solutions during irregular operations. At no time during the disruption did the point-to-point journeys of the aircraft present us with an unsolvable problem. For our crew network, the functional gap that was revealed in our crew scheduling software is in the process of being addressed and should be updated in a matter of weeks, which represents quick work by GE Digital and our teams to address the most notable cause of the event that we are currently aware of. So in terms of where we go from here -- this happen again, our access fall into three buckets: immediate mitigation efforts aimed at the last domino to fall; department level assessments and actions; and a systemic review supported by a third-party. Bob covered the immediate mitigation for implemented, our dashboard, supplemental staffing, crew communication tool enhancements, et cetera. He also covered a third-party review of the events and the Board's involvement in working with management to oversee our response. I want to briefly cover the second bucket, which is department actions. Each department has undertaken its own analysis to identify additional measures the departments can make to improve its management of significant disruptions while leaving the cross-departmental improvements to the systemic analysis conducted with a third party. Some examples of the department efforts include implementing a new crew scheduling phone system targeted for Q1 of 2023, create a network disruption pod and NOC, or network operation control center, to better integrate crew data and to fly cancellation decisions; increased the number of crew schedulers;, evaluate our cold weather preparedness and items such as assessing VIP procedures, protocols and tools to increase throughput; ensuring we have sufficient ground support equipment fuel that is viable in subside temperatures. This list isn't meant to be comprehensive either. Just to share you -- just to share with you that we have already identified some smaller scale opportunities for improvement. And we will have taken actions even before we get to the third-party recommendations. But in terms of the review by Oliver Wyman, we think it is a valuable exercise to understand how the accumulation events led us to the final result. And we still want to see if there are opportunities to improve performance on bad weather days to integrate and to our modernize operation efforts. We recently had an opportunity to test some of the new mitigation efforts implemented recently during the FAA technology outage earlier this month with a Notice to Air Missions or NOTAM system. Our NOC worked around the clock in constant contact with the FAA and the industry to make sure that our NOTAM was restored and valid before we pushed any of our flights. We took the time to ensure verification, safety and compliance, which is why we had not dispatched flight before the FAA ground stop. And it is another example that we will not sacrifice safety. We did not sacrifice safety during the December event, the NOTAM event, and we simply won't going forward. Safety is paramount. And we used our new warning indicators. We deployed additional head count to assist crew scheduling, even though we didn't end up needing them. And we executed target cancellations that help protect how we ended that day to assure a good start the following morning. So while we had a difficult start to that day, thanks to the swift actions taken and enhanced processes in place, we were number one in the industry in on-time performance the next day. Part of the organizational changes when I stepped into the Chief Operating Officer role was to combine network planning with the operations functions in order to further align commercial and operations objectives. And we recently announced a related org change by promoting -- VP network planning, to SVP network planning and network operations control. The goal of this move is to create a tighter feedback loop between scheduled design and schedule execution in order to add resiliency and reliability to our network. This is another action that I believe will help us tremendously. Since the disruptions in late December, our operational performance has been solid. The month of January has seen several ATC outages, historic precipitation in California, where we are the largest carrier, and multiple snowstorms in Denver. Through Monday 23, we are number two in on-time performance out of 10 airlines, trailing American Airlines by less than 1 percentage point. As a reminder of what we shared at Investor Day, I want to recap two areas: our operations focus areas and our capacity plan. First, much of what we are talking about in terms of operational improvement and technology upgrades, I addressed at our December 7 Investor Day. In particular, in the areas of operating quality and frontline staff and tools. In the area of operating quality, I noticed a focused area called network design recovery. While it was not planned as part of our 2023 delivery at that point, we had begun work in that area at the time of Investor Day. We had already selected over Wyman to assist us beginning this January. As part of our reevaluation of our 2023 priorities, we'll accelerate this work. In the area of frontline staffing tools, I noted focus areas of mobility/digital tools and continuous improvement. Again, these were specifically slated to deliver by the end of 2023 but will be evaluated again as part of the reassessment of our plans, given the challenges with crew communications we experienced. I want the third-party review to conclude before I opine on what exactly needs to be done and over what time line, but we have good line of sight to potential improvements in several operations areas that span multiple years, including 2023. Now we need to finalize our plan for 2023 and determine what sequence of improvements are most appropriate in terms of technology and tools investment. And secondly, our 2023 capacity growth is now up to 16% to 17% year-over-year, but this is apples to apples in line with the old 15% that we outlined in Investor Day. Nothing has materially changed in our capacity plans for this year. The increase is simply due to lower capacity in Q4 2022 due to the flight cancellations. We were headed all along toward network restoration, and the December events had nothing to do with staffing levels or our capacity plans. Speaking to 2023 capacity plans, it is nearly all going back in the key Southwest markets and adding market depth. These are markets that we borrowed from to fund new airport expansions in the pandemic. And as leisure demand remains strong and business demand improves, we have opportunities to build this back up. And this is lower risk capacity growth primarily in markets where we have the number one or number one share in a strong Southwest Airlines customer base. Our goal is to have the network fully restored by the end of 2023. And by summer 2023, we should be about 90% done. And in doing so, it should help fortify the operation with better itineraries, depth and reaccommodation options for customers, crews and aircraft when we do have weather or delays that create regular operations. So we plan to continue our investment in the network this year. And on the topic of 2023 schedules, last month, we extended our flight schedule for sale from July 11 to August 14. This included the -- in the Southwest points of strength as well as bringing back longer-haul markets, all part of our continued network restoration and accounts for anticipated travel demand for the peak summer travel period. Denver grew at just over 300 flights a day, the highest ever daily total account for any Southwest Airport, and Baltimore hits approximately 220 days departures, which is higher than summer 2019. We will peak with total daily flights of nearly 4,400 in July 2023. Our next schedule through October 4 will be published on February 9. I want to wrap up by reiterating that we are intensely focused on reducing the risk of repeating the type of operational event we had last month. And we are also focused on moving forward and running a great operation each and every day. So while there will be lessons learned, we aren't losing focus on the fact -- on the blocking and tackling that is necessary to efficiently operate our network. I'm confident that our people will continue to do just that, and I'm thankful for their focus on running a safe and reliable operation and providing excellent customer service to our customers. Finally, I would be remiss if I didn't commend the negotiating teams of TW 557 who represent our flight instructors; and AMFA, who represents our facilities maintenance technicians. These negotiating teams worked tirelessly to reach agreements for their memberships, and I am pleased we can reward these employees with well-deserved pay increases and quality-of-life enhancements. I'm also pleased that we just recently reached a tentative agreement with TWU 550, who represents our flight dispatchers, and they will be voting on their TA soon. We continue negotiations with the unions representing our other work groups that await a tandem agreement to vote on, and we intend to continue to pay competitive market compensation packages to our employees. Thank you, Andrew, and hello, everyone. I will provide a quick overview of our financial results and share some additional comment on our 2023 outlook. As a result of the operational disruptions in late December, driving a $620 million negative after-tax net impact, we reported a fourth quarter net loss of $226 million, excluding special items. These results are clearly disappointing and not where we expected to be. Our quarterly performance leading up to December 21 was strong and trending in line with our previous guidance expectation aside from CASM-X, which I will cover in a minute. As Bob mentioned, we still made tremendous progress in 2022 despite the operational setback in late December generating full year 2022 net income of $723 million, excluding special items. Despite the negative revenue impact from the flight cancellations in December, we generated record fourth quarter operating revenues. Brian will speak to our revenue performance and outlook here shortly, so I will turn to our cost performance and outlook. Beginning with fuel, our fuel hedge performed well last year, especially in a volatile market environment. In total, our full year 2022 fuel hedge benefit was roughly $950 million with roughly $170 million in fuel expense savings in fourth quarter alone. For 2023, we are 56% hedged in first quarter, 51% hedged in the second quarter and 47% hedged in second half 2023, which equates to 50% hedged for the full year. Based on the January 20 forward curve, we now estimate our first quarter fuel price to be in the $3.25 to $3.35 per gallon range, up $0.25 from our previous guidance and our full year 2023 fuel price to be in the $2.90 to $3 per gallon range, up $0.05 from our previous guidance. Our first quarter guidance includes $0.16 of hedging gains and a hedging premium expense of $0.06 per gallon. We recently added to our 2024 fuel hedge portfolio and are now 39% hedged with a fair market value of nearly $561 million in total for 2023 and 2024. We will continue to seek cost-effective opportunities to expand our hedging portfolio in 2024 with the goal to get to roughly 50% hedging protection. Moving to our non-fuel cost. We experienced a significant cost increase in fourth quarter primarily as a result of the December operational disruptions, including a lower capacity from the flight cancellations. The year over three-year negative impact to fourth quarter CASM, excluding special items, fuel and profit sharing, our CASM-X was 23 points. In addition to the impact from lower ASM, the majority of this headwind was driven by the estimated redemption value of rapid reward points offered to customers impacted as a gesture of goodwill and travel expense reimbursements to customers. There was also premium pay and additional compensation for employees, but that made up a much smaller portion of the 23-point CASM-X impact. Excluding the impact from the operational disruptions, our fourth quarter CASM-X was roughly 4 points higher than the high end of our previous guidance range of up 14% to 18% compared with fourth quarter 2019. This was primarily due to additional labor accruals at year-end. As a reminder, we have been accruing for all open labor contracts since April 1, 2022, and these accruals are dynamic as we continuously evaluate market compensation. Looking forward, we continue to experience year-over-year inflationary cost pressures as well as cost headwinds due to operating at suboptimal productivity levels. We now estimate first quarter CASM-X to increase in the range of 2% to 4% year-over-year, which is approximately 2 points higher than our previous guidance of flat to up 2%. This 2-point increase is due to the continuation of premium pay for a portion of January relating to the December operational disruptions as well as an increase in labor accruals for open contracts. For full year 2023, we now estimate CASM-X to decrease in the range of 6% to 8% year-over-year compared with previous guidance of down 1% to 3%. The vast majority of the change in guidance is related to the year-over-year impact from lower fourth quarter 2022 capacity as well as higher fourth quarter 2022 cost attributable to the December 2022 operational disruption. We have also increased our labor accruals this year, which results in a slight offset year-over-year. Putting aside the effects of the December operational disruptions, we continue to expect our second half 2023 CASM-X trends to improve from first half 2023 year-over-year. Turning to our fleet. We ended 2022 with 770 aircraft, which is net of 26-700 retirements. We received a total of 68 aircraft deliveries from Boeing MAX 8, which was two more than our previous expectation of 66 aircraft. However, we are still short 46 aircraft from the 114 contractually scheduled 2022 MAX deliveries due to Boeing supply chain challenges and the timing of the -7 certification. These 46 orders are reflected as 2023 deliveries in the order book included in our press release this morning. However, we don't expect to be caught up on MAX deliveries by the end of this year. We continue to expect 100 MAX-8s this year, which remains our planning assumption, and we continue to expect to retire 27 -700 aircraft which will bring our fleet count to 843 at the end of this year. We have also recently exercised options for delivery in 2024, as outlined in our press release. Our full year 2022 CapEx was $3.9 billion, relatively in line with our previous guidance. In regards to our CapEx plans for this year, we continue to estimate spend to be in the range of $4 billion to $4.5 billion, which includes $1.2 billion in non-aircraft capital spending. Bob and Andrew touched on our current thoughts regarding technology spend this year in light of the operational disruption. But I want to reiterate that we are focused on executing our operational modernization plans outlined at Investor Day, which includes our current expectation to spend approximately $1.3 billion this year, including both capital and recurring spend on technology investments, upgrades and system maintenance. And our total CapEx range should allow for additional CapEx investments as needed. Moving to our balance sheet. We ended the year with cash and short-term investments of $12.3 billion after paying a total of $3.1 billion to retire $2.9 million in principal of debt and finance lease obligations during 2022. This includes the $1.2 billion principal prepayment of our 2023 notes, which leaves a modest $85 million in scheduled debt repayments this year. Our leverage is at a very manageable 47%, which we expect to decline over the next several years. Our balance sheet remains strong, and we continue to be the only U.S. airline with an investment-grade rating by all three rating agencies. In closing, I am immensely proud of the progress our people made throughout 2022 and their continued resiliency through numerous unexpected challenges. While the last several weeks have been tough, we have not lost sight of the priorities and focus areas that we outlined at Investor Day. In addition to the operational modernization plans we already mentioned, we are eager to wrap up negotiations with all of our open contract labor groups. Although it's disappointing, we expect another loss in first quarter this year due to a carryover revenue drag from the operational disruption, we remain steadfast in our focus to generate consistent quarterly profitability. And even with the first quarter headwinds, our 2023 plan continues to support solid profits with year-over-year margin expansion for full year 2023. Furthermore, we remain determined to achieve our long-term financial targets to grow our profits, margins and returns while delivering on our commitment to provide outstanding customer service and reliable operations that have been a source of tremendous pride over our 51-year history. Thank you, Tammy. I'll provide a bit more detail on fourth quarter trends and our revenue outlook for first quarter. First, as Bob mentioned, we are very focused on taking care of our customers impacted by the operational disruptions last month. We've sent gestures of goodwill. We processed all bags for return to customers. We processed nearly all customer refunds and have completed more than 80% of the reimbursement requests we've received from customers for reasonable expenses related to alternative transportation. We're processing the remaining requests as quickly as possible and plan to have those largely completed by next week. We will continue working hard every day until all requests are resolved. Turning to our trends. At our Investor Day in early December, we shared that our fourth quarter revenue outlook remains strong. Leisure revenue trends were strong, both in load factors and yields and for both holiday and nonholiday time periods. Managed business revenues also continue to be strong, and all of that held true right up to the operational disruptions that began on December 21, and we were tracking right in line with our operating revenue guidance to that point. But in the last 10 days of the month, we incurred an estimated $410 million revenue penalty due to the operational disruptions. As the end of December is typically a low demand period for business travel, we experienced less of an impact on business travel trends than with leisure. We still came in at the better end of our managed business revenues fourth quarter guidance range at down 20% compared with fourth quarter of 2019. And despite the $410 million impact, we still generated record fourth quarter revenues of $6.2 billion and a record passenger yield of $0.177. We saw other positive contributors in the fourth quarter from our loyalty program with fourth quarter records and new co-brand card acquisitions and retail sales. In addition, we benefited from the continuation of increased take rates for upgraded boarding, and our portfolio of new cities and development markets also performed in line with expectations in fourth quarter, absent the event. So in all, there was plenty to be encouraged by in terms of underlying trends in the fourth quarter. We continue to feel good about our 2023 revenue plan. Admittedly, we are starting off first quarter with a $300 million to $350 million headwind, which we assume is attributable to the operational disruptions in December. However, booking trends have improved sequentially this month, and we believe the vast majority of the first quarter impact is isolated to January and February travel. For March 2023, leisure booking and yield trends appear strong and in line with what we would expect from a high-demand travel month. And based on recent improvements in close-end booking trends, we expect March 2023 managed business revenues to be roughly restored to pre-pandemic 2019 levels. Beyond that, we expect that our GDS and Southwest business initiatives will provide the opportunity to grow managed business revenues sequentially beyond March. So we are optimistic about both the improving sequential trends we're seeing as well as the early read on March bookings. And based on these trends, we currently expect first quarter operating revenues to increase in the range of 20% to 24% year-over-year. And then finally, while we have limited visibility further out on the booking curve, we continue to see no noticeable signs of a slowdown in macro travel demand and our booking trends. Our commercial focus areas and initiatives that we outlined at Investor Day remain unchanged. We continue to focus on driving value from network restoration, new market maturation, Southwest business and GDS, our new fare product, revenue management system modernization and in-flight customer experience enhancement. In closing, I want to acknowledge that we are mindful that we have a few new headwinds in 2023, both on the revenue and the cost side. And as a result, we will continue to work even harder on our revenue plans and revenue generation this year. Ultimately, we need to offset higher costs, and revenue is part of that equation. We still believe there is strong demand ahead of us, and we're encouraged by the revenue trends we currently see in March. Thank you, sir. We have analysts queued up for questions. So a quick reminder, to please keep your questions to one and a follow-up if needed. And operator, please go ahead and begin our analyst Q&A. Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will be from Ravi Shanker with Morgan Stanley. Please go ahead. Thanks, good afternoon everyone. Bob, thanks to you and the team for all the detail. Again, there was a lot of detail there, but if you were to just take a step back and look at the bigger picture here, there have been a few operating issues for, I'd say, the last 18 months or so. Is this just a series of unfortunate events given unprecedented circumstances? Or do you take a step back and say, hey, we have not invested in kind of tech and systems and things that we should have. Now we're catching up and kind of going forward? I think in that kind of realization understanding sort of determines your response and maybe also kind of if the regulators are focusing on this kind of how they will react to it. Ravi, yeah, thank you so much. I think I'd separate into three pieces. Number one, we invest a lot in technology. We've invested roughly $1 billion a year, and that will be even higher here in 2023. And so there's been no lack of investment. You've seen us implement things recently like an industry-leading aircraft routing and maintenance system. Just this year, we put in an entire new people and human capital management system and ongoing. Technology is always a journey. And so there are always things to work on. And again, as we've gotten larger and more complex, there are continued investments in things like bag tracking and software that's used in the stations and transfer -- bag transfer driver applications. And I could go on and on and on. So that's why you heard us at Investor Day and prior lay out one of our foundational strategies was modernize the operation, again, not because of -- we're radically behind but because we need to invest in the operation just as we continue to grow and continue to remain efficient. I think if you take this event, this event was different. We saw just a historic level of weather activity across the country that hit many cities, continued for days. Again, I'm not going to -- I don't want to blame just this on weather because it continued well after that. That caused an historic level of cancellations that turned into an historic level of aircraft reroutings that led to an historic level of crew reroutings or rescheduling. That ultimately was something we've never seen at that level, and it just overwhelmed the technology and the processes. And the technology, by the way, in crew scheduling, there's been some, I think, bad information. It worked as designed. We just never had seen this level of activity. And so ultimately, all of that coming at crew scheduling put us to the point where, rather than solving future problems, in other words, new routings for crew was solving past problems. And that's what the software was really not designed to do because we had never seen that before. It's never been a requirement. I'm glad to say that our folks, technology working with GE Digital have very quickly identified an enhancement and upgrade to deal with that. And that upgrade to the Sky solver is actually complete and in test right now, so they move very quickly. So I don't know that -- I think this event was very different, but I would acknowledge that there are things that we need to work on as we continue to grow the operation and become even more efficient and use technology. And Andrew, if you want to -- anything you want to add there? No, I think this functional gap was also -- other airlines use the software, and they had not asked for that gap to [be covered] (ph) there. So it was new for us. It's new for this tool at GE Digital has sold to not just us. And so it's not a common practice. It gets so far behind on issues resolved. In this situation, it did. We have a lot of medium-sized cities that are in the swathe of the weather. And we saw, as we got increased stress in the operation because of the cold weather, it led to incremental cancellations we talked about. We precanceled, as we always do, in large weather events. But then the larger that impacted -- larger-than-expected distress in the operation from the weather led us to more cancellations closer in, and that's what gave us a problem, which manifested in this kind of past issue that the solver could not take care of. And Ravi, the only other thing not to go on but I'll add is just the -- this was a significant event. We disrupted thousands and thousands of customers at a critical point in time and really made a mess here for our employees and our customers. And I can't apologize enough for that. And I own that, and we will do everything it takes to ensure that we don't have an event like that again, which is why we're doing short-term things that Andrew talked about. We've got this assessment coming here in weeks from Oliver Wyman and we will take the learnings there and implement those. So you -- but just at the end of the day, that kind of disruption cannot happen again. Got it. That is very clear. Thank you for additional color. Maybe as a quick follow-up. I think you said that the 2023 revenue impact seems to be isolated to Jan and Feb. What was the driver of that? Is that just kind of recovering the schedule to normal? Or did you see a buyer strike? And do you have any indication that, from a reputational standpoint -- because, obviously, we know that Southwest is one of the most beloved like airline brand in the country. Kind of are you seeing any eroding of that in customer confidence? Thank you. Yeah, I'll have -- yes, sir. I'll have Ryan jump in here, too. But I think we had -- you had a couple of things. You had, obviously, the return portion of trips that were affected during the holiday period that were then canceled that led into January, you have -- it's a low period of the year to start with. And so bookings and travel are generally low. I think you had a period of time there where we weren't -- just weren't taking as many bookings as we would typically. I'm sure you had some book away. The good thing is our customers are very loyal, and it's -- we're seeing that. Our March and forward booking trends in leisure look really strong. They look normal. They look in line with the plan that we presented at Investor Day. Our managed business looks like it will roughly currently â at current trends will be roughly in line with 2019 and restored to 2019. We had a sale recently. That sale went really well. We gave our customers affected over 2 million basically codes or 25,000 rewards points, and we're seeing our customers redeem those quickly at an even faster than typical rate for something like that, this gesture of goodwill. So while we disrupted our customers, and I'm very sorry for that, we are seeing our customers be loyal to Southwest Airlines, and we're seeing kind of normal trends March and beyond. Ryan? Yeah. I'll just give some additional color here. The first quarter is a tale of two halves. In the first quarter -- the first half of the quarter is very low demand time period, and that was impacted by the cancellations like Bob mentioned. And then it's just very tough with the hangover from the operational event kind of the first couple of weeks in January to get real traction. We did not want -- if you go out and look at the fares that we have published for this time period, there are regular kind of routine promotional fares. We didn't think it would help to be overly promotional in this time period. But then when you get into the second half of the quarter and President's Day and beyond and kind of into March, as Bob mentioned, both loads and yields look like we were on plan. March right now is roughly 40% booked. So that's enough to give us a good read on the month. And if you just kind of take the load and yields where they sit today and project that out forward and kind of what we would expect from here and what that implies for March overall, I think we're going to be very pleased with the performance in the month of March. So we're not seeing any sort of elevated cancellation rates for March. As Bob mentioned, March performed very well, responded very well to the sale. And so it just feels like it's -- we're kind of back on plan here in March. And then if you look at managed business travels, it's very early in the managed business travel booking curve, but those -- what we can see, those also look encouraging. So yeah, so the second half of the quarter, I think we're going to hopefully get back to the momentum we were seeing in the fourth quarter before the event. And we'll continue to monitor customer sentiment as we go forward here. But yeah, the customers expect us to do the right thing here, but largely, they're loyal and sticking with us. Hey, thanks. So I know you guys don't have revenue or RASM guidance for the year. But it seems like the industry is sort of moving at this flattish RASM metric for the year. Would you expect to [Indiscernible] with the industry? Or as you sort of rebuild credibility, customer loyalty, whatever however you want to call it, do you approach pricing any differently than maybe the overall market this year? It was a little hard to hear. It was a little hard to hear there, but I think that the question was really relative to the industry and performance do we expect to price any differently. I think we're not going to comment on forward pricing here beyond what's kind of out there on the shelf and what you all can see. But what I will say is that the go-to-market and promotional plan that we have executed thus far and thus far in this year is the exact same go-to-market and promotional plan that we had relative to before the event. So we're approaching things kind of per normal here. And I would expect, as we kind of get back on the plan in March and beyond, I expect that it will be just a normal year here in terms of how we manage things going forward. Yields -- loads and yields have been very strong. Going back to the post-Omicron environment last year, we had record yields in the fourth quarter even despite the event, and those yields would have been higher without the event. So we're -- it's a strong fare environment now, and I expect that to continue. And you obviously have the -- one of our strategic initiatives is the new Chase agreement, and we're seeing strong Rapid Rewards redemptions here right now as well, which is helping. Okay. And then hopefully, this sounds better. But I understand you don't think you need to cut capacity. But as you talk about kind of reduced risk, why not be a little bit maybe more prudent and cut some capacity and get through a period of better operations where you really ramp up the capacity? Yeah, Scott, I think the -- I mean, you would do that if you felt like there was a reason that it helps. So we actually feel the opposite. Number one, the event in December really had nothing to do with staffing. We were fully staffed. In fact, we hit our -- we beat our hiring goals in 2022. A lot of that is set up for our 2023 capacity. We're having no trouble hiring, including having no trouble hiring pilots. Almost all of the capacity in 2023 is going into restoring the network. It's going into existing city pairs, adding depth and breadth, and all that is not just good for our customers. It's good for the operation and operational reliability. So we actually feel the reverse, which is the restoration of capacity will be helpful in terms of operational reliability, not hurtful. So then the only other reason would be because you don't believe you can execute your hiring plans, which we are having no issue executing our hiring plans. We're actually a little ahead here in terms of staffing up for 2023. Andrew, do you want to add anything? I'd also say if you -- if one was worried about, can you operate this level of capacity, you would expect that to show up in your operating performance. And I mentioned that we were number two through Monday. I just got sitting here the updated numbers through yesterday, and we're number one in the industry in OTP for the month of January. For the month of December, we were number five out of 10 airlines even with the disruption, and we're number four going into the disruption, and we were number three during Thanksgiving, number three to the month of November. So it's obvious that we're able to operate the capacity that we have out there. It's not sitting out -- the fact we're above average in the industry with regard to that. So not showing that as a root cause. We're hesitant to make adjustments given that we think it could also be helpful as we go forward. But once again, we're going to get down to the root causes. And then when they show up, we will take actions based on the root causes. There's lots of solutions that people want to throw out there to us. But when you kind of take action on a potential solution and you don't understand if it addresses the problem, all you're doing is wasting resources and not necessarily addressing the problem. So we want to bottom out the problem even though it takes a little bit longer than people would like and then address those problems so it doesn't happen again. Hey, good afternoon. And thanks for taking my questions. So Andrew, maybe if I can follow up there. I mean, if I listen to this call, it sounds like you guys were properly staffed. The technology really wasn't the problem apart from this GE Digital issue. And you guys are talking about the network not being the issue. Cost guidance, CapEx guidance, all that really hasn't changed this year. So the outlook just kind of missed a beat but keeps going on. The problem is you guys did cancel a lot more flights than your competitors. And if I look at your completion factor this month, I think you will be trailing your competitors. Just look at yesterday, I think about a 6% cancel rate. So I guess what confidence can you give investors and your customers and your other stakeholders here that this was really just a one-off thing and not something that is more structural within the company? Yeah. I wouldn't call it a GE Digital issue. That software, that solver they sell to us and others performs well in normal times. This is a use case that nobody defined for them. So -- in their defense, the software worked fine. Now we did get to a bad spot there. With regards to our cancellation percentages, yesterday was 6%, there was snow in Midway. So Midway has specific operational restrictions. It's very tight quarters. And so when you have de-icing and winds coming from the wrong direction, it's prudent to be a little more cautious, and we cancel a little bit more because it was a low time of season, as Ryan talked about, a low time of year. So we could reaccommodate all those customers that were canceled out of Midway on the subsequent flights because we canceled them the day before. So we ended up beating our competitors by 20 points of OTP yesterday. They canceled less, but they delayed then hundreds of thousands of customers by canceling fewer. We made hundreds of thousands of customers on time, and a handful that had their flight cancel that were accommodated. So overall, we believe we gave a superior customer service yesterday. The day before that, that same-store system generated severe thunderstorms in Houston, including tornadoes near Houston Holiday that even put the ATC tower down for a while. We had zero percent cancels in Houston for that and -- for that day because we have the infrastructure there to handle it. Up North, the carrier that operates out of Intercontinental canceled 20% of their flights in that day to handle it. So in that situation, a very flattering compare. But once again, I imagine they would say they have infrastructure issues. They're different than Hobby. So a lot of times, those percentages look deceiving if it's about a specific airport in particular. And so you have to look at the environment that's caused you to cancel, you have to be safe and understand how you commit your customers. Net-net, it resulted in a very flat and on-time performance for us yesterday and pushed us over the edge to be number one for the industry. So I think that's a quality product. The customers love it. NPS score is good for that kind of stuff. And so I think that's what our customers want to see. Yeah. And if you take the data in January is very way down the weeds here, but it's very polluted by the January 11 NOTAM issue, where there were all kinds of issues as well. for most of -- prior to the day you're talking about here, most of the day, I think the 15 days or so prior to that, we were 99 -- in the 99-plus a couple of several days in the 99.9% completion factor range, several days canceling one flight. So you just have to watch the aggregate because if you have an anomaly in a day that's very different, like the day Andrew described or the NOTAM day, it will throw that -- it will throw it off. Obviously, you know that. I'd say in the NOTAM day, as I mentioned in my remarks, we didn't push before the ground stop. So basically, that means we got a much later start because we were being safe, and we wanted the FAA to tell us that, that was validated before we pushed because of how we read the regulations. Therefore, we ended up with more cancellations that day, a significant number more than some of our competitors there. And so that inflates the numbers for January overall. But once again, it was safe and we ended up being set up nicely for the next day. And then lastly, when you look at our competitors, don't forget, they outsource 40% to 50% of the departures to some low wage regionals on behalf. Customer doesn't realize that. So when they give you a number that says, cancel this many, make sure you're including all the branded operations, not just their ma inline. And for sure, we do look at seats and flights impacted. But I guess coming off this call, where is the urgency to ensure that specific to you guys this doesn't happen again? I mean, does it come in the form of more urgency on the pilot contract? Do you need to look at more non-aircraft CapEx? I mean just help investors get their arms around it, please. I think the urgency is across the board. There's nothing -- everything is on the table. And as Andrew pointed out, we went through in these remarks, we have things that we're doing right now, early warning dashboards, staffing up, crew scheduling, we're looking at de-icing procedures top to bottom. We're buying more in covers for extremely cold weather. We're looking at fuel mixes for ground equipment when you have sub-zero temperatures on and on and on. We're also waiting patiently here. And it will be weeks, not months, to get the Oliver Wyman report to understand root causes and what we need to do there. But we will do everything that it takes whether that is buying engine covers, technology changes, whatever that list may be to ensure that this kind of event doesn't happen again. I disconnect contracts because the -- we've had -- we've made great progress. We've got -- we've gotten 5 agreements here in the last couple of months with our unions. I'm very, very proud of that -- and our negotiators, and I'm very proud of our union partners. We have a couple more to go. We're making, I think, really good progress. We have two of those that are in mediation. Pilot applied attendance. That mediation process is a defined process controlled by the mediator. The mediator controls the schedule, the meeting times, the meeting dates, but we're making progress in both of those as well. We're eager to finish those up. Our employees are terrific. We're going to -- we've always paid well and we're going to pay well. We're going to have market competitive compensation. You know that. We know that, and our employees know that. So I am eager to wrap those up, but mediation is a process. I'd say we know what happened to the last on the fall as I call it. We've put in place with urgency. And that was the urgency we had, make sure the same thing doesn't repeat itself. So we have the safeguards for that same thing not to repeat itself, but we think there could be common root causes. That's why when we take the time between the weather starting and us getting to that kind of position with our crew scheduling software. Lots of decisions were made, lots of coordination between ground operations, our control center, our crew scheduling. Lots of equipment that was used to handle cold weather. Something in there in that sequence of events led us to the spot where we were at the end. And so immediately protect that situation to not happen again and then follow the string upstream to find the series of actions that led us to there and resolve those. And so that's what we're taking the time to do. It's a couple of weeks. I think it's worthwhile to take a few weeks since we have the kind of emergency stuff done to find those root causes that you can address, and that may require incremental spending or maybe incremental management effort, and we shall see. But we certainly have intention and plans to have that start up right away after that report is done. And then I know we're going on and on. It's just so important. The last thing I would add is that we -- while this event was something significant and something we are absolutely not proud of, we've got a 51-year history of operating really, really well. We were operating really well prior to this event. We had good performance in '22 leading up to December 21, good performance at the holidays, Thanksgiving, Labor Day, et cetera. So never forget that we are -- we haven't always -- always will be a terrific operator. The main point here is we will attack this head on whatever we need to work on here. Especially once we understand the OW report, we will attack it with a sense of urgency. We will boost our spending, if that's technology if we need to, but we will do everything to double down to make sure that this does not happen again. It's critical. I don't think interlining changes. If we had interlining there, then there may be some subset of customers that we could have reaccommodated. But other airlines were full this time of year as well. So we would have still had the same event. We still would have in this discussion even if we had interlining. Now domestic interlining has prohibited the scope agreement with our pilots. So we have to get scope relief to do that. But should they accommodate us there and we put an interline, that made the margin help with some level of disruption, but you would still have the large, large majority of people would not have been accommodated through a direct interline. And second, Tammy, thanks for including the fact that you've updated your labor cost accruals. Just to clarify, the industry convention seems to be to exclude any planned retro pay or signing bonus. I assume that's also true for Southwest. Jamie, we're doing our best to include the total cost to get these labor agreements over the finish line here. So as we shared back in December, the environment is dynamic, and we're continuously evaluating that. But our estimates include the total cost, I guess, is a better way to say that, to wrap up our contracts as well as recently, of course, ratify contracts. Got it. I'm sure you're looking forward to locking down the contracts. So I'll stop hounding you about it. I appreciate it. Thank you, everybody. That's it for me. Hey, thank you. I wanted to ask you about work rules. And if they are modernized and aligned with operational recovery. There's been so much written about technology gaps fairly or unfairly. The media is really run with those talking points. I'm not sure if you're willing to go there, but for example, do your pilots need to call into a call center to verbally confirm reassignment? It seems like the numbers that would have been required in this event would overwhelm any call center, and it feels like maybe there could be an app for that. Any thoughts on that would be great. Duane, this is Bob. I'll just start and then Andrew has got a lot more detail than I do, but I think I'd break it into two pieces. We have electronic notification in place for our crews. And there's more work to do there in terms of there's all kinds of things that you use electronic notification for. But that's -- yes, there's been some report that that's out in place. It's absolutely in place. What we need to work on is the -- and it's a contractual change electronic acknowledgment. So that's which I believe Andrew does not require -- in other words, to know that, that has been acknowledged, for example, accepting a crew reroute. That's a contractual change to do that. Obviously, to -- for the operation, you have to know not simply that it was delivered electronically, but it was acknowledged and it's going to happen. So there is work to do. There is some work to do on the electronic notification, but we do have that capability. But there's also, I think, even more work to do on the contractual piece of this, which is the acknowledgment. And obviously, those two contracts are open, and that's a piece of what our negotiators and teams are working on. But Andrew, if you want to add. Yeah. I think crew communication was a problem during the event, not the problem. So we definitely want to improve that. We have some means, consistent with the current contracts, to have some level of electronic communication with our flight crews. Both have learned from this. I think we will incorporate that in our negotiations. I think we will wait until we finish the negotiations before we kind of design the next generation of electronic communication tool with our crews because it must respect the contractual agreement. So I think this event will get us all aligned on the need for improving that. And once we get that ironed out in the open contracts, then we'll go and develop the next generation of that electronic communication. That's helpful. And then just on my follow-up, I'll stick with you, Andrew. Can you comment on what percent of your network is out and back flying? And I know it's too early to prescribe the medicine here. But any thoughts on your ability to increase out and back or if that might be a potential solution? I can't recall off the top of my head. I don't want to give you a number for fear of being wrong. We have, in the past -- this comes up a lot. We've put into our schedules in like test areas of the region out and back. So we did this in Midway, I think, three years ago or four years ago. And so we put this around the system to see if that improves anything by increasing out and back to certain percentages, and we haven't found that to be the case. We found other things we can put into our schedule to help with on-time performance. And part of the move actually with the moving network planning and our control center under one roof is because it is difficult to nail down how to incorporate recoverability into your schedule, even though everyone seems to have an opinion. We know we can incorporate crew needs overall. We've gotten very good at that, maintenance needs, ground-up needs. We can model to a good level of detail the predicted on-time performance for a schedule. But how does one define what's a recoverable schedule is actually more difficult to contact design than you might imagine. So bringing the two groups together, we can create a tighter feedback loop through smaller continuous improvement efforts to test and learn smaller iterations of recoverability built into the network is the design -- the desire behind this idea of moving them under one organization, and they've already started that. We'll see cross-pollination of people who work on our control center now working in our network planning to help design schedules, people who design schedules, doing a tour in the control center to learn what's like to operate it. And so we think that tighter linkage should help us incrementally improve recoverability into the schedules. But we're definitely -- all years about doing that but they kind of out and back is something that gets thrown around. And really, we haven't seen how that can have a direct cause and effect improvement. Hey, good morning or good afternoon. Just on the hiring, you talked about staffing was not the issue. I was kind of curious if you could provide a little bit more color on the hiring plans this year and the cadence. Because if you look at your capacity growth, there's a lot more capacity growth in the second half. And I think that's something that kind of causes some concern given just a lot of growth coming in and given having to address some of these operational issues. So could you talk a little bit about the hiring cadence here? Savi, it's Bob. Absolutely. And then, Andrew, if you want to chime in, just in terms of where. But the -- yes, there's obviously timing to hire and their timing to train and become proficient, especially in certain areas like the ramp. And so it's a piece of why we actually came in above our targeted hiring for '22 is to get ahead of that for '23. So some of that will be front loaded a bit in '23 as we prepare for capacity in the back half. Our hiring in '23, the plans right now, I think we hired just over 11,000 in '22 net. It's roughly 7,000 net in '23. So it actually falls roughly 40%, again, because there's a piece of the '22 hiring that was a setup for '23. And again, we don't -- there's no evidence that we were not staffed for the holidays or that we're not currently staffed. We are well staffed. The one exception in terms of the change from year-over-year pilots, we hired net roughly, I think, just under 1,000 pilots in '22. The plan is to hire net roughly 1,700, I think, in '23. So that actually is increasing. Our classes, we'll watch them every single day. We're just down meeting with potential new hires earlier this week. We're having no trouble attracting terrific pilots to Southwest Airlines, no trouble filling classes. There's been some discussion of attrition, are you seeing higher attrition in our pilot area. Our attrition last year, I think, in our flight ops group was under 1%. We've got a lot more new hires, which you would expect it to be a little bit elevated there. But it's, again, under 1% and roughly normal. So we're not seeing any issue attracting pilots to Southwest Airlines. But Andrew, I don't know if you want to talk any more detail about just where. So in aggregate, we'll have less hiring this year than last year. And that's true for every work group except for pilots. And so as we've mentioned before, we are pilot constrained in our flying. We're not flying all of the aircraft where we could. We're producing all the ASMs we could right now because of the number of pilots not the productivity of pilots. And so as we run our training plan here this year, by the end of next -- excuse me, the back half of this year, we've told you before that we will no longer be pilot-constrained. And that's when we'll start using our full fleet, which is why you see the kind of pop-up in capacity there in the back half of the year. The groups we've kind of pre-hired, they don't have as long as the training footprint as pilots do. So therefore, the proficiency they get is on the job, so to speak, for some of them. And that's why you see if you ever look out the window and airport and see a different color vests. Those are people who are still in training but OJT trainings, those who are fully proficient. And so you want them to be out in the network now taking some repetitions, if you will, so that when the capacity comes later in the year, they've had more experience. So that's why you'll see the numbers coming down as capacity goes up later in the year. That's super helpful. And if I may, just on the -- it sounded like from a CapEx standpoint, if you needed to kind of increase in spend on some systems to kind of expedite some of the changes, it would fall within that CapEx. But I was kind of curious from a resource standpoint, do you have that ability to kind of -- would you kind of pivot? Or would you be able to kind of increase the amount of tech activity that you do this year? Yeah. We have -- for your first question, yes, I think that's captured in the ranges that we provided, number one. And two, the technology spend in total was already increasing from 2022 -- and then three, your technology support is always a mix of employees and contractors and third parties that we use in terms of development. So yeah, we have the ability to flex as needed. It may not just be IT. It could be equipment. So we're not prejudging all the extra spend would be IT. It could be the case that we need new or different de-icing trucks or some other infrastructure at the airport. So there is non-tech work that is likely to come out of this. It's not just tech. There was some tech shortcomings that we've addressed, and there could be more tech we do to get ourselves even better. But I think -- there will also be some other equipment and other kind of operating changes we make that don't fall in the technology realm. And again, I think the range is wide. I think all of that would be captured in the CapEx range that we provided. Ladies and gentlemen, we have time for one more question, and we will take our last question from Conor Cunningham from Melius Research. Please go ahead. Hey, everyone. Thanks for the time. Just on the book way estimate that you gave for the first quarter. Curious if you could parse out just how the corporate side of that's doing. When I think about you selling your network and what Southwest does great domestically, the operations are obviously going to be a big debate there. So just curious on how that commentary has gone so far or that conversation has gone so far. Yeah, Conor, it's Ryan. Of course, immediately following the events, in the days following the event, we were out there talking to kind of general consumers but also talking to corporate travel managers to make sure we had a really good handle on sentiment and what they were needing to hear from us. And so -- and those conversations have continued. We're getting direct feedback from them as well. And from a corporate travel standpoint, as you would expect, they outlined the need for us to be open and transparent about our mitigation plans, what we're doing to ensure that this doesn't happen again, making sure that we have plans in place to take care of customers and that we keep them regularly updated. And of course, we're doing all of those things. We're out in the field talking to them all of the time to making sure that they understand what we're doing. When we ask them about their plans for 2023, the vast majority of those corporate travel managers say that they do not plan to reduce the level of flying on Southwest this year, which I think is a positive sign there. And then when you just look at the bookings from the managed business side as they've come in here in the first quarter, for sure, there was an impact in January. It was -- those first couple of weeks of the year. Those are big booking months. The hangover was real given the proximity to the event. So there was definitely a hangover or there was an impact in January and some into the first part of February as well. But when I look at February bookings and kind of where we're -- what we're trending towards here, and we're kind of getting into the meat of the booking curve for managed business travel. So we've got a good look at it. February is much better than January. In fact, I think February is sequentially better. It will likely turn out that February is going to be sequentially better than where we ended in the fourth quarter. And then, of course, as we get to March, we're expecting that we're roughly back to pre-pandemic levels on the managed business side. So we've got -- we're certainly focused on that market. That's a big part of our plans for the year, and we'll keep after it. But as we get further into the quarter here, I'm encouraged by how resilient they've been. Okay. Appreciate that. And then just on the -- you talked about the crew network issue in your prepared remarks and that you're rolling out a new system in the next couple of weeks. Just curious on how much collaboration you have with your pilots and maybe your other in-flight crew members when looking for a fix there. Did they have an influence at all? Or were you not allowed to talk? Like can you just maybe talk a little bit about the overall culture there with them talking about the fixes? Thank you. Well, I think I'm not quite sure if I'm getting your question but I don't please redirect me. So the system is what we call Sky Solvers. It's called something else by the manufacturer. It had a functional gap I talked about. We are putting in a fix to that. We call it -- upgrade. You will now have the functionality to be able to solve the past crew member problem such that they don't hamper us in the future. Now this is not something that we -- our crew members would be -- in their unions would be happy that we fixed this problem because they didn't like the result of having to fix in there. And so I think from that perspective, they would like -- they want to get the job done, so to speak. As far as the culture, we're in mediation. We're in negotiations in the final stages. And so that's always noisy, if you will. They would like certain changes, and where it's coming down to is a lot of the changes they're asking for on the scheduling side, and this was a scheduling issue. And so it kind of dovetailed nicely for them to be able to kind of give input on it. And I think those things we can improve upon, and we're happy to take those suggestions. And we actually have a big confab with them coming up here in a couple of weeks where they're going to come in and get our subject matter experts together and talk about how we can improve on the scheduling front. And I even sat down at one of the other unions yesterday, the day before, for the same reason. So we welcome their input. We want to establish a good professional relationship for them of how we can jointly improve. And so maybe this is a silver lining as we can start down that path. And I just -- just add that. Yes, you've seen a lot of the news that there are things that our unions have said that we have asked for, for years quote unquote and things like to work on notification. And we agree, there's work to do on notification. I just want as you know, we agree with them, and that work is going on in negotiations here. And I'm optimistic that we'll get there. Second, we've got this all of our Wyman report that will wrap up here quickly, and it's a comprehensive review, and it's a wide-ranging collaborative review with a lot of parties, parties that were involved, including the frontline in Denver, for example, and the NOC and leaders that were involved. But we're also including our union leadership in that work to gather their feedback as well because they're valued partners, and we want to listen and understand. And then as Andrew said, you've got things that are more wrapped up in negotiation like scheduling rules that I don't know that I attached to the event and the operational disruption. That's a normal part of negotiations, just like compensation. But -- and we'll be moving through that as we continue to move through mediation. But no, we value our union partners, and we're listening to them certainly in terms of their viewpoints of what happened in our December issues. We've already said for this, once a report comes out and now identify areas we need to improve upon, we will work with them to jointly develop solutions in the applicable areas for them. So I think we're committed to them be part of the solution as we look to take advantage of the lessons learned reported. Okay. Well, that wraps up the analyst portion of our call today. I appreciate everyone joining, and hope you all have a great day Thank you. Ladies and gentlemen, we will now begin with our media portion of today's call. I'd like to first introduce Ms. Linda Rutherford, Chief Administration and Communications Officer. Thank you, Chad, and welcome to the members of the media on today's call. We can go ahead and get started for the Q&A portion. Chad, if you'll get them queued up for us. Certainly. [Operator Instructions] Thank you. And our first question will be from Dawn Gilbertson from the Wall Street Journal. Please go ahead. Hi, good morning --afternoon everybody. I have two questions. The first one is for Bob or Andrew or both, and the second one is for Ryan. The first one is you guys seem to be sending some mixed messages here. You clearly state the staffing sign issue. Andrew just said crew communication was a problem, but not the problem. And then you mentioned this functional gap and said other airlines didn't -- also didn't have this gap addressed. But isn't it because the scope of your issues here were so large, that's why it exposed this system? So I guess what I'm asking here is how much of the -- without waiting for the Oliver Wyman report how much of this was bad decision-making on Southwest Airlines? Or what was the problem, please? Well, the reason we do the work is to find the problem. I know we'd like to know it now and not later, but that's the point of it, respectfully. But we know that the -- when this kind of functional gap showed up was because you had a lot of close-in cancels. As I mentioned earlier, we frequently -- if we're seeing a storm come in, you do cancels in advance. So I cancel today for tomorrow, just like we did, yes, recently with Midway. And so that we had done for the storm. Then we got ourselves in a position where we're making lots of cancels close in. And as Bob mentioned, from the 23rd, which was still a weather event and towards the 24th or a transition to a crew event, sometime in that time frame, this level of closing cancels led us to get behind and then we lost the use of the automation. And when we lose use of the automation, there's just not enough hours in the day for the crew schedules to catch up manually. They almost did a couple of times, but we know, ultimately, we didn't. And so then the question becomes, well, what were the sequence of events that led to that point. We've had a lot of these close-in cancels. That is what we're trying to get to the bottom of so we can address that. And so we don't know that right now. So that's why we don't give you a very clear answer on that specific thing, even though we understand where ultimately that led to. Okay. That's helpful. So you're saying that you guys had, obviously, a lot more last-minute cancellations than others since they recovered much more quickly even though you don't know why that was at this point? Is that correct? I'm not necessarily saying versus others. I mean for ourselves, we have a lot of close-in cancels, and that's what led to our problem is what we believe at this point in time. I've not done a comparative that I have in front of me that I can tell you that -- what the others did at the same time, that will also be part of the work that we'll look at as well. But as far as what I can see right now, what I'm suspecting at this point in time is that was the sequence. But once again, you need to kind of dig into it with both interviewing people to understand who did what when, so to speak, with the interviews and then also with the data to corroborate that, that was actually what happened. So it's -- I wouldn't call it tedious, but it's detailed work to fit that picture all together and come out with a time line that shows with good fidelity and backed up with data of what happened and what that led to. Okay. Thanks very much. The second question is for Ryan or somebody or maybe Tammy. Can you guys attach them -- I know you've given the total dollar figure, but can you attach some dollar figures to the dollar figure of refunds, the dollar number? I know you're only 80% through on reimbursement. And also on reimbursement, I'm curious, did you guys, because of the scale and scope of this and the damage to your reputation, did you broaden the definition of reasonable as you're going through all these expenses? Thanks very much. Yeah, I'll take the first part and then let Tammy take the financials. Throughout the event, right away, we promised -- we knew it was the right thing to do that we had significantly impacted holiday travel plans here. We knew it was the right thing to do to offer refunds and then to offer reasonable -- to reimburse for reasonable expenses related to alternative transportation. And the direction that we gave the teams were to be generous in that regard and lean towards the customer. And so I think a lot of these decisions are subjective, but I think the team did a really good job of balancing, understanding what is reasonable and leaning towards the customer in order to do the right thing by them. So I think it was -- admittedly, it's a subjective element that you've got to kind of find where the line is there, but I think our teams leaned into the customer and largely did the right thing there. Tammy? Yeah. And on the financial impact, as we shared in the release, the total cost impact was $390 million for the fourth quarter. And the lion's share of that was the customer reimbursements and the Rapid Reward points that we offer to our -- and that we expect to be redeemed. So there was a much smaller portion that related to premium pay that we paid to our employees. So the lion's share of that was the customer reimbursements in Rapid Reward points. We haven't given the specific dollar amount of that, but it was probably roughly 50-50 between those two categories. And Dawn, I'll just add one more thing here. The -- and those customers that were most severely impacted that we issued the gesture of goodwill for, we issued those Rapid Reward points roughly three weeks ago. And when we look at those customers today, 25% of them already have future travel booked on Southwest Airlines. So -- and in 3 weeks, that's really pretty good. So I think that it is a -- I take that as a sign of confidence that customers understand. They understand that we messed up there. We did everything that we could to make it right and that fourth of them already have future travel booked on Southwest. And Dawn -- not necessarily with those points, some of them with those points and some of them being cash, just future travel. Dawn, just the fact -- I think it changes day to day, but on the reimbursements, which are obviously the most complicated thing around, I think our goal -- we're tracking to be 95% complete by tomorrow and then have them all wrapped up by next -- probably early next week. So we're moving through them very quickly. Hey, guys. Thanks for taking my question. I was curious, could you talk a little bit more about that $1.3 billion in technology spending? Is that back-end infrastructure? And does that include things like the upgrades to WiFi and the in-flight improvements that you're making this year? The technology spend, yeah, it would include all -- everything that you referenced. And again, the $1.3 billion includes technology, the upgrades and the ongoing maintenance of the system. The -- but the WiFi piece of that, it does not include. So that would be incremental. It's really our investment and ongoing support of the -- of our technology infrastructure, including all investments, but it's not the customer investments like the WiFi on the aircraft. Thanks. And are there any specific upgrades like you guys have worked on the maintenance systems, anything that you are actively working on? It was probably in place before the December event. But any other systems that will get an upgrade this year as part of your plans? We have a couple that are ongoing at different levels of maturation, if you will. So we just finished up with the maintenance replacement just recently. That was a big event. We're in the middle of upgrading our ground ops infrastructure, so one of our efforts you may have seen it from Investor Day, a paperless turn. So we're upgrading -- and that comes in so many releases, some of which have already deployed and now allow us to eliminate all of our paper in our turn. That's part of -- modernizing operation within our control center. And we have an operation system and a flight planning system. Both of those have RFPs that have already been completed, and the work has been awarded. And then in our cruise system, we have just completed an RFI, which is what you do before you do an RFP. And so we'll get the results of that and great lessons learned from this event and then with the next step on the crew stuff. So each of the big operating areas has tech workers underway. And as you would expect, some are further ahead than others. And Kyle, that $1.3 billion is across the enterprise. There's a lot of commercial systems that are being upgraded and invested in as well. So it's across the enterprise. Hi, thank you, all for taking the time. I know that the DOT yesterday had announced a little more detail about some of the issues that they're looking into in regards to your December issues, and they mentioned that they are examining whether your schedules may have been unrealistic. I wondered if you guys had any comment on that. Yeah, we saw that. And we know, as Bob said, we messed up, and that will include scrutiny from regulators and like officials. So we understand that, and we'll cooperate fully. As I mentioned in one of the analyst reviews, if you -- if one were worried about with your schedule operable, then you'd expect to see poor on-time performance for reliability. And to the contrary, really well before the Christmas vacation, including Thanksgiving vacation in November, we've been running above average in the industry, culminate even being number one this month. So you don't see the signs of a schedule that is out of whack with the resources ability to operate given our strong operating performance over the last three months. And just generally, there's a lot of talk about hearings and, obviously, the coordination with the DOT. And we're obviously coordinating and cooperating with our oversight committees. And I mean we welcome the discussion. We welcome the focus on the resiliency of the aviation system. We've had several personal conversations with the Secretary just in terms of how we're doing and our focus on our customers and his focus on customers as well, and we're aligned, obviously there. So we would -- we'll support all of this, as you would expect. So I'm wondering if you think that the computer system used for crew scheduling can be repaired or if your intention is to replace it entirely as part of this process. And whichever solution is used, do you have any estimate for how much it will cost to either fix or repair it and how long it will take before the repaired or new system is fully in place? Thank you. As we mentioned earlier, there's an upgrade already in our test system from GE Digital. So the upgrades in there. We haven't even talked costs. I don't not sure if it's going to cause us anything or not, but it will be upgraded here in the production in a few weeks' time, and we think this addresses the shortcoming we have for the specific instance. And just to get a reminder that this GE system, Sky Solver, it's an industry tool that many airlines use. It performs well, and it performed as it should. And even in our event, what was revealed was this requirement that no one has ever seen, we would ever seen, where the -- you have this need to solve past problems because there are so many problems coming and just volume coming out of the system. And working with GE, they have put a fix in place and now in test in weeks, I mean, a record time. So the software, again, it's industry standard crew scheduling or rescheduling software that we and others use, and it did perform as intended during the event. So just to be clear, the problems with crew members letting you know where they were and where things stood having to call in rather than having an app to notify, you don't see a need to change the system fundamentally to have a more electronic form of notification? As I mentioned earlier, that was a problem. We have been a problem, it wasn't the problem for the situation. It was a symptom of the problem. And so our contracts with our crews right now require telephone calls in these situations. In other situations, we have some level of electronic communication available now. We will make incremental improvements to that. Some have already been deployed now and some will be deployed in the next few months. But to have a more comprehensive electronic communication requires changes to the contract with the crew members. Those are open right now. We're discussing it with our unions. And should they agree, then we will develop new crew communication tools consistent with the contract for development as soon as practical. Have you raised the possibility of opening the contract for that one issue and having to -- because as we understand it from the statements from the unions during the December, they were not fans of the current system about. Having an agreement on a new notification and new electronic crew notification system now before you get to the entire contract itself because the entire contract itself could obviously take months. Well, the entire contract's been for a while. We're in mediation, which hopefully, as Bob said, means we're towards the tail end of it, and it's not -- we would certainly be open to that if they want to do that. They've not told us that they want to do that. But if they want a site agreement before based on just communications, we will certainly do that. But right now, the approach has been to have that incorporated into this final push of the current contracts, and I think that's wise and practical for us to work on. So we're happy either way. But right now, we've seen no indication than the current path. . And at this time, we have time for one more additional question, and that question will be from Richard Velotta from Las Vegas Review Journal. Please go ahead. Thank you, and good day. You indicated that added capacity by Southwest do several destinations will not be curtailed despite what happened in December. But we're hearing that Harry Reed International is starting to have internal capacity problems and that airlines might not have much choice in terms of when their operations occur. Has Southwest had any problem scheduling their times of operations as the airline schedule grows in Las Vegas? And do you think the future capacity issues in Las Vegas could curtail flights in the future? Right now, we've seen no general capacity constraints to our operation and at Harry Reed International. It's normal as an airline -- an airport grows that you work on expand capacity in different areas. You work on taxiways, you work on bag systems. These are all normal course of business and Harry Read seems to have a good plan and execute upon that in coordination with the airline. So we're happy about that. I will note that Las Vegas has been so successful in attracting new attractions. We do see a lot of general aviation or private aircraft in the weekends that kind of add a surge of demand. But other than that, we see no changes to the environment. Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Ms. Rutherford for any closing remarks. Thank you, Chad. If you all have any other questions or follow up, our communications group is standing by at (214) 792-4847 or, of course, through our media newsroom at www.swamedia.com. Thank you all very much for joining us.
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EarningCall_1269
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Greetings, and welcome to the Norfolk Southern Corporation Fourth Quarter Fiscal Year 2022 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Luke Nichols, Senior Director of Investor Relations. Thank you. Mr. Nichols, you may begin. Thank you, and good morning, everyone. Please note that during today's call, we will make certain forward-looking statements within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These statements relate to future events or future performance of Norfolk Southern, which are subject to risks and uncertainties and may differ materially from actual results. Please refer to our annual and quarterly reports filed with the SEC for a full disclosure of those risks and uncertainties we view as most important. Our presentation slides are available at nscorp.com in the Investors section along with our reconciliation of any non-GAAP measures used today to the comparable GAAP measures. Good morning, everyone. Welcome to Norfolk Southern's Fourth Quarter 2022 Earnings Call. Here with me today are Ed Elkins, our Chief Marketing Officer; and Mark George, our Chief Financial Officer. I'm also pleased to welcome Paul Duncan, who moved into the role of Chief Operating Officer on January 1. At our Investor Day last month, we shared our strategy to create long-term shareholder value through a balanced approach of reliable and resilient service, continuous productivity improvement and smart and sustainable growth. At the heart of that strategy is a service product that allows us to compete in that $860 billion truck in logistics market and gives our customers the confidence to build Norfolk Southern into their supply chain. I was at the Midwest Association of Rail shippers winter meeting last week, talking with customers about our new strategy. and the reactions were extremely positive. Now our job is to prove it consistently. With performance, we made great strides to close the year and are encouraged by our progress. We will continue to refine and evolve to provide a service product to market values. Service is at the best it's been in more than 2 years, and customers are noticing. Volumes in December were at 52-week highs, outperforming typical seasonality as Ed and Paul's teams work collaboratively with our customers to attract business to Norfolk Southern, overcoming headwinds associated with a slower network in the first 3 quarters that constricted our capacity. Our team persevered adapted and achieved strong results in a challenging year. For both the fourth quarter and full year 2022, we were able to achieve double-digit growth in both revenue and EPS. We established new records for full year revenue, operating income, and other metrics that the team will detail later this morning. Also this quarter, we finalized national contracts with the unions representing our craft colleagues. These agreements recognize the hard work and dedication of our frontline railroaders with historic wage increases in an unparalleled health and welfare benefits package. With national bargaining now complete, we started discussions at the local level to address important quality of life issues. I would like to thank the entire Norfolk Southern team for their incredible effort during the fourth quarter and throughout all of 2022. I'm proud of the improvement our team has delivered and the momentum we have created. Our relentless focus on service continues in 2023. You'll hear more from Paul momentarily about how our across-the-board improvement is now allowing us to target specific opportunities for service and productivity enhancements. We recognize that the macroeconomic environment in which we operate is uncertain, and you'll hear more about the impact of that from Ed and Mark. Longer term, we are building on the momentum we carry into 2023. And of course, we've charted in our new strategy. As you heard at our Investor Day, we believe Norfolk Southern is uniquely positioned to deliver long-term shareholder value through top-tier revenue and earnings growth, industry competitive margins and balanced capital deployment. We will get there by being a customer-centric operations-driven service organization, and we look forward to sharing our progress with you. Now Thank you, Alan, and good morning. I am excited to be leading the operating team as we implement the vision set forth this last quarter. My focus since assuming the role of Chief Operating Officer has been in 2 areas: collaborating with marketing and our customers to convert improved service into increased volume on the network; and getting out to talk with our field leaders about our new strategy to be a customer-centric operations-driven organization. The team has tremendous pride in Norfolk Southern and the feedback we are hearing is overwhelmingly positive. When we talk about growth, our people hear stability and opportunity. One 40-year Norfolk Southern veteran in Birmingham told me last week, he has never been more optimistic about the direction and culture of the company. I'll begin with a safety discussion on Slide 5. Our injury frequency rate improved 22%. Every conversation will begin with safety in 2023 and beyond. Operating safely is the the communities that we serve. This is an area where we have made great strides, but even one serious incident is too many. Thank you to those closest to the ballast line for the gains we achieved in safety in 2022 and and for the efforts we will all make safely delivering in 2023. Moving to Slide 6. Since we spoke last at our Investor Day, our service is the best it has been in more than 2 years. Our leadership, the implementation of our simpler, more executable operating plan top SPG and our continued resource adds have contributed to significant improvements in service for all of our customers. For premium intermodal, we safely delivered a perfect peak season for our largest parcel customer. Domestic intermodal performance has improved. Average container transit times have been reduced by 12 hours between Chicago and the Northeast, our largest corridor, with consistency also now meeting expectations. Merchandise performance is consistent, and this is another segment where our improved velocity is creating capacity. Both trains are cycling at historic best transit turn times, maximizing our asset utilization across commodities. You'll note that train speed has continued to climb from our low point last year with terminal dwell also creating capacity for growth. Our service product has turned the corner, and we are focused on building further reliability and resiliency into our network that our customers expect moving forward. Moving to our productivity update on Slide 7. We are committed to our balanced approach to service, productivity and growth. Let's start with locomotives. We have made solid progress on getting more productive use out of our fleet. You can see that here in terms of increasing our locomotive miles per day. At Investor Day, I referenced the flywheel effect that speeding up the network will produce. This is the start of that flywheel, which produced a 6% improvement last quarter and has improved 12% so far in January. Getting our locomotives moving more efficiently ensures we are creating capacity for growth. Next, we have grown our workforce, and that has been a critical element to our service improvement. Our GTMs were flat versus last year while our training pipeline has remained above steady state levels, pressuring workforce productivity. This is a good news story looking forward. as we are building the capacity we need to be reliable and resilient with the gains in service that we have made. We will build upon this foundation to drive greater workforce productivity as we bring volume back on the railroad. Lastly, we have set another quarterly record for fuel efficiency. Our increasing fluidity certainly has played a role alongside our portfolio of fuel efficiency initiatives including our fleet modernizations and idling compliance initiatives. Improving productivity is key to our balanced plan, and we are going to continue driving sustainable efficiency gains to provide value for our shareholders and our customers. On Slide 8, I will recap the industry-leading progress that we have made on hiring in 2022 and talk about what we see ahead. We entered the year in the very early stages of priming the conductor training pipeline and ramped up in record time, which was no easy task given the tightness in the labor market. We increased training wages, drove efficiencies into our onboarding process Jump started a grassroots campaign leveraging referral incentives and more. These efforts have paid off with much of our network reaching the minimum staffing levels determined by our data-driven approach. We are now focused on shoring up the remaining crew bases that are short, and we are determined to do so in 2023. As we make progress, we are deploying go teams more effectively and are executing the resiliency vision laid out at Investor Day by cross-qualifying crews and expanding training efforts. Moving to Slide 9. I will cover a few items that we are working on as we enter the new year. First, let's talk about the culture of continuous improvement we are building. We have greatly improved service and to bring our vision of long-term service resilience to reality. We know we have to keep getting better. Let me provide a few examples. With Intermodal, we are using the initial rollout and learnings from our high-frequency operating plan discussed at Investor Day, along with our perfect peak season to improve capacity and reliability across our intermodal franchise. On the merchandise side, we are applying continuous improvement principles identifying and implementing those next levers that will drive even greater resiliency and resource productivity to move cars faster and more consistently. We are building tools as part of our digital transformation to provide more actionable and timely information to a more empowered workforce. Next, we are slated to modernize another 115 locomotives this year, converting them from DC to AC traction technology and giving them a full rejuvenation. These 115 rebuilds will reduce locomotive hauling capability equivalent to 150 DC locomotives, providing additional capacity for growth with fewer assets. Our DC to AC conversions will continue to provide even greater fuel efficiency and added pulling power to increase train productivity further. Our DC to AC conversion strategy will provide further opportunities to grow train size and increased train productivity, which we discussed at Investor Day. We have made marked progress on this long-term initiative. And just this month, we increased train size 53% in 1 of our 2 highest volume export cholines which will provide greater capacity and resiliency in our customer supply chain. Next up, let's talk about our capital investments. Our best-in-class engineering team safely delivered a productive year with more than 520 track miles of rail replaced, the most NS has done in 3 decades. We installed 10% more ties in 2022 than in 2021 with the same level of production teams and our servicing teams worked 27% more track than in 2021. We are committed to safely building and maintaining a reliable and resilient infrastructure for our customers productively. We're primed to execute on our capital plan in support of safety, resiliency, growth and productivity -- this will include a longer siding between Cincinnati and Fort Wayne, which will incorporate additional resilience into our train network. This is just one of the efforts we will highlight as the year progresses. Lastly, we are intensely focused on converting the capacity gains that we have made with top SPG and our disciplined execution of the plan into additional volume moving over the railroad in 2023. Our intermodal, merchandise and bulk service are all now consistently performing at high levels of service across our network. I will now hand it to Ed to expand on the market outlook and talk about how we can put this capacity to work. Thank you. Thank you, Paul. It's great to have you with us, and good morning to everyone. Let's review our results for the fourth quarter, starting on Slide 11. Overall, revenue grew 13% year-over-year to $3.2 billion, with higher revenue from fuel surcharge and price improvements more than offsetting a 1% decline in volume. The pricing environment remains strong and we capitalize by delivering our 24th consecutive quarter of year-over-year RPU less fuel growth in intermodal and our 30th out of 31 quarters in merchandise. Speaking of merchandise, Volumes recovered to prior year levels as service improved in the fourth quarter, enhancing our ability to drive value for our customers. Our largest gains were in the sand and proppants market to support the recent surge in demand for natural gas production followed by corn and soybeans also driven by exceptionally high demand. We saw declines in our steel and automotive markets where equipment availability was particularly challenged. As Paul highlighted earlier, we are making meaningful progress on improving car velocity in our merchandise fleets, and we started to see the results of that increased velocity toward the end of the quarter. Merchandise revenue increased 12% year-over-year to $1.9 billion and revenue per unit, excluding fuel, reached a record level from price gains and positive mix. Shifting to Intermodal. Total revenue improved 10% year-over-year as higher revenue from fuel surcharge and price gains more than offset a 4% decline in volume. The volume decline was concentrated within our domestic lines of business where headwinds from a loosening truck market and higher inventories heading into the holiday season negatively impacted demand. Conversely, our international lines of business grew in the fourth quarter. Our international intermodal volume rose 5% year-over-year as several of our customers shifted back to inland Point intermodal services amid lower ocean rates and easing supply chain congestion. Total intermodal revenue per unit and revenue per unit, excluding fuel, were up year-over-year on higher fuel revenue and price gains. If we turn to coal, our results for the quarter reflect both our success in capturing upside revenue potential from the market dynamics as well as our ability to create capacity for growth through improved service. Coal revenue for the quarter increased 28%, driven by price gains, volume growth, higher revenue from fuel surcharge and liquidated damages from prior volume shortfalls. Both revenue per unit and revenue per unit, excluding fuel, reached record levels, reflecting the value of our market-based pricing approach in these volatile energy markets. We were able to leverage increased equipment availability from improved cycle times to capture more utility coal business, which led to 9% volume gain in utility coal in the fourth quarter. Our export coal markets also grew due to higher demand driven by geopolitical conflict. Overall, coal volumes increased 8% in the quarter, and this volume growth was partially offset by year-over-year declines in coke shipments resulting from facility closures. Let's move to Slide 12 for the full year of 2022. Total revenue for the year reached $12.7 billion, a 14% increase from 2021 driven by higher revenue from fuel surcharge and price gains, partially offset by volume declines. We delivered record level total revenue and revenue less fuel, revenue per unit and revenue per unit, excluding fuel, despite 3% decline in total volume. Volume headwinds were strongest in our intermodal franchise, where a weakening truck market and supply chain congestion led to declines in annual volume. We saw growth in our coal business as a strong export market and a strong global market for energy increased volumes for coal on NS. Our performance as the year progressed into 2022 provides evidence that our recovering service product is providing momentum to the commercial side of our business. We're working together internally to enhance our offerings in the marketplace and to ensure that we are delivering the value our customers need to be successful. Lastly, if you will join me on Slide 13, our outlook for 2023 is cautiously optimistic amid uncertainty in the macroeconomic environment and some signals of a slowdown in activity. Our improving service levels will drive opportunities for modal conversion from truck and increase our capacity to address unmet demand. At the same time, economic conditions could be a headwind to volume. At least in the near term, while lower fuel prices and accessorial revenues will temper our revenue per unit. Within merchandise, we anticipate that macroeconomic conditions will pressure a variety of the markets that we participate in. We're mindful of recent weakness in industrial production, particularly with respect to manufacturing, and that drives many of our markets. Current forecast for manufacturing in the U.S. shows contraction in 2023 as businesses rightsize inventories to demand. Additionally, the weak housing market will be a headwind to many of our industrial businesses and we expect this weakness to persist in 2023 as the housing market adjusts to higher interest rates. Volumes will also be supported by increased equipment availability and overall network fluidity. Looking at intermodal, volume growth will be dependent on the macroeconomic environment, although our improving service levels will create capacity for growth. Total revenue will be pressured by lower fuel surcharges and reduced storage revenue as supply chains continue to normalize throughout the year. Household balance sheets are supported by excess savings accumulated during the pandemic and credit remains available for many despite becoming more expensive. And so long as the U.S. consumer remains resilient, we would expect supportive demand for intermodal. Weakness in the truck market at the start of the year, along with housing will be a headwind but we anticipate the truck market to rebalance supply and demand later this year. Our international business will continue to benefit from lower ocean rates and improving supply chain fluidity at inland points, prompting a return of our customers to Inland Point Intermodal. Turning to coal. The current outlook for the utility and export coal markets supports a flat to modest year-over-year volume improvement. While overall utility demand is likely to remain flat, our capacity to handle more of that demand will increase with efficiency and productivity improvements on our network. For export, Norfolk Southern will benefit from additional coal supply coming online despite softening seaborne prices. We expect the global supply of met coal to continue to be restricted by geopolitical factors which should support demand for U.S.-sourced coal. We will experience tough coal pricing comps in the first half of the year, which will pressure export met ARPUs on a year-over-year basis. Overall, we are energized by our recent momentum heading into '23, and we are focused on leveraging that momentum to drive value for our customers and grow our business. Uncertainty and downside risks are certainly still present, but we're going to continue to focus on the things that we can control to successfully execute our strategic plan and results for our customers and for our shareholders. And lastly, I'd like once again to recognize our customers for their partnership throughout 2022 and thank them for their business. We appreciate all of their support as we move forward in 2023 with sustained momentum toward delivering the service product that they need to succeed. Thank you, and good morning, everyone. I'm on Slide 15. As you heard from Ed, we had another quarter of strong revenue performance, up 13%. Operating expenses in the quarter were up $333 million or 19% year-on-year, driven primarily by elevated fuel prices and some significant adverse accrual adjustments that I will describe shortly which had an outsized impact on the operating ratio. Moving to Slide 16. Let's reconcile the drivers of the changes in operating income, operating ratio and earnings per share. Talking specifically to operating income, the $52 million improvement was aided by the first row in the bottom section, a favorable wage accrual true-up related to our commitment to getting retroactive wages distributed to our employees before the end of the year. It was not only the right thing to do, but the acceleration created the added benefit of saving payroll taxes for employees as well as for the company. That adjustment provided a $16 million expense savings, which equates to 50 basis point tailwind to the OR and a nickel boost to EPS. But in the second row of the reconciliation at the bottom you will see that there was a $57 million expense headwind from numerous unexpected adverse items in the claims category that I'll put in 3 buckets. Accrual adjustments related to personal injury reserves based on actuarial studies, adjustments to environmental reserves based on activity and costs associated with derailments that occurred during the quarter. Combined, these adverse items versus a smaller positive adjustment last Q4 results in $57 million of year-over-year headwind in the fourth quarter, which equates to 180 basis points OR drag and $0.19 of EPS. Absent those 2 reconciling items I just detailed, core operating income growth was actually $93 million, and that translates to EPS growth of $0.44. The OR contraction at 180 basis points reflects lower incrementals driven by the net inflation impact as well as service-related costs. So let's drill into the operating expenses for the quarter now on Slide 17. Fuel was again a primary expense driver this quarter, up $141 million or 62% due to elevated fuel prices. Materials & Other was up $78 million, which included the $71 million increase in claims that was heavily impacted by the items we just discussed. Compensation and benefits were up $55 million or 9%, driven by elevated wages from the new labor contracts as well as higher employment levels. Purchased services were up $48 million or 10% in the quarter, driven primarily from continued inflationary pressures, costs related to our service environment as well as technology-related costs as we progress our digital transformation. Some of the inflation impacts are associated with intermodal operations that more than offset savings from lower intermodal volumes. Depreciation was up $11 million year-over-year, consistent with prior quarters. But let me point out that we are nearing completion of our periodic roadway depreciation study and the findings will result in a quarterly step-up in our 2023 depreciation expense. You can expect in 2023 that the quarterly year-over-year growth will be around double what you see here, meaning that the full year impact will be a step-up in the $40 million to $50 million range. Shifting to Slide 18. Let's look at the results below the line. After spending much of the year as a net expense, other income flipped back to a more normal profile and amounted to $34 million, an increase of $13 million over last year. Net income in the quarter was up $30 million or 4%. EPS growth at 10% exceeded the net income growth due to strong share repurchase activity. Turning now to Slide 19 and looking at the full year results. EPS was $13.88, an increase of $1.77 or 15% relative to 2021 and driven by record revenues of $12.7 billion, which was up 14% compared to 2021. As you look at the full year OpEx and operating ratio headwinds versus prior year, Recall the adverse impact of the wage settlement. Moving to Slide 20. Property additions at $1.9 billion ended the year exactly as we had been guiding. We had another strong year for shareholder distributions with over $4 billion returned again in 2022, with over 12.6 million shares repurchased. Dividend distributions were up 14%, and you will have read about our Board just approving a 9% or $0.11 increase to our quarterly dividend here in the first quarter. All this demonstrates our commitment to return capital to shareholders. Thanks, Mark. Let's turn to Slide 21. Our outlook for 2023 reflects the uncertainty of a challenging macro landscape in which the path of the demand environment and inflation are unclear. At this time, we see full year revenue level with 2022 performance. We expect to be able to absorb volume pressure with share recapture. Thanks to our improving service product. ARPU will be down to flat as we deal with pressure from softening coal pricing, lower fuel surcharge revenue and the eventual unwinding of accessorial revenues as supply chains unlock. ARPU will benefit from another strong year in core pricing gains. There are a lot of variables that are hard to predict in this uncertain environment. But in a flat revenue environment, it will be difficult to grow operating income in 2023. With the cost benefits from an improving service product being more than neutralized by inflation as well as the ARPU headwinds I just described. As you heard from Mark at Investor Day, we're expecting CapEx in to be roughly $2.1 billion for 2023. This is consistent with and supportive of the balanced and disciplined spending plan that Mark detailed in December. Despite the uncertainty, we entered 2023 with great confidence and momentum. When we look ahead, we see more than cyclical economic challenges in front of us. We see long-term macro trends that create opportunities for a franchise built for growth like Norfolk Southern. We have the right strategy, balancing service, productivity and growth. We have a strong and still improving service product. We have the right team of talented, dedicated railroads, and we are just getting started. We will now open the call to questions. Yes. Great. Wanted to see if you could offer some more, I don't know, some more detail some additional perspective on the yields, revenue per car in intermodal and also in coal. I guess on intermodal, you sound pretty constructive, but -- just wondering if on domestic intermodal, you see some flow-through of potentially lower market pricing into what you get paid or whether you think your contracts protect you on that? And then I guess on coal, just a little more detail on the kind of how we ought to model things given some of the puts and takes. You listen to some of our customers on their earnings calls, and you've heard their outlook, it's no doubt of the loose truck market right now. I'm not going to get into any individual contracts. But we see some, what I would call, green shoots out there in terms of bottoming perhaps in the spot market, it's reached what we think is a sustained bottom for the last few weeks. We've also seen a decrease in the total number of motor carriers that are licensed in the U.S. We think that's a very positive development sustained for the last 3 months. and export of used trucks is continuing to increase. So as we go forward, I think that we reached a point of stability and the market is going to rebalance, we feel okay about RPU going into -- and our opportunities for RPU going into '23 in the market space for truck. On the coal side, fourth quarter, we had a liquidated damage claim, which beefed up that RPU in the fourth quarter. Looking forward, as you can see the forward curves just as well we do, we're going to have a tough comp and a tough road ahead, particularly in the second quarter, in terms of comparisons. But there's still support out there for export met coal in the market, and we're going to handle more utility coal than we did last year. I think you mentioned on the call at the end that the macro backdrop, it might be tough from a full year perspective to grow EBIT dollars. I'm just sort of curious, as you think about your big picture outlook. Is there a differential first half, second half? Do you expect EBIT growth to be possible at some point as we move through the year? There are, as you noted, a lot of uncertainties out there and some cross cuts. There's some tailwinds for us, but also we've got a number of headwinds and Ed just articulated a couple of those rate pressures. I'm going to let Mark talk a little bit about the cadence of what we're seeing through the year on revenue and expense. Yes, really, it's going to depend a lot on the way the top line evolves. And if, in fact, there is a recession that we have to deal with, with some demand destruction. But as we think about -- we've got a lot of tailwinds in the year, including really strong core pricing that we anticipate as well as fuel efficiency. We had 3% fuel efficiency this year. We expect another good year next year. And I do expect that we'll have a wind down of some of the service-related costs now that our service product has improved. However, that would probably start to manifest more in the back half. And then, of course, we'll have the absence of some of the wage adjustment that we booked in the third quarter related to prior years. And this quarter, I would expect that big claims impact that we had in the fourth quarter was truly anomalous, and I wouldn't expect it to be of repeating nature at all. So those are some of the tailwinds as we look into the year. But we are swimming against some pretty heavy headwinds. As we talked about on the call, we do have meaningful inflation to absorb, including the wage increases. And we've got some level of diminishing coal RPU and accessorial revenues as we go through the year, again, mainly in the back half. And then the depreciation step-up that I mentioned, which will be more evenly spaced throughout the year. So -- but again, a lot of good tailwinds. We've got good core pricing and -- but the headwinds are kind of what I laid out. The biggest variable is really going to be volumes. So how much we get win. Maybe I can pick up on that last comment. So in terms of the volume, I know you expect to be able to get some share recapture here. Do you think that ultimately yield a positive volume outcome for the year? And I guess, Mark have been helpful in terms of laying out the OR expectations, particularly a little bit more close in. So certainly, I would love to understand sort of your view on the potential for OR improvement or maybe holding the line in 2023. But if not, sort of first quarter, first half sort of how do we think about how things are trending out, just given some of the puts and takes you just outlined. I'll take a swing at it. This is Ed. We finally have our service back to a place where we were able to take on additional volume. And we're seeing the benefits of that improved service right now. So yes, I think we're going to be able to claw back some volume effect as I'm certain of it. The question I think that we're all trying to answer is, can we claw back enough to overcome the demand instruction that's present or might be present in the market in '23. I know I don't have to, but just to give you a flavor for what we look at -- you start with inflation, you go to interest rates and what that is doing to many markets, including housing, which is very important for our business. We've seen manufacturing inflect in the past 3 months to a negative there's a lot of uncertainty. The way I would describe our position is we are guarded, but we are poised for opportunity. We have the right service right now. We're building the capacity as soon as the opportunity manifests itself, we're going to be able to deliver. And when I think about what are the positives, the tailwinds for us, service recovery starts right there, which leads to network fluidity and capacity improvement, there's some chance that there might be a soft landing. There's a lot of people that think there could be. The customer that we talk to our customers, they're poised for growth, and they want to grow. They're investing for growth. And we're going to look at all those factors, and we'll be ready. Yes. And Chris, we don't really want to get into quarterly guidance because there are a lot of variables. But I can just point you back to the tailwinds we talk of. Right now here in the first quarter, we're going to have probably a pretty good compare given where volumes were last year. So I think that's -- that will be -- that will probably represent one of our better year-over-year quarters, but we're really looking at a very uncertain outlook here in the second and third quarter. And we don't want to get into projecting right now at that level of granularity. Mark, just a couple -- just quick follow-ups for me. So one, the flat operating income translates to EPS growth this year. I suppose you can still eke out some earnings growth under that scenario given maybe some share repurchase and then the other income kind of coming back. If you could just talk about that? And then totally get the uncertainty and it's one of the most uncertain that I've ever seen. But I wanted to ask you about what you can control, which is the OpEx base ex the fuel. So you mentioned the depreciation step up, you have some visibility on labor per the PEB or the agreement. I also think you said in the past, there's like $40 million a quarter of inefficiencies that you endured last year. So I assume that some of that can unwind. So So I'm just trying to understand how do you think the OpEx base ex fuel moves relative to that $6.4 billion that you did in 2022. So EPS growth relative to EBIT growth and then OpEx base ex-fuel expectations for '23? Thanks, Amit. I think if you go back to our financial framework, we would expect that if we have kind of flattish earnings that EPS growth should exceed that and be positive, for sure. So that just fits right into the framework we talked about back in December at Investor Day. The $40 million ex -- sorry, the $40 million of service-related costs will start to unwind here. I mean, right now, we've got much improved service, although we are spending money to compensate for the fact that many of our locations are still below minimum staffing levels. So there is still a fair amount of overtime, recrews and incentives out there. But as the head count starts to increase in many of those core locations, I do expect toward the back half, especially that these costs will start to unwind from the $40 million per quarter significantly lower, like I said, more into the back half. And then we've got inflation in a lot of the other P&L line items, but we're working to mitigate a lot of those costs through more stringent control. I think equipment rents, as an example, that's one area where higher network speed, that should help us try to keep a lid on the growth on equipment rents. And even purchase services is an area where we've had a significant escalation due to the cost of service as well as inflation impacts. As inflation moderates, I do believe that, that will come under control as well. Just want to go back to the comment on labor and the crew basis. I know you said you were targeting stopping those at a minimum level. Any way to quantify is it sort of less than 10% of those at this point that you need to go? And then I guess with respect to that, staffing levels at the bases that are fully staffed, are you starting to look at maybe building incremental staff there to potentially capture any inflection as we go forward given the growth opportunities? Yes. Allison, we had talked about in the fourth quarter a number that was about 1/4 of our crew base is below minimum staffing levels. It's roughly in that neighbourhood right now. And frankly, as we move forward, it's going to be highly dependent upon where we see markets headed in overall demand. So we are continuing to hire into our environment or into that environment. Pardon me, our conductor training pipeline remains very robust. And certainly, you've seen the improvements in our service product as we've addressed both resources leadership and plan, and our service is now the best it's been in over 2 years. Paul, why don't you talk a little bit more specificity on what we're doing with respect to our craft colleagues. Yes, absolutely, Alan. As you stated, we remain on pace to continue and hit our hiring targets. And as Ed alluded to, we're going to continue to match that towards the forecast as we go. As we've come out of the contract negotiations, now it's a matter of focusing on what the future looks like as far as conductive redeployment, predictive work schedules as well as quality of life and those discussions are taking place as we speak. I wanted to see if you could give any additional color on the potential impact from assessorial fees winding down this year. And Mark, maybe compare the timing of that wind down to the timing of the moderation in the service-related costs that you talked about? I'm just trying to figure out what the net impact from that could be over the balance of this year. This is Ed. Thanks for the question. We look at this very carefully along with our customers and stakeholders. When we look globally, we see that the congestion at the ports that both coasts has really alleviated itself. And that's also true at most of our intermodal ramps on the inland side. But you look at good spending in the U.S., which has plateaued for the consumer, but it's plateaued at a level that essentially is where we should be in like 2025 or 2026. So there's still a tremendous number of goods being brought into the country, trying to fit through a pipeline that was designed for arguably 2023. And so that congestion still exists in some places, really around the warehousing on the Hinterland and Inland locations. We think it's going to unwind. In terms of the timing of that unwinding we're watching very carefully. We think it will happen in '23 at some point. Yes, Justin, probably more like the back half, and it won't be necessarily precipitous the way we're assuming. But I would say it's roughly on par with kind of the timing we're thinking about the relief on service-related costs as well. I mean we'll lose asset [soil] revenue will gain in freight revenue because our customer supply chains will be more fluid, and we'll be able to move more business. I just want to make sure I'm understanding the guidance right. So it sounds like flattish revenue, not growing operating income, but not really declining a lot. So sort of flattish revenue, flattish operating income, flattish OR, plus or minus a little bit, but no big growth or declines. Is that ultimately what you guys are trying to say at this point? I just want to make sure I understand that. And then just 1 just thing I just want to clarify, where do you think head count goes from the January levels you gave us in the slides? Scott, this is Alan. Thanks for the question. Yes. Flattish is in the ballpark for revenue. I think Mark talked a little bit about some of the cross currents that we have, both on the top line and on the expense category. Can you repeat your second question? We had a break up quite a little bit in the middle. Yes, associated with headcount. Yes. Scott, as of this morning, we're north of 7,500 T&E. And our target right now for May is to be in the 76-plus -- 7,600-plus range. And as stated earlier, we'll continue to adjust that target as we see the markets play out. So I guess, Alan or Mark, I mean, we just had your Investor Day a month ago where you guys talked about resiliency, and I don't think anyone's faulting you here for a week macro. But is this the environment where you want to build in the resiliency into the network, maybe kind of piggybacking off that view on headcount. Is this where you add in capacity and really look to set up for growth potential in '24 and beyond? Yes. This is exactly what the environment we were contemplating. Here we are, we're continuing to hire. We're hiring aggressively. We need to because in some locations, as we talked about, were short of cruise. Resiliency is also about investing consistently in our assets, which includes our technology, it includes locomotives, track, intermodal terminals. It includes freight cars designed to help us compete with truck. And it includes -- yes, it includes our people as well. It also includes processes and a continuous improvement plan as we lift our service is the best it's been in over 2 years. But we're not stopping there. We're going to continue to evolve our product and we're going to continue to improve. And we're looking a couple of years out, how do we position ourselves so that our customers can compete and grow and we can compete and grow with them. Two-parter, if I may, please. You said that you expect share gains to offset some of the natural macro volume deterioration. Can you help us understand how much of that is "in the bag" with kind of new contract wins or kind of contracts have signed versus prospective as your service improves? And second question is, there has been some chatter on regulatory scrutiny on train length obviously, is a big part of top SPG and also for some of your peers. Can you talk about kind of how real that risk might be over time? Thank you, Ravi. For volume, we are going to -- we are producing a service that's allowing us to take back share that should be on Norfolk Southern. And that includes from the highway. And that's where we're really focused. It's how can we add value for our customers so that their top selection is Norfolk Southern. And over the past couple of years, our customers have to make difficult decisions. and we are helping them come back to the place where we can add the most value for them. And we're confident sure there's going to be lots of macro headwinds, but we're seeing it now, we can earn back some of that freight even in a down environment. Yes. Ravi, let me talk about the regulatory environment, if you will, for just a second. What we -- we're fully engaged with the STB. We've met with 4 of the 5 members just since our Investor Day on December 6. And they're really encouraged. What we told them as we spoke with them last year is we were fully committed to restoring service. They've seen that. They see it in the metrics and they hear it from our customers as well. And now, they're seeing us start to grow a little bit. And so we're aligned with them, and we're delivering on our promises for service and our promises to help our customers compete and grow. Just coming back on the trucking market, your long-term approach to gaining share against truck through higher service and just curious whether with the capacity, the slippery cap capacity and pricing environment that you're seeing right now and should that persist? Does that provide you with a significant challenge with regards to gaining market share given that price dynamic. And I know at least 2 of your competitors have started acquiring trucking companies, OR CN but H&R and TransX, and then Coaster Home, your TSX by quality. Is that something that you would envision doing as a way to offset some of that challenge by buying a trucking company and then converting it to rail? Is that something you'd consider? Just curious as to all that -- how that pertains to your [indiscernible] strategy? Walter, let me address the second question first, then I'll turn it over to Ed on how we compete with truck. Look, we got a franchise built for growth. And there are a lot of unique strengths about Norfolk Southern's franchise, the markets we serve and the customers with whom we are aligned. And so we are extremely confident and our ability to deliver organic growth. And we laid out that investment thesis in our Investor Day. And why don't you talk about how we're going to grow and compete with truck. Sure. Well, first of all, we have a fantastic partnership with our key customers. And that includes our key customers in that trucking space. I say all the time, we are not competing against trucks. We're competing against the highway. Truckers are our customers. and that's a great place to be. Sure, the current environment is challenging, but we've been there before. We've seen these cycles play out time and time again. The market is rebalancing right now. And I think when you look out past '23, it's clear that rail intermodal, specifically on Norfolk Southern is going to be a very compelling place to be for customers. We talk all the time internally about the -- all the innovation that's going into reducing the carbon footprint for transportation But if you want to reduce your carbon footprint by about 70% to 90%, just put it on a train on Norfolk Southern. It's the easiest way to do it. So we think the value prop long term is compelling. And even in the short term, we think we are very well positioned to compete with our customers. Thank circling back to yield a little bit. I mean the identifiable headwinds of fuel and accessory unwinds are very clear. It sounds like you think the core can still offset a lot of that, which has been really Norfolk's bread and butter for the last several years. But in this loosening truckload market, weaker economic backdrop, are you finding that there's any areas where your pricing power it's coming under pressure a little bit due to customers' unwillingness especially in the loosening truckload market as we think to intermodal. I think what makes me optimistic about our ability to continue to price in the same way that we have for years and years is the increasing value of the service that we're providing. Right now, we're producing a service that is very valuable to our customers we're supplying capacity that allows them to move that freight from the highway back to the railroad. And you know what, we're going to continue to develop and enhance that value just like just like Alan talked about. We're not stopping in terms of understanding what our customers need and what sort of service will provide value to them. We're really looking at the 3-, 5-, 7-year horizon on how we can deliver value for our customers, that's how we're going to continue to produce the results that we have so far, and we're confident in that. So does that mean core is a little bit stickier than in intermodal since there's more little conversion potential there as opposed to maybe economically sensitive merchandise? Yes, so does that mean that core is maybe a bit stickier in intermodal, given the potential for share gain as opposed to more economically sensitive merchandise? I don't know. I think when I look across the markets that we serve, I think we've got potential to continue to produce -- leaving coal out of this for the time being because of the year-over-year headwind -- we've got a great track record. We're going to continue to do that. One for Mark. Can you just give us a little bit of color on the average comp per employee going forward. Obviously, this quarter, you got the accrual, the incentive comp tailwind. You probably got some mix of new hires still in there. So any color you can provide on the OpEx side when we look at that throughout the rest of 2023 would be helpful. And then for Paul, I know we're talking a lot about grounded conductors in the headlines, and this is a big thing that's starting in the industry. But maybe you can just level set the time line that you think this could progress to the extent you can offer one because it does seem like it's a new event, but we'll obviously, I think, at least take quite a bit of time for this to really get past pilot program and implementation to be more meaningful that we might see something live and in the field? I'll start with the comp and ben per employee. Brian, we ended pretty much where we had signaled we'd be on a per employee basis, excluding the adjustment there that deflated it a little bit. I would expect in '23, you'll see that number step up in Q1, like we talked about due to the payroll tax resets, and it will probably be in that 35 and change range. And while it would normally step up again in Q3 due to the wage accrual or the wage increases that take effect there in the third quarter. That will probably get offset to a large degree by the unwinding of some of these service-related costs. So I would expect kind of flat in that 35,000 and change territory throughout the year. Yes. And just adding to the second question on that. As we stated, national bargaining was complete here in December. We've already begun negotiations with our labor unions on conductor redeployment. From the fact of the time line we're in negotiations, but there's certainly a regulatory piece of this. But as we have the discussions and we think about the long-term future of where we want to be, there are benefits from a predictive work standpoint. There are certainly benefits from a work-life balance and quality of life standpoint that have been challenges in the industry for a number of years that we feel get addressed through some level of conductor redeployment. So we think there's a compelling reason certainly for the industry and the regulations to move forward in support of conductor redeployment. And certainly, back to what Ed was talking about. We have to continue to find through our balanced approach of service productivity and growth those next opportunities to drive greater value for our customers and bring that volume on our railroad. So we think that's all a part of our value proposition in the long term. And do you think you could see a pilot program for one of those initiatives starting this year? Or is that a little too soon to expect? It's too soon to say at this point. we're ongoing negotiations. We want to have those discussions first and cross that bridge when it comes. I was hoping you could speak to the kind of visibility that you have in automotive for 2023? And how far out you think that goes? And perhaps looking at a little further, you could also comment on any changes that you anticipate in that franchise as far as routing, et cetera, as the industry converts to electric vehicles? Sure. There's clearly a bow wave of unmet demand out there for automobiles in North America. And the industry is really focused on delivering and trying to work that off. We are, too. We've invested in new cars for that fleet, and our fluidity has improved significantly. We are continuing to refine that. That's going to offer us the opportunity to help our automotive customers meet some of that unmet demand. Turning to the question. I think your question was about EVs and future supply chains. We've seen a tremendous amount of investment in new capability for whether it's EVs, construction, whether it's battery construction, whether it's battery recycling, there's a tremendous amount of interest out there and some investment going forward that we are working to make sure that we can support. So I wanted to ask about the state of labor relations as you see it. To what extent has it moved -- or has it improved since moving past the PEB? Obviously, negotiations had gone a little bit contentious, but wanted to hear your perspective on if that's improved since then? And then to what extent do you think you might have to make further concessions on benefits or sick leaves or anything around that sort of thing? And then given the benefits you're describing around kind of the flywheel effect and the service improvements that you're seeing, I'm wondering if volumes do come in a little bit weaker than expected for this year, given the aggressive hiring, what do you do with those excess employees? Or do you see yourself in an environment where maybe you have a little bit more head count than what's needed and what do you do with those employees? I'll address part of that and then turn it over to Paul. Now that we're done with national negotiations, we can turn to local negotiations in which we are collaborating with our craft colleagues to modernize our labor agreements to improve their quality of life, enhance operational flexibility and provide more predictable work schedules. That benefits us, that benefits our craft colleagues and benefits employee engagement. And we're seeing that as we get out into the field and talk to our employees about the future of Norfolk Southern, a balanced approach on service, productivity and growth. In respect to what would happen were we to enter into a downturn, that is factored into our thinking. And it certainly provides an opportunity for enhanced training and enhanced flexibility for our employees. Paul, do you want to talk a little bit about what you're seeing out in the field? Yes, Alan, I mean, you touched very well on the very first level the lever would certainly be investing in our workforce, cross qualification, extended training board consolidations, et cetera, where we have opportunities there. But we also have the lever of attrition. And we've seen what has taken place in the industry with furloughs, we just have not seen for those come back. It's very expensive in the long term, and we do not see that as certainly one, if any lever that we want to pull. We want to ensure, again, if there is a volume downturn, we are in a position as that volume comes back to handle it and handle it well. So that is how we are going to approach a downturn in potential volume. If you look at the senior management incentives, they've recently been very much in the short term tied to OR and operating income with the long term tied to returns on capital with the TSR multiplier. At the Investor Day a few weeks ago, Andy Adam said that she was working with the Board to really redo the incentives both for senior management and for some other employees subject to the incentive program to really align with this new strategy that you guys laid out for us a few weeks back. Can you talk a little more about the changes that are being made and what you're doing at the compensation structure level to really encourage the behavior you're looking for in the long-term strategy? Bascome, thanks for the question. We are, as Andy noted, we're in discussions with our Board to make sure that our compensation plan is aligned with our strategic goals. We've always done that, right? And as we noted at Investor Day, our strategic goal is to deliver top-tier revenue and earnings growth through industry competitive margins and a balanced capital deployment. And I think you'll end up seeing in '23 that the structure has been amended a bit to reflect the alignment with our strategy. There were a lot of odd issues that occurred this year, and I think you hit some of them in terms of accessorials and in terms of liquidated damages. I'm kind of curious, with the big shift that we saw with West Coast to East Coast shipments from customers and now we're dealing with this inventory overhang. How do you think that affected our business in the Eastern U.S. Is it better for you if these containers dock in the west and get handed over in Chicago? And do your customers see a return to the West Coast at some point this year, maybe when labor situation settles? Is my understanding is it still tends to be a little cheaper to dock West than East. Just kind of curious how you thought that, that shift that's probably a little more transient impacted your business? This is Ed. Thank you for the question. I love talking about the business. The shift from West Coast to East Coast has been ongoing for the better part of 20 years. And that evolution has occurred because of economics over time as manufacturing has shifted south and west from Japan to Korea to China and now towards Vietnam and Myanmar, et cetera. it makes those all-water sailings more attractive. When you look at the population center of the U.S., which is East of Mississippi. The expansion of the Panama Canal and now the use of Suez is also a compelling reason why those economics tend to work more. Our position is pretty simple. We want to be able to handle those shipments effectively, whether they come in through the West Coast, [indiscernible] quite a few to will or whether it comes through the East Coast. There's no doubt that there is a lot of inland infrastructure associated with transloading on the West Coast that makes that compelling. And we're perfectly positioned to help our customers deliver that volume to the population centers in the east. At the same time, we've invested a lot of money to make sure that we're a compelling partner for our ports and for our steamship lines as they come through the East Coast. We've invested a lot of money in some of our largest lanes are those shorter lengths of all that emanate from whether it's Savanna, Charles or Norfolk or from New York, et cetera, that allow us to add value to those shipments. And just to follow up to that. What are your customers telling you in terms of their plans on inventory reduction where you may see more normalized shipment levels? I think the outlook from our customers is that there's been a work down in inventory recently after that run-up. I think many of their customers are now getting their inventories in much better shape. And it really comes down to having the right product, not necessarily the right number of any given product, but the right type. And so we're encouraged by those recent work downs. And as we move into '23, again, guarded in terms of economic outlook, but poised for opportunity as soon as they manifest themselves. So one sort of detailed question and then I had a question for you, Ed, on sort of rail share. So just to start off, if you think about the starting off point for flattish EBIT guidance, can you just let us help us understand is that from a GAAP basis or adjusting for some of the accruals? And then as you think about the last couple of quarters, have noticed the carload traffic, particularly chemicals in ag, you guys have been outperforming CSX. And I'd love to get your perspective on how important sort of rail share is to you and the growth strategy going forward. CSX has historically had a little bit bigger carload footprint. I think that you guys have had as you've been investing a lot in intermodal over the last decade. How do you think about that sheer situation playing out, right? Are you guys outgrowing them because of some specific network advantages? Are you winning them in the marketplace? Any thoughts on that would be really helpful. Sure. Yes. The market that we really study is that $860 billion truck and logistics market. There's 5 trillion-ton miles moving in North America. And majority of those move adverse to railroads. We -- that's where I'm focused is how do we convert that business -- more of that business to Norfolk Southern. Railroads are, in some ways, defined by geography, but we are defined by our customer base, and that's what we're focused on. Great. So just a follow up -- a couple of clarifications. On staffing, are you saying you're only 100 off your T&E target, and that's your goal there? And then I guess, the total employees, you ended with about 19,250, up about 1,200 from a year ago. Maybe give your thoughts on where that is a year from now. And then maybe -- I don't know, Mark, can you talk about what service level costs are still embedded in there, given the service gains versus inflation? I'm just trying to figure out where the opportunity is? Ken, for now, based on the economic outlook of 7,600 target that we had still exists. We're going to continue to hire in locations where we're tight And going forward, as you look here into 2024, obviously, there's a lot of uncertainty out there. we've talked about that. And so I don't want to get too far ahead of ourselves. I will tell you that right now, the conductor training pipeline is elevated, but it will remain so until we get to target and feel like we're recruiting, hiring and training at a steady state. And certainly, volume growth profile will mean that, that number is constantly moving. The target headcount number is constantly moving. And Specific to your question on where the service costs reside, Ken, I'd say roughly half of those sit in comp and ben between overtime, recrews, incentive expenses, as well as recruiting and training. That's really where, I'd say, half of it said. There's also a fair amount in purchased services. A lot of the disruption cost sits there. And there's also a little bit sitting in materials as well with regard to locomotives. So it's battered throughout the rest of the P&L, but half of it sits in component. Well, what we indicated was it's roughly $40 million a quarter that we're dealing with. And I would expect that, that number to come back down closer to, but not all the way to 0, by the time you get to the end of the year. So that's it. Great. And then just a follow-up for me, if I can. Paul, you noted 202 locomotive miles per day. Can you talk about targets there, given the service improvements where you think we end the year with? We are just now beginning to get the service back to where we wanted it to be here within the past several weeks and if not the past couple of months. So we described at Investor Day the flywheel effect that is going to take place, fully expect as we continue to resource up to the group piece that we spoke to and the service gains that we have made that we're going to continue to see that improve throughout the year. Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Alan Shaw for any final comments.
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EarningCall_1270
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Good morning, and welcome to the Washington Trust Bank Conference Call. My name is Bruno and I'll be your operator today. [Operator Instructions]. Today's call is being recorded. And now, I would like to hand over to Elizabeth Eckel, Executive Vice President, Chief Marketing and Corporate Communications Officer. Ms. Eckel, please go ahead. Joining us today's are members of Washington Trust's executive team, Ned Handy, Chairman and Chief Executive Officer; Mark Gim, President and Chief Operating Officer; Ron Ohsberg, Senior Executive Vice President, Chief Financial Officer and Treasurer; and Mary Noons, Senior Executive Vice President and Chief Retail Lending Officer; and Bill Wray, Senior Executive Vice President and Chief Risk Officer. Please note that today's presentation may contain forward-looking statements and actual results could differ materially from what is discussed on today's call. Our complete Safe Harbor statement is contained in our earnings press release, which was issued earlier yesterday and as well as other documents that are filed with the SEC. All of these materials and other public filings are available on our Investor Relations website at ir.washtrust.com. Washington Trust trades on NASDAQ under the symbol WASH. Thank you, Beth, and good morning, everybody, and thank you for joining our call. We appreciate your time and interest in Washington Trust. This morning I'll provide some comments about the fourth quarter as well as our thoughts on the current environment. Ron Ohsberg will then discuss our financial performance and afterward Mark Gim, Mary Noons and Bill Wray will join us to answer any questions you may have about the quarter. Before I turn to our quarterly results, I'd like to make a few brief comments. In December, we announced that Mark Gim will retire as President and Chief Operating Officer this April and that he has immediately been elected to our Board of Directors. I'd personally like to thank Mark for all the contributions he's made to Washington Trust over the past three decades. During his tenure, he's provided great strategic vision and led key business line growth. We look forward to his continued guidance as a member of our Board. It's also my pleasure to introduce Mary Noons, who will become the first female President and Chief Operating Officer in Washington Trust 222 year history upon Mark's retirement. Mary is another Washington Trust veteran and over her 30-year career played a key role in the successful revenue growth and market expansion of our retail lending operations. She's a proven leader, a strategic thinker, and has a passion for service excellence and process improvement. I look forward to working alongside her. I'll now turn to our quarterly results. I'm pleased to report that Washington Trust posted sound fourth quarter net income of $16.6 million or $0.95 per diluted share. Total loans grew by 5% in the quarter and 20% for the full-year 2022, reaching a record high balance at year-end. While increasing wholesale funding balances and costs challenged net interest margin in the quarter, this robust loan growth helped deliver near record quarterly net interest income, attracted new customers, and positioned the balance sheet for long-term success. Our main non-interest income drivers, wealth management and mortgage banking were both under pressure in the quarter. Rising interest rates had an expected impact on mortgage revenues in the quarter despite strong loan production. Wealth management revenues were affected by lower levels of assets under administration resulting from market pressures and from the departure of client facing advisors from our Wellesley office, which we previously reported on our Q3 call. Ron will provide more details in his comments. We are pursuing legal remedies associated with this matter and remain committed to servicing our wealth management clients and growing this key line of business. Expenses were up slightly in the quarter, but included a $600,000 contribution to our charitable foundation. This allows us to continue our tradition of assisting the organizations that provide health and human service, housing, and other support to those in need in our local communities. I'm proud to report that our Board approved a strategic diversity, equity, and inclusion plan and we launched our employee-driven DE&I Council in the quarter. I very much look forward to working with this team to ensure that ours is an accepting inclusive workplace built to reflect and benefit our employees, customers, and the communities we serve. We continue to take a long-term view and will be protective of credit and capital as we consider avenues for growth. The current period of continued, although moderating inflation and the result in unpredictable rate environment are challenging in the short run, but they're temporary. We continue to invest in talent to support growth, and are also focused on rational technology investments to improve the customer experience and to ensure a secure operating environment. As Ned mentioned, fourth quarter net income was $16.6 million or $0.95 per diluted share. Net interest income was $41.3 million, down $700,000 or 2% from the preceding quarter. The net interest margin was 2.65% down 17 basis points. On the funding side, average in-market deposits increased by $84 million, and average wholesale funding sources rose by $220 million, the rate on interest bearing liabilities increased by 78 basis points to 1.64%. Repayment fee income was modest at 15,000 and PPP fees in the quarter were 59,000 and collectively that added 1 basis point to the margin. Turning to non-interest income. This comprised 25% of total revenues in the fourth quarter and amounted to $13.8 million, down $2 million or 13% from Q3. Wealth management revenues were $8.6 million down by $901,000 or 9%. The decrease in revenues corresponded with a decrease in average AUA balances, which were down $527 million or 8%. December 31 end of period AUA totaled $6 billion down $361 million or 6% from September 30, reflecting net client asset outflows of $673 million, partially offset by net investment appreciation of $312 million. AUA declined by $604 million due to client asset withdrawals related to the advisors that left the company at the end of Q3. This resulted in a prorated reduction of revenues of approximately $525,000 in the fourth quarter. The full run rate quarterly revenue loss related to these withdrawals is estimated to be $876,000 or an incremental $351,000 over Q4. Since the end of 2022, we have been notified of additional client withdrawals totaling approximately $55 million with an estimated Q1 prorated revenue loss of $40,000. Mortgage banking revenues totaled $1.1 million down by $944,000 or 46%. Realized gains were $1 million down $726,000 or 42%. Mortgage loans totaled -- mortgage loans sold totaled $55 million in the fourth quarter down by $21 million or 28%. Market competition has continued to compress the sales yield. Total mortgage originations were $268 million down by 11%, and we placed 85% of mortgage originations into portfolio compared to 74% in the preceding quarter. Our mortgage origination pipeline at December 31 was $102 million, which was down $62 million or 38% from the end of September. Regarding non-interest expenses during the fourth quarter, we contributed $600,000 to our charitable foundation. Excluding this item non-interest expenses were down $308,000 or 1%. Salaries expense decreased by $797,000 or 4%, reflecting adjustments to performance-based compensation accruals, lower wealth management compensation and volume-related decreases in mortgage compensation. Legal, audit and professional fees increased by $294,000 or 42% reflecting higher legal expenses. Now turning to the balance sheet. Loan growth was strong. Total loans were up $261 million or 5% from September 30, and by $837 million or 20% from a year ago. In the fourth quarter, total commercial loans increased by $70 million or 3%. Within this category commercial real estate loans increased by $66 million with additions of $146 million, partially offset by payments of about $80 million; and C&I increased by $4 million as new volume of $48 million was offset by payments of $44 million. Residential loans increased by $179 million or 8% from September 30, and by $596 million or 35% from the end of 2021. In-market deposits were up by $34 million or 1% compared to September 30 and by $196 million or 4% from a year ago. Regarding asset quality, it remained strong. Non-accruing loans were 0.25% and past due loans were 0.23% of total loans. The allowance totaled $38 million or 74 basis points of total loans and provided NPL coverage of 296%. The fourth quarter provision for credit losses was a charge of $800,000 consistent with Q3 and reflects loan growth continued negative trends in forecast of macroeconomic conditions, and strong asset and credit quality metrics. We had net recoveries of $264,000 in the fourth quarter and year-to-date net recoveries of $368,000. And Mark, I just -- I just want to say it's been absolutely lovely working with you and wishing you all the best. Glad you're staying on the Board, and welcome Mary. So funding, maybe we can start there. Can you take us through your thoughts on using brokered CDs and how that will continue, what the trajectory there is going to look like? And maybe a spot margin for the month of December? And any forward guidance you can give us on spot margin that would be super helpful. Sure. So we view brokered CDs and FHLB. We always separate that out from what we call in-market deposits. And we view brokered CDs and FHLB; it's kind of fungible funding sources. Brokered CDs have lately trended lower -- lower cost than FHLB, but there's less inventory out there. So I would say we would take full advantage of all the brokered CDs that we can collect. And FHLB is a little more instantaneous. You call; you get the funding the same day. It's a little harder to get those brokered CDs in and there's more competition out in the market to get them. But I would say we would rely on those as much as we can. Great. And then can you just remind me your brokered CD balances I know at September, it was $422 million, where it came in at December? Okay. Great. Thank you. And then, just lastly, can you comment on how we should think about expenses, expense growth for full-year 2023, obviously a lot of moving parts? And just also wondering with the pressure on expenses has that slid your branch plans at all or how we should think about that? Thanks. Yes. So I think our guidance on expense, we'll keep that mainly to the first quarter. And we're looking at a 2%, 2.5% increase in Q1. Mainly as we have merit increases implemented in payroll tax resets and those types of things. For the full-year, the branch, we expect the new branch impact and those branches will open later in the year that's $1 million. And also we have new FDIC insurance expense coming in at $1.4 million that that was not on the 2022 run rate. Laurie, this is Mark. I'll just comment on the branch timing. I -- we have to balance the expense of opening branches in the short-term against the long-term value of increasing our deposit gathering radius and scope. So I think we are mindful of trying to balance near-term cost in a challenging economic environment against the long-term value of improving our funding base, which remains a strategic priority for us. Branches are part of that. So is commercial deposit gathering and cash management, and we have a really substantial focus on that from a strategic point of view. So branch opening timing might vary a little, but it would really be more based on when it's feasible as opposed to a desire to minimize near-term cost. Thank you, Laurie. Our next question is from Mark Fitzgibbon from Piper Sandler. Mark, your line is now open. Please go ahead. Thank you. Good morning, everybody, and let me echo Laurie's comments. Congratulations to Mark and also congratulations to Mary on your new role. Ned, I wonder if you can help us think about how you're thinking about your loan deposit ratio. I think its 1.02 right now. Is that likely to serve as sort of a governor on balance sheet and loan growth in coming quarters? Yes. I don't think so. I mean I think we're -- we've got a strong commercial pipeline and strong -- not as strong as historic resi pipeline. And we think we have to continue to serve our customers and prospects in the marketplace. We need to focus on deposit gathering, Mark, and fund that loan growth in a better fashion than we have been able to in the -- certainly in the recent quarter. Obviously in the fourth quarter we had huge loan growth at a time when the funding source available to us was borrowed funds and/or increasingly expensive deposit base, so not the perfect scenario. So I think more focus on growing the deposit side of that question, than reducing the loan side in the short run. We think positioning the balance sheet for the long-term is important. Serving the customers continues to be important. We can't choose when to service them, we need to stay in the marketplace and stay active. But at the end of the day, we do have to be focused on loan-to-deposit ratio. And at some point, it could become a governor. I don't see that in the near-term. Okay. I guess I was just thinking about like your capital ratios are not as high as they've been historically sort of 580 TCE ratio. I know the regulatory ratios look good. But I just wondered if it may be made sense to kind of slow growth a little bit on the loan side to let deposits catch-up and let capital ratios build, particularly if we're going into a more difficult economic period. So Mark, this is Mark Gim. I'll take just a shot at the question about loan growth and kind of how we try to think of it in terms of long-term opportunities. Our credit quality standards have not changed at all, and we're very mindful of the economic environment in 2023 and 2024 might worsen if the U.S. and global economies slip into recession. That said, we're seeing opportunities particularly on the commercial side of the house from customers who we have not seen before, who are very high credit quality. And we think the ability to establish some of those relationships for the long-term, when we might not have had that opportunity is something we need to follow-up on. I'll turn it to Ron for comments on capital and the difference between TCE and our regulatory capital ratios. But just, with -- again, with a comment that we're very focused on credit quality we're very proactive about trying to identify potential risks long before they happen. So we don't go into this lightly. And Mark, this is Ned. Obviously, a lot of the asset growth in the fourth quarter was resi and strong high-quality resi. And obviously, we're hopeful that at some point down the road, we'll be back at a point where we're selling the large majority of those loans and not growing the balance sheet as much as we have in the prior two quarters. So when that will happen, is anybody's guess, it's obviously rate-related. So itâs a good question, and I think we have to be thoughtful about all those angles and Ron on the capital front? Yes. Yes, Mark, I know we share your concern about GAAP capital as it is. And we agree that regulatory capital still is fine. I do believe we have enough capital to support the kind of growth that we've been booking. As far as the residential that those have favorable regulatory capital implications. So I don't see any reason either on the funding side or on the capital side for us to necessarily curtail our lending activities. Okay. And then, last question is on the wealth side. It looked like you had $600 million leave with those full relationship people, and there's another $55 million coming this quarter, it sounds like. How much realistically beyond that is at risk in your view of leaving? So Mark, this is Mark. I'll take that as best as we can. It's difficult to predict how much will leave. As you know, having non-compete non-solicited agreements in place doesn't necessarily ensure clients will remain with us even though we have been very active in reaching out to clients to a firm that they will -- they know that we're continuing to service them and that they -- for the time being are remaining with us to be serviced. So it's hard to predict. I think we would certainly say we're much closer to the end of that runoff in the beginning, but we don't have any -- it's difficult to give specific guidance. But did that group of four people have a book of $1 billion. I mean we sort of know that it's not going to go past that? Or can you give us a sense for what's the size of the total relationships were? Yes. As disclosed, collectively, they managed or were associated with about approximately $1 billion in assets as of September 30, 2022. And I think Ron has disclosed how much of client asset withdrawals are there. As a practical matter, we measure and continually refresh our outreach to existing clients, those who have affirmed that they will stay with us for the time being. But we -- and while we're confident in our outreach efforts, I think we're very reluctant to try to give a guidance number as to how much is at risk out of what remains. Hey, good morning, everyone and echoing everybodyâs thoughts here. Congrats, Mark, and welcome Mary, look forward to getting to meet you and work with you in the future. So I just wanted to start off by circling back on the margin guidance and outlook. Ron, I think you said you're expecting $250 million to $255 million here in the first quarter. Can you give a little bit more forward guidance assuming the Fed stops raising rates here in the first quarter, maybe two more 25 basis point hikes? Does the margin stabilize at this point? Or does it actually reverse course and start to trend up? Or how should we kind of think about that? Yes. I think best case; it kind of stabilizes over the next couple of quarters. We still have quite a bit of liability re-pricing to come, a lot of that in the first quarter, which explains kind of the dip between Q4 and Q1. So we're a little guarded about this. I mean there's a number of different ways interest rates could play out over the course of the year. So that's why we really just kind of prefer to stick to one quarter at a time right now. Okay. Can you give a little color on the rate of new loan production? What the new loans that are coming on the books, what kind of yields you're getting on those? Yes. So in the fourth quarter, total commercial loans came in a weighted average of about 5.66%, mortgages came in at about 4.84%. And that reflects the average for the quarter, Damon; obviously, as short-term rates have trended up LIBOR-related commercial loans coming on the balance sheet will be at a higher rate at December than they were in October. And then also from a mortgage production perspective, it's important to note that the lead time to book a mortgage typically means that the loans that are hitting the balance sheet are 60 days, 45 to 60 days rate locks in terms of prior pricing decisions. Mary, maybe you can give some indication of what our current jumbo rates might be that are going in the portfolio ballpark. Yes. So I'd say that what you saw in rates for fourth quarter certainly will be higher in the first quarter of this year because we had implemented across the Board rate increases as funding costs went up and overall mortgage rates went up. Even though we've seen a dip in the conforming rates, we have not adjusted our portfolio rates. So those will continue to be attractive for the first quarter. Got it. Okay. That's helpful. Thank you. And then, as you guys think about your deposit betas, this past quarter, I think your total sold deposit linked quarter beta was around 31% and cumulatively around 20%. With the big ramp-up expected here in funding costs in the first quarter, what do you see like your overall beta during the cycle kind of playing out? Yes. I don't have a calculated beta number to share with you on this call, Damon. But clearly, there is a lot of market competition out there. We have customers coming in asking for rate exceptions depending on the nature of the relationships, we will grant those to retain the deposits it's competitive. And I think that -- I think betas will go up from here, let's just say that. Damon, this is Mark. I'll try to give a little -- if I can, Iâll try to give a little color on that. Our stance on the retail side has been not to be at the front edge of rate retention but to keep an eye between providing fair rates to customers and maintaining as lower deposit cost of funds as we can, consistent with competitor practices. Probably the highest betas are those for institutional and perhaps municipal or public fund type deposits, one could view those two different ways. As ARPA type funds get released to states, for example, there has been opportunity to bring those in. They are certainly at a higher cost in the short-term, but also bring with them the opportunity to bring in non-interest-bearing relationships, for example. And so while the betas on those might be high and then flat to inverted yield curve environment in the long-term, we see value in either maintaining those or bringing them on Board. So while we have on the kind of commercial and municipal side, a higher beta on the interest-bearing accounts, we view it as a sound business to try to maintain in the long run rather than letting it walk using equally priced wholesale funding, but then potentially losing the opportunity to renew or grow that relationship. Yes. We've got relationships with about a third of the cities and towns in the State of Rhode Island. We'd like to have that be more and we're seeing success on that front. But those are relatively expensive deposits in the short run. On the interest-bearing side, they do tend to come with deposit accounts or DDA accounts, operating accounts. So that's one of several strategies that we hope will be helpful in the long run. But again, to Mark's point, in the short run, they might drive betas up. Okay. I don't mean to belabor the discussion on the margin here. But looking back at my notes from last quarter, I think the guidance was like $285 million to $290 million for the fourth quarter, and it came -- you guys came in at $265 million. I mean that's a pretty sizable turn of events. And I'm just trying to kind of connect the dots here. So is it fair to say that the loan growth was just really strong and you just -- you're forced to tap outside sources and higher cost funding and it just had immediate impact on the margin? Is it pretty much like that simple? Okay. All right. I appreciate that. And then, just lastly, on loan growth outlook. You guys seem pretty optimistic here going into 2023. Any guidance on kind of full-year expectations for the overall portfolio? Yes. Damon, it's Ned. The pipeline is strong. It was strong at year-end, kind of in the $250 million level. It's grown since then. So we are seeing opportunity. We think we'll be in the sort of mid-single-digit growth range again. We have seen a tapering off somewhat on the payoff side. So that could be helpful. So yes, I think we're going to see strong growth. And frankly, going into the year with a pipeline that's strong I think we'll see better growth in the early part of the year than we did last year. Last year, we ramped up towards the end of the year, but we've got some momentum. So I think it will be a little bit more spread out over the course of the year and continue to be strong. Mary, do you want to comment on resi? Yes. So for resi, we have, I believe a 13% increase in our volume for what will hit portfolio. What I'm hoping is that, that's a little lower and more go to sales, and we have -- we're working on certain fronts to increase our salable avenues. But we already have a very diverse salable outlet; we're structured to have multiple channels for outlets for our production. We've just hit a little kink in the yield curve on those. So I think we'll have very strong production. We're very oriented to the purchase market and purchase market in our region is very strong, and it's anticipated to stay that way. Thank you, Damon. We currently have no further questions. I will now hand back to our speaker for final comments. Elizabeth, please go ahead. Well, thank you all for joining us. We appreciate your interest and your time, and we look forward to talking again to you in the coming quarters. Meanwhile, we'll be head down and focused on serving our customers well as always. So have a great day, everybody.
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EarningCall_1271
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Good morning, and good afternoon. Thank you for joining LG Electronics Earnings Release Conference Call for the Fourth Quarter of 2022. [Operator Instructions] Good afternoon. My name is Sang Bo Sim from Investor Relations. Thank you for joining LG Electronics Earnings Release Conference Call for the fourth quarter of 2022. With me are representatives of each business management division, Mr. I-Kueon Kim from Home Appliance and Air Solution; Mr. Jeong-hee Lee from Home Entertainment; Mr. Ju Yong Kim from Vehicle Component Solutions; Mr. Dong Cheol Lee from Business Solutions. We are also joined by Mr. Sang Ho Park from Global Business Management Group, Mr. Choong Hyun Park from Corporate Business Management Division; Mr. Hyungyu Lee from Finance Division; and Mr. Hong Su Lee from Accounting Division. Please note that all statements we'll be making today regarding the financial results of the fourth quarter are subject to change in accordance with the result of the external audit. I would also like to remind you that uncertainties in the market and changes in strategies may cause our results to be different from the outlooks and forward-looking statements made today. Today, I will outline the overall performance results of the fourth quarter of 2022 and the outlook for the year 2023 and the first quarter. Then each division will take turns to deliver its business results and outlook. After that, I will share our ESG activities and achievements. Now let me start with the consolidated financial results of the fourth quarter of 2022 and the outlook for 2023 and the first quarter. Consolidated sales of the fourth quarter was KRW 21.9 trillion, and operating profit was KRW 69.3 billion. Despite sluggish sales in home appliance and TV due to slow demand caused by inflationary pressures in major countries, revenue grew year-on-year on the back of strong sales in vehicle components. H&A and BS remained profitable, but operating profit decreased by a large margin year-on-year due to rising marketing costs entailed by intensified competition in the appliance business as demand for durable goods became sluggish and increased promotion cost to secure sound inventory levels in TV and IT. I will now briefly review the fourth quarter performance of each business. H&A recorded KRW 6.4 trillion in sales, KRW 23.6 billion in operating profit and 0.4% in profitability. HE recorded KRW 4.5 trillion in sales and KRW 107.5 billion in operating loss. VS recorded KRW 2.4 trillion in sales, KRW 30.2 billion in operating profit and 1.3% in profitability. BS recorded KRW 1.2 trillion in sales and KRW 77.8 billion in operating loss. Each business will later share its respective business results and outlook in detail. Let's move on to the profit and loss and cash flow of the fourth quarter. In terms of profit and loss, reflecting financial income and expense, equity method gain and loss, other nonoperating income and expense, corporate income tax and income and loss from discontinued operations, we posted KRW 212.4 billion in net loss. Next, on cash flow. Q4 cash flow from operating activities was KRW 472.2 billion and cash flow from investment activities was negative KRW 1 trillion, resulting in net cash flow of negative KRW 1.1 trillion. When reflecting cash flow from financial activities of negative KRW 123.5 billion, cash balance at the end of Q4 came to stand at KRW 6.3 trillion, a KRW 1.2 trillion decrease from the previous quarter. Next is the key financial position and indicators for the fourth quarter of 2022. As of the end of the fourth quarter, assets stood at KRW 55.2 trillion, liability at KRW 32.7 trillion, and equity at KRW 22.5 trillion. In terms of leverage ratios regarding liability to equity, debt to equity, and net debt to equity, we continue to maintain a healthy financial condition. Now the outlook for the year 2023 and the first quarter. In terms of the business environment, impacted by the interest rate hike in many countries, political risk in Europe, concerns of an economic downturn are on the rise and weak demand stemming from declining consumer sentiment is expected to persist for the time being. As part of our business strategy to overcome the situation, we will respond to changes in market demand in an agile manner by launching innovative and differentiated new products and strategic models to target the volume zone. We plan to secure additional top line growth in promising business areas such as contents and service platform and B2B businesses. In terms of operations, we will focus on profitability-centered risk management in the first half and actively respond to possible improvement in demand in the second half to maintain top line growth momentum on an annual basis for 2023, and also continue to enhance profitability. Our first quarter revenue is projected to decrease year-on-year, impacted by weak demand in appliances and TVs. That said, we expect stable profitability on the back of efforts to improve cost structure and reduce costs. Now let's move on to the fourth quarter results and outlook for 2023 and the first quarter by business. We will start with H&A. Let me share the fourth quarter results of H&A. We recorded sales of KRW 6.4 trillion, a slight decrease year-on-year as revenue declined in Korea and overseas markets due to weakening demand for appliances caused by deteriorating macroeconomic conditions. Operating profit decreased year-on-year due to rising fixed cost burdens and marketing costs entailed by intense competition. Next is the outlook for 2023 and Q1. Concerns of an economic downturn are expected to continue to shrink demand for appliances, and subsequently, competition in the market is expected to intensify more than ever. Amid this environment, we will gain top line growth momentum by proactively responding to shifts in market and consumption trends such as demand polarization. We will aim to secure profitability by improving manufacturing cost structure and reducing expenses, including logistics costs. In Q1, we will secure revenue levels similar to that of the previous year by strengthening our presence in the premium segment and driving business in the volume zone. We plan to maintain solid profitability by optimizing spending, including logistics costs and expenses to address competition. I will share the fourth quarter results of HE. Sales declined year-on-year, impacted by the geopolitical risk stemming from the protracted Russia-Ukraine conflict and weakened consumer sentiment due to concerns of a global economic downturn. Operating profit decreased year-on-year due to increased marketing spending to sell out inventory during the peak season. Now let me share the outlook for the year 2023 and the first quarter. In the market, amid uncertainty over global TV demand improvement, competition in the premium products segment is projected to get fiercer. Accordingly, we will lead the expansion of the OLED TV market based on differentiated product competitiveness, strengthen competitiveness in LCD TVs by further applying quantum nano cell technology, and capture additional growth opportunities by driving platform-based businesses. In the first quarter, revenue is expected to decrease year-on-year due to slowing global TV demand, but we plan to improve profitability through efficient management of resources. Let me share the fourth quarter results of VS. Sales grew significantly year-on-year, thanks to increased OEM orders on the back of high order backlogs. Despite increased costs from running new production subsidiaries, operating profit continued to be in the black, thanks to revenue growth. Next, the outlook for 2023 and the first quarter. Amid easing of the auto semiconductor shortage, uncertainties regarding global demand for vehicle components continue to exist in the market due to macro risks such as the geopolitical situation in Europe. We will maintain high top line growth and sound profitability by securing more business for high value-added, high-performance products based on differentiated product competitiveness and strengthening our presence in the vehicle component market with stable supply chain capabilities and timely action toward additional top line opportunities. In the first quarter, we will seek to grow the top line through stable supply chain management and continue to be profitable by improving the cost structure. I will share the fourth quarter results of BS. So we continue to post growth in information display. Q4 sales decreased year-on-year, impacted by dampened demand in the global IT market. Operating loss was expanded against the previous quarter impacted by the drop in revenue and jump in promotion costs to reduce channel inventory. Now let me share the outlook for the year 2023 and the first quarter. IT demand is expected to continue on a downward path due to concerns of a global downturn. Information display is projected to maintain a growing trend, though the pace of growth may be somewhat slower. We will continue to seek revenue growth by strengthening our product lineup with new products and securing more B2B projects by offering tailored solutions for different verticals. We will also focus efforts on preemptive risk management by proactively managing inventory and optimizing spending with the market situation in mind. In Q1, we will improve profitability and seek to achieve a turnaround by focusing on stabilizing operations through timely action to address the IT peak season and strict management of inventory and spending amid demand contraction in the market. Last but not least, let me share our ESG activities and achievements. As a major ESG management company in Korea, LG Electronics has been playing a leading role in corporate social responsibility. In recognition of our efforts, we continue to receive A grade in 2022 in ESG ratings provided by renowned external institutes such as MSCI and KCGS. In particular, we were included in the Dow Jones Sustainability Index World list for 11 years in a row. DJSI considers not only economic achievements, but also nonfinancial performance such as environment, social, governance related practices in this evaluation. Building on these capabilities and achievements, we presented our ESG vision of a better life for all and 6 strategic initiatives to achieve this vision at CES in January. To accelerate our actions to mitigate climate change, we established a challenging goal to become carbon-neutral by 2030, and to ramp up the use of renewable energy to 100% in our sites around the world by 2050. In terms of products, we also plan to drive and lead ESG efforts by reducing carbon emission of 7 major products in the product use stage by 20% compared to 2020 levels, and expanding use of recycled plastics to 600,000 cumulative tonnes by 2030. Moreover, we will take action to realize our vision of a better life for all by strengthening ESG risk management across the supply chain, promoting diversity in our organization and culture, and developing products with enhanced accessibility to enable anyone to use them without obstacles. Going forward, LG Electronics will pursue competitive and reliable ESG activities by managing relevant risks and improvement plans across our decision-making process and deriving optimal solutions to create value for all stakeholders through systematic and expert ESG efforts, including the ESG Committee. That brings us to the end of the fourth quarter earnings release and outlook for the year 2023 and the first quarter. We will now take questions. Operator, please commence with the Q&A session. I have 2 questions. First, on corporate-wide operations. It's only in a new year. Last year, there were some price issues such as logistics issues. So was there any effect in improvement of margins? And to talk about B2B and B2C. Now it seems that B2B guidance is pretty okay, but in terms of B2C, it seems a little bit weak. So can you please talk about this year's corporate-wide revenues and profitability? And whether there is any effect in terms of margin. Usually, we have a seasonality that is high in the first half and low in the second half. Do you expect our seasonally higher earnings in the first half and lower earnings in the back half to continue into this year? We usually have this seasonality because we have high proportions of consumer products. . My second question is on BS. What is your outlook on BS division's revenues and profitability? Up until 2021, there were some improvements in terms of margin. However, from 2022, now the margin has been falling a little bit. Can you please talk about it? Let me answer your question on corporate-wide operations. We expect rising inflation, geopolitical risks and deep concerns over slowing economy to continue into 2023. In terms of our business environment, while there are positive factors like that of the eased raw material and logistics costs and a bigger contribution of our EV component business to our profitability, we also have risks such as prolonged demand declines, subsequent intensification of market competition and market cost increases. Despite the hurdles, we expect to focus on managing risk, especially to our profitability amidst slowing consumer demand trends in the first half of this year and to prepare for demand improvement by ratcheting up our fundamental business capabilities in the back half of the year to continue top line growth and secure strong profitability for the year. On the logistics and raw material price changes you mentioned, from 2020, there have been changes in terms of logistics costs. So we reflected the changes from 2020. Pardon me there, from the end of 2022, we reflected the changes by reviewing our contracts with ocean shipping companies. As a result, from 2023, we expect a significant tailwind in terms of our cost savings. On the effect of raw material cost declines, we have already reflected based on the lead time from product manufacturing to sales. So now we think that the effects will be reflected from the third quarter as we conclude our contracts with ocean shipping companies. On seasonality, you mentioned our profits in 2022 showed a familiar seasonal trend, high in the first half and lower in the second half. And this year, we intend to stabilize our quarterly profits by having a sound inventory build and facilitating the B2B business. Let me answer your question on BS division's revenues and profitability. As noted in the remarks on the 2023 outlook today, if the slowing demand trends in the market continued into this year, there will be inevitable impact on our business. With that said, we have set up and are implementing detailed plans for 2023 to improve both revenue and profitability against last year. On the revenue front, we will continue to drive revenue growth by improving our portfolio with new model launches and expanding new B2B project orders. On profitability, despite competition-driven risks such as marketing or raw material cost increases, we aim to enhance our profitability by reducing costs and improving cost structures proactively. I have 2 questions. My first question is on HE. It seems that setting a price for OLED TVs can be tricky. While LCD panel prices have plummeted, it is unlikely that OLED panel prices will fall. In light of this, what is your price positioning strategy to drive OLED TV demand? Do you have any plans to decrease the ASP this year? And my second question is on VS. This year, macro trends for VS are likely to be unfavorable, such as declining demand for vehicles and the weakening dollar, unlike your great 2022 performance beyond a turnaround. In such a tough environment, do you have any other profitability improvement plans than the volume ramp-up? Let me answer your first question on HE. As you know, LCD panel prices have plummeted. And since LCD panel makers have been adjusting their capacity utilization, I believe that further price drops will be limited. And so the gap between OLED panels and LCD panels will be maintained. And as an OLED TV market leader for over 10 years, we are going to focus on our competitiveness to provide value to customers. And as for the ASP plan, we're going to move in the direction optimized for each region and market by appropriately pricing the product in a way that it will reflect the fundamental value unique to LG's OLED TVs. In particular, we are going to provide a differentiated competitiveness of our OLED TVs and especially with our wireless AV connected OLED TV, which is our first in the world, we are going to provide differentiated value to the market, and we are going to maintain a value premium over LCD TVs. Let me answer your question on VS. As you said, the uncertainties surrounding the business environment such as vehicle demand declines are expected to continue into this year. Nevertheless, we aim to pursue high growth in the markets by continuously securing more product orders and expect to see robust revenue growth in 2023 based on cotton backlogs. On profitability, we also expect improvement driven by the growth of our volume and revenue in addition to tailwinds from product and product mix improvements, which we've made by strengthening our internal capabilities in regards to winning new orders and to ensuring a sound level of orders for many years. Moreover, in 2023, we will further enhance our profitability by improving cost structures more proactively across our operations, like improving SCM and production efficiency along with volume ramp-ups. This is Sei Cheol from Citigroup. I have 2 questions on corporate-wide operations and VS. First, on corporate-wide operations. Now FX rates are falling again after reaching a peak in the back half of last year. Has this caused any impact on your profitability? And then secondly on VS, as we're likely to see slower macroeconomic trends into 2023, there are concerns over weak demand for vehicles. What is your outlook on the demand for vehicle component this year? . Let me answer your question on corporate-wide operations. When the dollar falls, that could result in some impact on each division's results depending on the scale of their revenues and purchases based on dollar value. However, on corporate-wide operations, the FX headwinds on our revenues have been only limited based on the stable operations of our business portfolios in each region. And on profitability, the impacts would also be limited as we are able to provide a natural hedge like currency matching with our global operations in addition to managing FX volatility through various tools. Let me answer your question on VS. The automotive market has recently been recovering from COVID-driven demand slowdown and its rate of recovery is slower than expected due to the prolonged Russia-Ukraine conflict. To quantify it, e-market research firm expects vehicle production to grow by 3.5% year-over-year in 2023, and we expect our vehicle component business to grow beyond that growth as both installations of connected car components and the demand for EV component increase led by high growth within the ex-EV markets. I have 2 questions. My first question is on H&A. Concerns are being raised about negative revenue growth in 2023. In this context, what is your strategy to protect profitability, and what is your target profitability? And my second question is on HE. Driven by shrinking TV demand in 2022, the distribution inventory issue has persisted in the market. So what is the current status of your inventory levels? And it is my understanding that there has been an increase in your expenses for the normalization of distribution inventory. Could you give us an update on your inventory levels? And considering demand outlook for 2023, what is your inventory management strategy, both for customers and channels? Let me answer your question on H&A. Amid concerns over an economic recession and declining demand in the home appliances market, our revenue started to turn negative, as you've heard in the beginning of the call, as we have entered Q4 last year. This tough market environment is expected to continue into 2023. And even if there is a possibility that difficult macroeconomic environments such as inflation and interest rate hikes will ease to some extent after the second half of the year, it will take quite some time for consumer sentiment, that has been weakened due to decreased disposable income triggered by inflation, to recover. Under these circumstances, we will continue to enhance the competitiveness of our premium products. And at the same time, by expanding our volume zone product that we have been preparing continuously, we are going to work on overcoming the impact of declining demand and maintain growth momentum. Also on the cost side, we are going to maximize the effects of decreased raw material prices and logistics costs. And under a contingency plan, we will be carrying out cost-cutting activities to maintain the business structure where sustainable profitability can be secured. Let me answer your second question on HE. In 2022, decreased sales driven by a slowdown in global TV demand have led to increased inventory levels of manufacturers, including us, and distributors. And thanks to our detailed and preemptive management of PSI and our efforts to maintain sound inventory levels during peak season, our current inventories are managed at normal levels, which is lower year-over-year. As concerns over an economic recession and slowing TV demand persist, heightened competition within the market is expected to continue. Therefore, sound inventory management as a strategy to protect profitability will become increasingly important this year. Our goal is to maintain the current level of inventory by closely cooperating with distributors to improve the accuracy of demand forecasts. And we aim to continuously maintain sound inventory levels by developing product and sales plans that are aligned with actual sales. I have 2 questions. My first question is on HE. Will your TV business strategy be affected by LG Display's decision to close its LCD panel business? And what is your response to the market's concerns over the possible shrinkage of the OLED TV ecosystem? Please comment on this, if possible? And then my second question is on H&A. As mentioned before, we have high expectations for the improved profitability in terms of logistics costs. And I'm wondering how have the terms and conditions of the logistics contracts changed compared to the past, such as contract rates or contract period? And how much will it contribute to H&A's margin improvement this year? Let me answer your first question on HE. As you may well know, we will continue our strategy to pursue the qualitative growth of our TV business by solidifying our presence in the premium market led by OLED TVs and accelerating our efforts to change the fundamentals into more software oriented. Amid an oversupply of LCD panels stemming from slowing TV demand, panel makers are expected to maintain flexibility in capacity utilization in order to prevent further price drops and protect profitability. In response to this, we are going to work on sourcing from multiple panel suppliers other than LGD, and we are going to improve the supply chain management, and we will make sure that we meet our supply plans and that our strategy to focus on premium products remain on track. And we believe that LGD's shift from LCD to OLED, we believe it could have a positive impact on the expansion of the OLED ecosystem. And once LG Display improves their fundamentals to become more high-end oriented and thus create economies of scale, we will also be able to deliver differentiated customer experience unique to LG OLED TVs to more customers by adding fundamental value to our products based on a more stable supply of OLED panels. Let me answer your second question on H&A. Market conditions, including falling ocean freight rates since the second half of 2022, were reflected in the negotiations for the logistics contract for 2023, and substantial efforts were made to meaningfully improve our cost structure. Although freight rates may differ depending on whether the contract is short term or medium term, the rate decreases have been reflected to secure competitiveness in ocean freight rates after sufficiently taking into account the volatility in the market. The new rates are applied as of January 2023, which will contribute to P&L improvement. Also, not only ocean freight rates, but also trucking rates are declining due to weakening demand. Logistics inefficiencies such as demurrage and costs associated with moving from one warehouse to another that we experienced during the pandemic are expected to be eliminated in 2023. Although uncertainties remain amid challenging macro environment, including global demand slowdown, we do expect our cost structure to improve to close to pre-2021 levels. I have 2 questions. My first question is related to TV. As you know, TVs have been evolving continuously from 2K to 4K to 8K. And as TVs evolve in terms of resolution, it is only natural that it is consuming more power. And currently in Europe, they are imposing regulations on TV power consumption. So I would like to know what is our response to this. And as you know, 8K TV can be a critical inflection point for us. But I'm wondering how we're going to respond to these regulations being imposed by the European Union? My second question is on corporate-wide operations. What is your CapEx plan for 2022 and 2023? Can you please elaborate on it? It's been already known that Innotek's investment is around KRW 2 trillion, which is even larger than LG Electronics. Can you please provide that information, excluding LG Innotek? And can you also talk about the CapEx for 2022 and 2023? And can you also tell us, especially where you're making investments? Let me answer your first question on HE. In the case of our 8K LCDs, we were already aware of the regulations. So we are fully prepared to meet the EU's energy requirements. And for OLED as well, since our OLED business primarily focuses on OLED with high energy efficiency, we do not believe we will see any issues or problems in terms of EU's regulations on power consumption. Let me answer your question on CapEx. As you know, we have made investments of just over KRW 2 trillion on an annual basis based on our role to set CapEx investment only within our EBITDA. On investment area for 2023, we plan to continue that funding to maintain and strengthen the existing business capabilities to develop an intelligent approach to manufacturing innovation and to achieve digital transformation going into 2023. We'll also continue to invest in identifying new promising areas and diversifying our business portfolio. So we expect this year's CapEx to stand at around mid KRW 2 trillion levels like last year. However, we do plan to minimize unnecessary investments and further the efficiency of our resources amidst changes to our business environment such as concerns over economic slowdown or slowing global demand, so that we can continue to secure and improve our financial health. This is Cha Yumi. I have 2 questions on VS and BS. The first one is on VS. How are the backlogs as of the end of 2022? What is your targeted amount by the end of this year? If possible, can you please provide the information by each business? And do you expect any impact on that given the FX rates that are now falling? If so, what do you expect that amount to be? And then secondly, can you talk a little bit about BS division's robot business' progress and plan for 2023? Let me answer your question on VS. We recorded a backlog of KRW 80 trillion on the back of a surge of new orders in 2022. In terms of each business' shares of the total backlog as of late 2022, infotainment took off a percentage in the mid-60s, EV component around 20%, and automotive lamp about like reached 10%. In terms of our backlog at the end of 2023, there might be some FX impact. But we're to continue growth momentum with more order intakes down the road and expect the EV component business to continue to take up a larger share of the total backlog in the future on the back of high growth within the EV market and LG Magna's DV effects. Let me answer your question on your question about BS divisions, robot business progress and plan. A survey on the robotic industry found domestic service parts have shown a high 42% CAGR over the past 3 years. Standouts are logistics robots for manufacturing processes for tending robots and serving bots being rolled out. With the government quickly addressing regulations in the sector, we expect the market to continue its growth trajectory. In response, we have done serving, delivery, logistics, guide, and disinfection bot businesses for various verticals such as hotels, hospitals, residences and F&B companies. In particular, we have made integrated solutions to provide our customers with differentiated experiences based on our technological capabilities to best meet requirements like aligning with their different operating systems. In 2022, we expanded our delivery bot sales for strategic partners and kicked off our supply of robotic logistics and delivery solutions, making major achievements. Going into 2023, when the serving and logistics bot market is to steadily grow, we will continue our readiness of unmanned and automated solutions based on robots for each vertical, so that more of our customers can meet and experience our LG coy. Since there is no more question, that concludes today's earnings call for the fourth quarter of 2022. For further questions, please contact our IR team. Thank you for joining us today.
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EarningCall_1272
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All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero on your telephone keypad. After todayâs presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one. To withdraw your question, you may press star and then two. Before proceeding, we would like to mention that this presentation may contain forward-looking information about TrustCo Bank Corp New York that is intended to be covered by the Safe Harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Actual results, performance or achievements could differ materially from those expressed in or implied by such statements due to various risks, uncertainties, and other factors. More detailed information about these and other risk factors can be found in our press release that preceded this call and in the risk factors and forward-looking statements section of our annual report on Form 10-K and as updated by our quarterly reports on Form 10-Q. The forward-looking statements made on this call are valid only as of the date hereof, and the company disclaims any obligation to update this information except to reflect events or developments after the date of this call, except as may be required by applicable law. During todayâs call, we will discuss certain financial measures derived from our financial statements that are not determined in accordance with U.S. GAAP. The reconciliations of such non-GAAP financial measures to the most comparable GAAP figures are included in our earnings press release, which is available under the Investor Relations tab of our website at trustcobank.com. Please note todayâs event is being recorded. A replay of the call will be available for 30 days and an audio webcast will be available for one year, as described in our earnings press release. At this time, I would like to turn the conference call over to Mr. Robert J. McCormick, Chairman, President and CEO. Please go ahead. Thank you and good morning everyone. Iâm Rob McCormick, the President of Trustco Bank. As usual, Mike Ozimek and Scot Salvador join me on the call today. Weâll follow our regular format for the call. I will briefly hit the highlights, then Mike, our CFO will give great detail on the numbers, Scot will cover the loan portfolio, leaving time for questions at the time. We had a great year at Trustco in 2022. Our net income was $75.2 million, up over 22% from 2021 and clearly a record. We also completely executed our stock buyback, increased our cash dividend for the second year in a row, and grew our loan portfolio to record levels and celebrated our 120th anniversary. Our loans were up about 5.7% year-over-year. As you would expect, most of this growth was in our residential mortgage area. We were very encouraged to see all areas perform positively. Commercial loans and home equity lending were both up. Even installment loans, a very small part of our business, was positive. We did see some deposit run-off, especially in the money market category. While weâre not happy about it, we are not surprised. Incredible deposit growth and stimulus money were much stickier than most of us thought they would be. We are taking a cautious approach with regard to deposit pricing now. We continue to stay very liquid in anticipation of an ever-changing rate environment. All of our performance ratios were very solid. Margin was 2.99, up over 2021. Non-performing loans to total loans was 0.37, down from 2021. Non-performing assets to total assets was 0.33. Our reserve for loan losses was just under 1% of total loans, resulting in a coverage ratio of 2.6 times. Our ROA and ROE were 1.22 and 12.6% respectively, both up from â21; and finally, our efficiency ratio was just over 50%. We continue to pay a very healthy dividend, resulting in a payout ratio of about 36%. We certainly had a pretty good 2022. We are approaching â23 with a strong backlog of loans, leaving us optimistic. We are taking a cautious approach in regard to our deposit offerings and closely watching rates. Now Mike will give us a lot of detail on the numbers, Scot will give color on the loan portfolio, then we can take your questions. As we noted in the press release, the company saw a year-to-date net income of $75.2 million and $20.9 million in the fourth quarter of 2022, an increase of 28.7% over the prior year quarter which yielded a return on average assets and average equity of 1.38% and 13.91% respectively. Average loans for the fourth quarter of 2022 grew 5.7% over $253.2 million to $4.7 billion from the fourth quarter of 2021. As expected, the growth continues to be concentrated within our primary lending focus, the residential real estate portfolio, which increased by $181.8 million or 4.6% for fourth quarter of 2022 over the same period in 2021. The average commercial loan portfolio increased to $21.1 million or 10.4% over the same period in â21. Total average investment securities, which include the AFS AECM portfolios, remained stable, increasing $2.3 million during the fourth quarter of â22 over the third quarter of â22. During the same period, the bank had approximately $11.6 million of pooled securities paid down and purchased approximately $19.1 million of securities. For the fourth quarter of â22, the provision for credit losses was $50,000. This includes a provision for credit losses on loans of $500,000 and a benefit for credit losses on unfunded commitments of $450,000 as a result of decreases in unfunded loans. The ratio of allowance to loan losses to total loans was 0.97% as of December 31, 2022 compared to 1% as of the same period in â21. Our focus continues to be on traditional residential lending and conservative balance sheet management which has continued to enable us to produce consistent, high quality recurring earnings. Our investment portfolio is and always been a source of liquidity to fund loan growth and provide flexibility for balance sheet management. As a result, we held an average of $669 million of overnight investments during the fourth quarter of â22, a decrease of $454 million compared to the same period in 2021. Given the current level of cash and the changing interest rate environment, the bank will continue to evaluate investing excess liquidity into the market. On the funding side of the balance sheet, total average deposits decreased $25.4 million or 0.5% for the fourth quarter of â22 over the same period a year earlier. The decrease in deposits was the result of a $94.5 million decrease in average money market deposits and a decrease in average time deposits to $72.2 million. These were offset by a $78.6 million increase in average savings deposits, a $12.5 million increase in interest-bearing checking account averages, and a $50.2 million increase in average non-interest bearing checking balances. During this same period, our total cost of interest-bearing deposits increased to 25 basis points from 11 basis points. This was primarily driven by an increase in time deposits to 74 basis points from 32 basis points over the same period last year. As we move into 2023, the bank has approximately $211 million of CDs that will mature at an average rate of 22 basis points in the first quarter of â23. In the second quarter of â23, approximately $234 million in CDs will mature at an average rate of 1.15%, and in the second half of â23 approximately $367 million in CDs will mature at an average rate of 1.87. Our financial services division continues to be a significant recurring source of non-interest income. They had approximately $954 million of assets under management as of December 31, 2022. Now onto non-interest expense. Total non-interest expense net of ROE expense came in at $26.3 million, up $284,000 compared to the third quarter of â22 and slightly over our estimated range of $24.9 million to $25.5 million. The increase from prior quarter is primarily a result of an increase in seasonal Q4 salaries and employee benefit expense and equipment expense, partially offset by decreases in net occupancy expenses, professional services, and outsourced services. ROE expense net came in at an expense of $101,000 for the quarter as compared to an expense of $124,000 in the prior quarter. Given the continued low level of ROE expenses, we are going to continue to hold the anticipated level of expense not to exceed $250,000 per quarter. All the other categories of non-interest expense were in line with our expectations for the third quarter and fourth. We would expect 2023âs total recurring non-interest expense net of ROE expense to be in the range of $26.2 million to $26.7 million per quarter. The efficiency ratio in the fourth quarter of â22 came in at 48.8% compared to 58.5% in the fourth quarter of â21. Finally the capital ratios. Consolidated equity to assets ratio was 10% for the fourth quarter of â22 compared to 9.7% in the fourth quarter of â21. The bank continues to be proud of its ability to maintain shareholder value during these challenging economic times. Book value per share at December 31, 2022 was $31.54, up 0.8% compared to $31.28 a year earlier. The bank enjoyed strong loan growth for the fourth quarter. Overall loans grew a combined $104 million or 2.2% in actual numbers. Year-over-year loans grew $294 million or 6.6%. The loan growth in the fourth quarter was spread across all our lending categories and market areas. Real estate increased by $88 million on the quarter and by $261 million year-over-year. First mortgages showed the largest quarterly growth at $72 million while home equity loans continued the recent upward trajectory and increased by $16 million on the quarter. Commercial loans also continued their recent growth path and increased by $14 million in the quarter and by $31 million year-over-year. We were very pleased to see the ongoing loan growth given the changes in market conditions over recent months. Purchase activity has slowed with the season and increased interest rates, but we continue to benefit from our strong market position and the solid loan backlog we carried into the fall season. Interest rates have eased a bit recently and our current 30-year base rate stands at 5.99%. Moving forward, we plan to keep our rates very competitive and be opportunistic as conditions warrant in terms of grabbing additional market share. Our loan backlog was strong at year end. It was down from the third quarter, which is normal, but well above that of last year. A significant portion of the backlog contains new money to the bank, given the very low levels of refinance activity. As mentioned previously and in addition to our existing branch network personnel, we are moving to add some additional loan originators in the residential area. In conjunction with this, we will in the first quarter begin to originate some secondary market products in addition to our normal portfolio loans. We will be originating Fannie Mae, Freddie Mac, and VA loan initially with additional product offerings likely to be added over time. While our portfolio product is still our primary focus, having the ability to access the secondary market will give us additional flexibility and opportunity for fee income. Although our initial steps will be modest, we are excited about this initiative and feel it holds a lot of potential for the bank. Asset quality measurements continued to be good in the fourth quarter. Non-performing loans dropped from $18.7 million to $17.5 million in the quarter while non-performing assets increased slightly to stand at $19.6 million. As a percent of total loans, non-performing loans now stand at 0.37% versus 0.42% a year ago. Charge-offs showed a slight net recovery on the quarter and a $312,000 net recovery on the year. The [indiscernible] ratio, or allowance for credit losses to non-performing loans, climbed to 263% at year end versus 236% a year ago. First off, talking about deposits, which is certainly the biggest focus for any bank right now, I think, Rob, in your prepared remarks you said that you were taking a more cautious approach to deposit pricing now. Iâm just curious if you can elaborate on that a little bit. Weâre trying to do what we have to do to retain what we have, Alex. Weâre much more in a hold pattern than a growth pattern with regard to deposits, keeping what we need and not really going out there full force. Youâre not seeing a 4% rate in our offerings right now. Okay, so a quarter or two ago, you were more willing to hold the rate and sort of let some excess run off, and now the target is to keep deposits at least flat and maybe grow them a little bit? Yes, I mean, a little more runoff wouldnât bother us probably either, Alex. It depends on what we have to pay for those deposits. Okay, and then as we kind of balance that against excess cash, which you guys still have a pretty elevated excess cash position relative to many other banks out there, and I know itâs a big part of your interest rate management strategy, Iâm just curious how low we could see that cash and equivalents get down to as a percentage of assets. Iâm reluctant to give a specific percentage, but as you said, thereâs a lot of room there, so weâre pretty comfortable with where weâre at. Again, as I said in the presentation, weâre pretty optimistic about â23. Okay. In terms of what youâre seeing on the residential loan portfolio, there was clearly a normal pace of pay-downs that you get in any interest rate environment as people move and pass away, upgrade and everything like that. Iâm just curious if youâre seeing any change, or maybe itâs a little bit early to kind of draw any sort of trends after a quarter or two, but any sort of change in what you maybe normally would have expected from normalized pay-down activity in the residential loan portfolio? Then just a final question from me, when I think about expenses, and you gave the expense guidance, you talked about looking to add some additional originators, thatâs all incorporated into the expense guidance for 2023, correct? Obviously the credit quality looks really good in terms of what youâve disclosed. Any increase in delinquencies that youâre seeing in either Florida or New York in the residential mortgages? Okay, great. Then I noticed there is a $314,000 increase in commercial loan NPLs in Florida. Is that one loan, is it collateralized, and any color you can provide on that? Okay. Okay, and then last one from me, can you talk about the competitive environment in residential mortgage underwriting? Obviously a big competitor announced theyâre pulling back. Then also, any color--Iâm not sure of the history, have you done secondary market originations in the past? Just a little more color on sort of whatâs driving that decision to target that market. Ian, I think you know our profile. Weâre a pretty conservative underwriter always, so we donât really change from--change our colors with regard to that. We try and stay conservative all of the time, and that maintains consistency which the market certainly appreciates. We have never originated secondary market, whether itâs Fannie Mae, Freddie Mac, FHA or VA. We do have a small relationship with a local mortgage banker that we buy loans on an individual basis from, but this is a new venture to us. We have hired very experienced, qualified people who have a long history of working in the mortgage banking industry to assist us with this, and so far, so good. Weâve originated our first VA residential mortgage and things seem to be going very well. Yes, thatâs [indiscernible] to do, Ian. Everyone comes in and out of the mortgage business, and one firm is hot and heavy for a period of time and then they back down and maybe lose a little market share, but thereâs always someone coming up to fill those shoes. Thatâs again why we try and stay consistent. Weâre not really looking to be a market leader with regard to residential mortgage lending, we just want to be a consistent performer and be able to fill our coffers and not worry about what the rest of the world is doing. As long as weâre able to do that, we welcome the competition. This concludes our question and answer session. I would like to turn the conference back to Robert J. McCormick for any closing remarks. Robert?
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EarningCall_1273
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Good morning and welcome to the National Rural Utilities Cooperative Finance Corporation Fiscal Year 2023 Second Quarter Investor Call. Today's conference is being recorded. Hello, I'm Heesun Choi, Vice President of Capital Markets Relations at National Rural Utilities Cooperative Finance Corporation. Thanks for joining us in our fiscal year 2023 second quarter investor conference call. On todayâs call Andrew Don, our Chief Executive Officer, and Ling Wang, our Chief Financial Officer will discuss our financial result during the three months [indiscernible] six months ended November 30, 2022. Before we begin our discussion, I want to remind you that some information provided and comments made during today's call will contain forward-looking statements within the Securities Act of 1933 as amended, and the Exchange Act of 1934 as amended. Forward-looking statements which are based on certain assumptions and describe our future plans, strategies, and expectations are generally identified by our use of words such as intend, plan, may, should, will, project, estimate, anticipate, believe, expect, continue, potential, opportunity, and similar expressions, whether in the negative or affirmative, or statements about future expectations or projections are forward-looking statements. Although we believe that the expectations reflected in our forward-looking statements are based on reasonable assumptions, actual results and performance may differ materially from our forward-looking statements. Factors that could cause future results to vary from our forward-looking statements about our current expectations are included in our annual and quarterly reports filed with the U.S. Securities and Exchange Commission. All the forward-looking statements are made as of today, January 18, 2023, and we undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances, or changes in our expectations after the statements are made. Today's discussion will also include certain non-GAAP measures. Please refer to our Form 10-Q, filed on January 13, 2023, with the SEC and also posted on our website for discussion of why we believe our adjusting measures provide useful information in analyzing CFCâs financial performance and the reconciliation to the most comparable GAAP measures. We will open the call for Q&A at the end of the presentation. You can ask questions via phone or submit your questions online if you're participating in this event via webcast. We invite you to join our Q&A session to ask questions you may have. Today's presentation slides and financial reports filed with the SEC are available in our Investor Relations page on our website at www.nrucfc.coop. A replay and call transcript will be also available in our Investor Relations page after this event. Thank you, Heesun. Good morning. Itâs Andrew Don, Chief Executive Officer for CFC. Thank you for joining us today. I am pleased to review our business and operations during our second fiscal quarter of 2023, which was the three-month period ended November 30, 2022. We have continued to generate solid financial results during the second fiscal quarter and for the first six months of our 2023 fiscal year. As of November 30, 2022, our total assets exceeded $33 billion, with our loans to members being the largest component in the balance sheet at $31.6 billion. This level represents a net increase of $1.5 billion from the May 31, 2022 fiscal year-end level. The $1.5 billion increase in loans to members during the six months ended November 30, 2022, reflected net increases in long-term and line of credit loans of $825 million and $688 million, respectively. The $688 million increase in line of credit loans outstanding was primarily attributable to funding provided for higher operating costs that our members have experienced due to inflationary pressures, as well as broadband investments in the form of bridge loan financing. Our long-term loan advances during the current year-to-date period totaled $1.7 billion, with approximately $1.6 billion or 95% of those advances made for capital expenditure purposes and only $40 million or 2% for the refinancing of loans made by other lenders. For the same prior year-to-date period, our long-term loan advances totaled $1.5 billion consisting of $1 billion or 69% for capital expenditure purposes and $437 million or 29% for members operating expenses, primarily due to increased power costs and natural gas prices during the March 2021 Winter Storm Uri. Of the total long-term loans advanced for capital expenditures during the current year-to-date period, approximately $397 million or 24% was to provide funding for our electric distribution members infrastructure investments and broadband projects. Our aggregate loans outstanding to our distribution members relating to their broadband projects increased to approximately $2 billion as of November 30, 2022, compared to approximately $1.6 billion as of May 31, 2022. From an operating performance perspective, our financial position remains strong as shown by consistently solid financial metrics achieved during the current year-to-date period. Our adjusted TIER was 1.23 times during the six months ended November 30, 2022, which was well above our goal of 1.1 times. Our member's equity exceeded $2 billion at the end of the second fiscal quarter. As we've previously discussed, we've had non-performing loans outstanding to Brazos Electric Power Cooperative and its wholly-owned subsidiary, Brazos Sandy Creek Electric Cooperative, due to their bankruptcy filings. On November 14, 2022, the bankruptcy court confirmed Brazos' plan of reorganization and as a result, we had a total of $15 million in charge-offs related to the Brazos and Brazos Sandy Creek non-performing loans during the current quarter. In December 2022, we received payments for a total of $56 million from Brazos in accordance with the provision of its plan of reorganization, which included the full $21 million of the secured portion of the loans. We also expect to receive payments on the remaining amount of the Brazos and Brazos Sandy Creek outstanding non-performing loans. Ling will discuss in further detail our loans to Brazos and Brazos Sandy Creek during her review. Our liquidity position remains healthy as we continue to maintain diverse funding sources to minimize the risk of being dependent on any single source or market. Our diverse liquidity sources consist of cash, investments, committed bank lines, guaranteed underwriter program, Farmer Mac Note purchase agreement, as well as repo facilities. With that, I would like to now turn this call over to Ling, who will review our financial results in greater detail. Thank you. Good morning. This is Ling Wang, the Chief Financial Officer of CFC, and I am going to move on to Slide 7 and review the financial results during our second fiscal quarter of 2023. Our total assets at the quarter ended November 30, 2022 were approximately $33.2 billion, an increase of $1.9 billion or 6% from the fiscal year ended May 31, 2022, primarily due to the growth in our loan portfolio. Our loans to members totaled $31.6 billion as of November 30, 2022, an increase of $1.5 billion or nearly 5% from May 31, 2022 level and an increase of $890 million or 3% from the prior fiscal quarter-end. During the current fiscal year, we experienced increases in all of our business segments. Specifically, our distribution loan portfolio increased by $1 billion and power supply loan portfolio increased by $292 million. We also experienced increases in NCSC and RTFC loans of $201 million and $9 million, respectively. Our total liabilities increased by $1.6 billion or 6% to $30.8 billion as of November 30, 2022, compared to 29.1 billion as May 31, 2022, largely due to the issuance of debt to fund the growth in our loan portfolio. Our membersâ equity, which excludes cumulative derivative forward value losses and accumulated other comprehensive income, increased by $47 million or 2% to $2.1 billion as of November 30, 2022, compared to the May 31, 2022 level. Our adjusted debt to equity ratio was at 6.54 times to 1 at November 30, 2022, an increase from 6.24 times to 1 at May 31, 2022. The increase of the adjusted debt to equity ratio at November 30, 2022 was largely due to an increase of additional borrowings to support a loan growth and CFC's Board of Directors authorization of patronage capital retirement of $59 million, which was paid in July 2022, partially offset by the six-month adjusted net income. While our goal is to maintain an adjusted debt to equity ratio of approximately 6 times to 1, we expect that our adjusted debt to equity ratio will remain elevated above our target of 6 times to 1, due to strong loan growth we had. We currently anticipate approximately $1.3 billion in net long-term loan growth over the next 12 months. For the current quarter ended November 30, 2022, CFC generated an adjusted net income of $48 million and adjusted TIER of 1.2 times, compared with an adjusted net income of $64 million and an adjusted TIER of 1.32 times for the same prior year quarter. The $60 million increase -- the $60 million decrease in adjusted net income in the current quarter from the same prior year quarter was primarily attributable to an increase in the provision for credit losses of $15 million and an increase in the operating expenses of $4 million, partially offset by a $4 million decrease in losses recorded in our investment securities. For the six months ended November 30, 2022, CFC generated adjusted net income of $105 million and adjusted TIER of 1.23 times, compared with adjusted net income of $118 million and an adjusted TIER of 1.29 times for the same prior year period. The [$30 million] (ph) or 11% decrease in adjusted net income was primarily due to an increase in the provision of credit losses of $15 million and increasing operating expenses of $5 million, partially offset by increasing adjusted net interest income of $6 million and a decrease in losses recorded on our investment securities of $2 million. Our adjusted net interest income was flat at $84 million during the current quarter, compared to the same prior year quarter, as the increase in the average interest earning assets of $2.2 billion or 7% was offset by the decrease in the adjusted net interest yield of 8 basis points or 7% to 105 basis points. The decrease in the adjusted net interest yield was largely due to the combined impact of an increase in our average cost of borrowing of 36 basis points to 3.25%, partially offset by increasing average yield on our interest earning assets of 25 basis points to 4.09%. Our adjusted net interest income increased by $6 million or 3% during the current six months period compared to the same prior year period. The increase was primarily attributable to an increase in average interest earning assets of $2 billion or 7%, partially offset by the decrease in the adjusted net interest yield of 3 basis points or 3% to 1.08%. The decrease in the adjusted net interest yield was largely due to the combined impact of increasing our adjusted average cost of borrowings of 21 basis points to 3.12%, partially offset by an increase in the average yield on interest earning assets of 16 basis points to 4%. We expect our adjusted net income will remain flat over the next 12 months. However, we believe that our adjusted TIER will decrease slightly over the next 12 months, primarily attributable to our projected decrease in adjusted net interest yield based on our assumption that short-term interest rate will continue to increase in the near future and the yield curve will remain inverted. The overall compensation of our loan portfolio at November 30, 2022 remain similar, as compared with May 31, 2022. With $31 billion or 98% of our portfolio consists of loans to rural electric systems and $477 million or 2% to the telecommunications sector. The percentage of CFC's long-term fixed rate loans was at 88% of total loans outstanding as November 30, 2022, compared to 90% as of May 31, 2022. The line of credit loans accounted for 9% of total loans outstanding as of November 30, 2022 compared to 8% as of May 31, 2022. We typically lend to our members on a senior secured basis with 92% of our loans being senior secured at November 30, 2022 compared with 93% as of May 31, 2022 level. We offer long-term loans to our members for up to 35-years on a senior secured basis. The majority of our long-term loans are amortizing loans, and the average remaining maturity of our long-term loans, which accounted for 91% of our total loan outstanding as November 30, 2022 was 19-years. We expect $1.5 billion of schedule long-term loan amortization and repayment over the next 12 months. We had loans to the same three CFC power supply borrowers totaling $203 million or 0.64% of total loans outstanding classified as non-performing as of November 30, 2022 compared to $228 million or 0.76% of total loans outstanding classified as non-performing as of May 31, 2022. Non-performing loans include loans to Brazos Electric Power Cooperative and its wholly-owned subsidiary of Brazos Sandy Creek Electric Cooperative, totaling $99 million at November 30, 2022 compared to [$114] (ph) million as of May 31, 2022. The reduction in non-performing loans of $25 million during the current quarter was due to a combination of the charge-offs related to the non-performing loans to Brazos and Brazos Sandy Creek and the receipt of loan principal payment are not a non-performing loan. Loans to Brazos accounted for $78 million of which $57 million was unsecured and $21 million was secured as of November 30, 2022 compared to $86 million of which $65 million was unsecured and $21 million was secured as of May 31, 2022. Loans to Brazos Sandy Creek accounted for $21 million and $28 million as of November 30 and as of May 31, 2022. The charge-offs that we recorded during the current quarter totaled $15 million, $7 million for Brazos and $8 million for Brazos Sandy Creek. As a result, we recorded a net charge-off rate of 0.19% and 0.10% annualized for the three months and the six months ended November 30, 2022 respectively. In comparison, we had no loan charge-offs during the same prior year period. Prior to Brazos and Brazos Sandy Creekâs bankruptcy filings, we had not experienced any default or charge-offs in our electric utility and telecommunications loan portfolio since fiscal year 2013 and 2017 respectively. As Andrew mentioned earlier, we received payment of $56 million from Brazos in December 2022 subsequent to our current quarter end. These payments reduced our loans outstanding to Brazos to $22 million from $78 million as of November 31, 2022. The entirety of which is unsecured. We expect to receive the remaining unsecured portion of the loans for Brazos over the next six to 12 months. We also expect to receive payments for the Brazos Sandy Creek outstanding non-performing loans in accordance with the provisions of Brazos plan of reorganization from cash available for distribution by Brazos Sandy Creek. And the sale of Brazos Sandy Creekâs 25% tenant income and ownership interest in the Brazos Sandy Creek Energy Station. On December 20, 2022, Brazos Sandy Creekâs 25% tenant income and ownership interest in the Brazos Sandy Creek Station was sold for a credit bit of $105 million to Riesel HoldCo, which is referred as a HoldCo from now. That is an entity formed by the Brazos Sandy Creek no holders including CFC. We were allocated ownership interest in HoldCo based on our 7.41% share in the $105 million credit bid, which totaled $8 million. HoldCo intends to manage its ownership interest in the asset directly and potentially sell it at a future date. We currently do not have a timeline for the disposition. Our allowance for credit losses was $68 million as of both November 30 and May 31, 2022, while the allowance coverage ratio decreased slightly to 0.21% as of November 30, 2022 from 0.22% as of May 31, 2022. The allowance for credit losses reflected an increase in the collective allowance of $2 million offset by a decrease in the asset specific allowance of $2 million. The collective allowance increase of $2 million was due to an increase in total loans outstanding and a decrease in the historical recovery rate assumption used in determining the collective allowance for our electric power supply loan portfolio. The asset specific allowance decrease of $2 million was attributable to -- primarily to charge-offs totaling $15 million related to Brazos and Brazos Sandy Creek non-performing loans. Partially offset by an increase in the asset specific allowance for another non-performing loan to a CFC power supply borrower, due to a decrease in the expected payment on this loan. We continue to believe that the overall quality of our portfolio remains strong as of November 30, 2022, as historically proven by a limited track record of default and losses on loss in our electric utility portfolio. Our total debt outstanding was $30.4 billion as of November 30, 2022, an increase of $1.6 billion or 6% from May 31, 2022, primarily to fund the growth in our loan portfolio. We maintain a diverse funding sources, including funding from our members, as well as capital markets and non-capital markets funding to minimize our risk of being dependent on any single source of market. As both November 30 and May 31, 2022, $5.4 billion of CFCâs funding came from our members in the form of short-term and long-term investments. Our member investments represented 18% of our total debt outstanding as of November 30, 2022, compared to 19% at May 31, 2022. At November 30 2022, our funding under the Guaranteed Underwriter Program and notes payable with Farmer Mac totaled $9.4 billion or 31% of our total debt outstanding, an increase of $164 million from May 31, 2022, due to a net increase of $212 million in borrowings under the Guaranteed Underwriter Program, partially offset by a net decrease of $47 million in the borrowings under the Farmer Mac no purchase program. Our capital Market related funding sources totaled $15.6 billion at November 30, 2022, an increase of $1.5 billion from May 31, 2022. The increase was primarily due to a net increase of $747 million in collateral trust bonds, due to our issuance in August and October 2022, a net increase of $390 million in borrowings on the repurchase agreement, a net increase of $326 million in dealer commercial paper and a net increase of $49 million in dealer medium term notes outstanding. At November 30, 2022, capital markets related funding sources accounted for 51% of our total funding, compared with 49% at May 31, 2022. At November 30, 2022, 57% of our total debt outstanding was secured and 43% was unsecured, compared to 56% secured and 44% unsecured at May 31, 2022. Our short-term borrowings increased by $630 million to $5.6 billion accounting for 18% of our total debt outstanding at November 30, 2022, compared with $5 billion or 17% of total debt outstanding at May 31, 2022. The increase in our short-term borrowing was primarily due to an increase in dealer commercial paper and borrowing on the repurchase agreement. A total of $3.9 billion or 69% of our total short-term borrowings came from our member short-term investments at November 30, 2022, compared with $4 billion or 79% at May 31, 2022. Our member investments have been a stable and reliable funding source for us. Over the last 12 fiscal quarters, our member short-term investments have averaged around $3.7 billion. Our intent is to manage our short-term wholesale funding risk by maintaining dealer commercial paper outstanding at each quarter end with a range of $1 to $1.5. This slide present CFC's long-term debt maturities and amortization over the next 12 months from January 2023. Our upcoming non-member debt maturities and amortization consists of $755 million in collateral trust bonds $725 million in dealer median term notes, $47 million in retail median term notes, $96 million in Farmer Mac notes payable and $185 million in Guaranteed Underwriter Program. During the current quarter, we issued $350 million of 10-year collateral trust bond and $500 million three year dealer median term notes. We borrowed $200 million with a seven year term under the Farmer Mac note purchase agreement and $200 million with a 30 year amortizing structure nder the Guaranteed Unwriter Program. We had $390 million short-term borrowing under our repurchase agreement as of November 30 2022, which we repaid on December 02, 2022. Subsequent to our current quarter end, in December 2022, we issued $400 million five year dealer medium term loans. Excluding our member median term notes maturities of $503 million, which have traditionally be reinvested with us, we have approximately $1.8 billion of refinancing need over the next 12 months to fund the upcoming maturities from January to December 2023. As we have consistently stated, we will look to utilize both capital markets and non-capital markets funding sources to refinance upcoming debt maturities in due course. This slide shows the various sources of liquidity that CFC had in place at November 30 2022, our available liquidity from various sources included cash and investments, committed bank lines, guarantee underwriter program and Farmer Mac revolving no purchase agreement, totaling $7.2 billion as November 30, 2022. During the current quarter, we amended the three year and the four year committed bank revolving line of credit agreements to extend the maturity dates to November 28, 2025 and November 28, 2026, respectively. Subsequent to our quarter end in December 2022, we closed a new facility totaling $750 million under the Guaranteed Unwriter Program. Including the $750 milliion availability under the new facility, we currently have a total of $1.52 million availability under the Guaranteed Underwriter Program. As indicated in the table, at November 30, 2022, short-term investments from our members totaled $3.9 billion, because our members have traditionally roll over a large portion of their short-term investment with us at maturity. We consider our member investments to be very stable and reliable source of funding for CFC. Excluding our member short-term debt maturities, we had approximately $3.7 billion of debt maturities over the next 12 months as of November 30, 2022. These debt maturities consist of outstanding borrowings under repurchase agreement of $390 million, dealer commercial paper of $1.4 billion and long-term and subordinated debt obligations of $1.9 billion. Excluding the $3.9 billion debt maturities related to our member short-term investment, we have a total liquidity equal to 1.9 times or $3.5 billion of liquidity in excess of our debt maturities over the next 12 months subsequent to November 30, 2022. This does not include the $1.5 billion scheduled repayment and amortization on long-term loans that we expect to receive from our members over the next 12 months. This slide represents CFC's projected long-term debt issuance need over the next 18 months subsequent to November 30, 2022. Our cash needs are derived from two primary areas: refinancing existing debt maturities and funding loan growth, partially offset by the amortization and repayment of loans from our members. Our funding needs are also driven by our member investment levels. We expect our net long-term loan growth over the net 18 months period to be approximately $1.8 billion. As indicated in the last column, our expected long-term debt issuance over this period are approximately $4.5 billion, mainly to refinancing existing long-term debt maturities. To meet our funding needs, we will continue to look to balance capital markets and non-capital markets, secured and unsecured financings while always look to access the most attractive cost of funds for our members. To conclude our call, I'd like to leave you with a few key takeaways where you consider CFC as an investment opportunity. These key items are areas that CFC consistently focus on and represent credit strength when viewing CFC as an investment. CFC's credit ratings from Fitch, Moody's and S&P remained strong and stable at A+, A1 and A- on a senior secured basis and A, A2 and A- on a senior unsecured basis respectively. During the current quarter, Fitch affirmed CFC's credit rating and stable outlook on December 7, 2022, S&P reaffirmed CFC's credit ratings and outlook. CFC's secure offering in the capital markets is in the form of collateral trust bond. As a reminder, our collateral trust bonds are secured by the pledge of electric distribution cooperatives senior secured mortgage notes. The overall quality of our loan portfolios continued to be strong with 79% of our loans to electric distribution borrowers and 16% to power supply borrowers. In addition 92% of our loans are made on a senior secured basis. CFC continues to receive strong support from our members, both in terms of new lending business and as a valuable funding source. Our short-term and long-term member investments totaled $5.4 billion at the end of the current quarter, compared with 4.2 billion at our fiscal year-end 2017. Over the last 12 fiscal quarters, our total member investments have averaged $5.2 billion. Our member's equity has grown by 49% to 2.1 billion from $1.4 billion at May 31, 2017, as we are committed to grow our equity through retained earnings. We continue to maintain diverse funding sources and demonstrate a healthy liquidity profile. Our funding sources are very well established and have remained stable. Thank you, again, once to join us today to review our results for our fiscal quarter ended November 30, 2022. We appreciate your interest in CFC and look forward to discussing our financial performance and funding plans in the future. I'd like to ask the operators to open the lines for questions and also suggest that you submit your questions via the web service, so we may respond to those as well. Thank you. Hey, good morning. Thank you for taking my question. I just wanted to ask, so you mentioned that you wanted to sort of keep access to like a multiple sources of financing. I was curious if you could give us some color around how you were thinking about hybrids? And on that note, I know you have a junior staffs that could be redeemed next year? Just trying to think how you guys think about that issue, particularly? I mean, obviously, we've issued subordinated debt in the form of hybrids several times over the last couple of years to manage our debt to equity. As you noted, we actually do have a -- we had a 2013 issuance and there was a 10-year fixed float, so that does actually come up for potential call. I believe this April, we are certainly looking at options, as well as what the pricing would be. It is certainly a tool that we've used to manage our adjusted debt to equity level and we'll continue to consider that as a source of funding. I don't know, is there anything more specific you had related to that or? Okay. Thank you very much for joining us today. And if you have any additional questions, feel free to contact myself or Heesun Choi. Have a good day.
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EarningCall_1274
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Welcome to this presentation of the SSAB Q4 and Full Year Report for 2022. My name is Per Hillström. I am Head of Investor Relations. And with us today here is President and CEO, Martin Lindqvist and also our CFO, Leena Craelius. And the agenda, Martin will start to go through the year and the quarter, another record year for SSAB. Leena will go into the financials a bit more in detail. And then Martin will handle the outlook and the summary. And we finish off, as usual, with questions and answers. So by that, please, Martin, take the stage. Thank you, Per and good morning. 2022 was, I would say, a very volatile year with a lot of things that we needed to handle with â started with the invasion of Ukraine, problems with transports and so on, but having said that, we had a very good year. And if we start with one of the most important KPIs safety, we continue to improve our lost time injury frequency. We were just above 1.0, which is compared to the history, really good and I would also say compared to the industry on a good level. We are not done. We need to come down to zero and we have, of course, the ambitions to become the safest steel company in the world. We also had record earnings. The adjusted operating profit was or EBIT was SEK29.3 billion, which was the best year we have ever had. â21 was a good year, but this was more than SEK10 billion better for the full year. We continue to generate decent and strong cash flows. Cash flow before dividend amounted to SEK14.2 billion, so another year with strong cash flow generation. And when we ended the year, we had a net cash position of SEK14.3 billion compared to not that many years ago, a net debt position. In Q4, we also took an impairment write-down of the goodwill related to the acquisitions of IPSCO and Ruukki of $33.3 billion. That affected as a one-off for the fourth quarter. And the board â we had a board meeting yesterday. The board will propose to the AGM a dividend of SEK8.70 per share. And we have, as you know a dividend policy of putting our dividend between 30% and 50% of net profit, and this is smack in the middle, 40%. The Board will also ask the AGM for that authorization to buyback up to 10% of the shares in SSAB. If we move into the divisions, Special Steels, record earnings. We had a strong price realization, good development of the product mix. And the EBIT margin for the full year was 24.6%, which is really, really good. Q4 prices and product mix held up very well. We had planned maintenance in Q4, but we also saw a slightly weaker apparent demand in Europe that impacted shipments and result â these two reasons, but still a very good profitability of SEK1.4 billion in Q4. Another strong achievement is our U.S. plate operations, where we at the full year had an EBIT margin of 38.1%, so more than 38% in EBIT margin. We had record earnings and we continued to increase prices during the year, if we look at Q4, still a very good earnings of $2.7 billion. We saw that prices decreased somewhat in Q4 from very high levels, but all-in-all, a very strong achievement from North American plate or SSAB Americas. If we look into the plate-related divisions and start with SSAB Europe, for the full year, we had an EBIT margin of 17.1%, which is slightly lower than we had in 2021. In Q4, we had a planned maintenance outage. We decided to do the maintenance on one of the blast furnaces in row that was planned for second half of â23. Given the low apparent demand in Europe, we decided to do that already in Q4. And the idea then was that if the market normalizes we would start it up again early in January. And I think we started it up 2nd or 3rd January, so itâs now up and running again. And we saw during Q4 as we knew we would see lower realized prices. Tibnor, itâs a function of the, I would say, Nordic strip market to a large extent. We saw weak demand, weak apparent demand and lower prices. In this turbulent environment, we managed to continue to take market shares on the distribution market in the Nordics in, I would say, all countries, Finland, Sweden, Norway and Denmark. The big â the main reason for the big negative result is the inventory losses that we take them when prices go down, we have this â so the underlying EBIT was much better, but including inventory losses, it was minus $403 million. And then Ruukki Construction typically run into a lower season in Q4 and Q1. And on top of that, the Nordic construction market slowed up. So they were around zero for the fourth quarter. So all-in-all, three high-performing divisions in the fourth quarter, the strip-related divisions with focus on the European business met lower apparent demand. If we then continue over to what we are aiming for in mid-term and long-term, 2022 was a very important year for the transition of SSAB. We actually delivered 500 tons of fossil-free steel to our strategic customers. We start now to see not only yellow goods, we see machines from Epiroc, trucks from Volvo and cars starting to use now fossil-free steel. And we see from the partnerships we have in automotive, heavy transport, construction machinery and material handling and also construction, we see a strong demand for these kind of products and a huge interest for this development. And I would say, overall, our transformation is on plan. And you know what we are going to do we are going to replace the blast furnaces and coke oven plants with new integrated mini mills in Raahe and LuleÃ¥ â build complete new mills in Raahe and LuleÃ¥. And we are going to take away the blast furnaces and the coke oven battery in Oxelösund, then install electric arc furnace there as well. And this is nothing new for us, because we have been running electric arc furnaces in our U.S. operations for many, many years. This will give us much better flexibility, much shorter lead times and virtually no carbon-dioxide emissions from our operations. And we are now in LuleÃ¥ and Raahe running our feasibility studies. They are ongoing. We have started in LuleÃ¥ the public consultation process for the plant we started that in Q4 and we have all seen HYBRIT development continue to develop the technique and we have during the quarter filed for a number of very, very interesting patents at the European patent office. One prerequisite for this is of course that we have fossil-free electricity. And this transformation will require for SSABâs part 3 to 4 terawatt hours more electricity than we consume today. But it is, in total, we are going to need less energy. We are just shifting from coal as an energy carrier into electricity. And this will also, the mini mills help us to get more flexibility in the mix. So we could use either a sponge iron or scrap in the melt and that will also help us to be able to reduce volatility, because what we are doing in the company and you see effects of that during 2022. We are reducing, working with increasing flexibility, moving the product mix and everything in order to reduce low point profitability and have a more stable development or a stable situation when it comes to earnings in a very volatile industry. So I am a strong believer in that, the most stable steel company in this volatile industry will over time be the winner. And when we do this transformation, we will be able to reduce 10% of all the carbon-dioxide in Sweden and all the carbon-dioxide emissions in Finland we will reduce with 7%. So we are also leading the way for the steel industry showing that what was usually called hard-to-abate industry that this is actually possible. And I usually say that without the steel industry doing its homework, there will be no possibility to meet the targets we have setup in the Paris Agreement. On top of this, the 3 to 4 terawatt hours we need for SSAB, we will also need for HYBRIT demonstration plant in Gällivare, another 5 terawatt hours for 2026 in order to start now to produce sponge iron in large scale. Thank you, Martin. Pretty much was already covered in Martinâs presentation. But if we have a look at the, first of all, the shipments, start with the steel shipments, we can see that the first half of the year, yes, it was strong, stable demand, volumes still growing and then we can see the lower demand on the second half of the year and mainly in the European market, as Martin already indicated, U.S. holding up better and emerging markets as well. If we look at the sales graph, we can see that the prices, yes, they were increasing during the first half of the year, started to go down during the second half of the year and then again, mainly related to European market demand coming down. Summing up these wonderful bars here, quarterly EBITDA for â22 and then analyzing the sales graph, we can say that the sales prices, they were well compensating for the higher raw material costs that we had, higher energy costs, logistic costs, higher maintenance and repair costs, fixed costs and the lower activity level as well, and on top of that, making then SEK1 billion higher result. So we can really be proud about the result in â22. If we then look into Q4, analyzing Q4 â22 versus â21, prices on group average level, still positive impact. However, the only division here underneath is Special Steel division with higher prices. The other division already had the lower prices. So, Special Steel still compensating for that. We have also FX impact, positive stronger U.S. dollar in the price analysis impacting volumes lower and mainly with the Europe division, Special Steel division and Ruukki Construction. Variable costs related to raw material costs being higher, PCI coking coal, iron ore relatively flat compared to last year and scrap prices slightly lower compared to last year. Fixed cost and capacity utilization were impacted with the Oxelösund maintenance and the repair work in Raahe. Comparing to Q3, we can see the price development, during the fourth quarter, also the mix becoming slightly weaker. Prices came down in Europe division, in Americas division, holding better still in the Special Steel division, as Martin said, volumes only slightly higher, this mainly coming from the Europe division having a higher portion of standard grades, thus impacting actually negatively the average price level. And the variable COGS here having positive impact and this is primarily coming from the lower cost of U.S. scrap. Other raw materials were relatively flat compared to quarter-on-quarter, and again, the maintenance and repair activities impacting the fixed cost and capacity utilization. What we were promising during Q3 results release that we will focus on cash generation and releasing working capital, the outcome we can see here, it is actually providing more cash flow than the actual EBITDA. So organization did really, really good job with this task and this is primarily, again, related to inventories. So we were heavily reducing inventories during Q4. Year-on-year comparison, more than $10 billion better result. Change in working capital and the deviation here is mainly related to higher raw material cost in inventory. Maintenance CapEx on similar level, taxes being high, but as you know, big part of this is related to â21 result, strategic CapEx up with the Oxelösund conversion program. And the dividend paid out this year, you can see here, and if the dividend is approved, what is proposed, the dividend payout this year will be around $9 billion. All this led to the very strong financial position that Martin already also showed $14.3 billion net cash â positive net cash. And as already also mentioned Board yesterday proposed to have SEK8.7 per share as a dividend corresponding to this SEK9 million payable and the authorization for the mandate for share buyback program. The impairment of goodwill was done at the end of the year as a normal annual impairment test process and it led to the write-down of $33.3 billion and it is not affecting the cash flow and all the taxes. Raw material prices, iron ore, leveling out, we saw an increase in prices at the end of the â22 mainly related to the China releasing lockdowns. And then on the other hand, coking coal peaking during Q2 in the year â22, started to come down rather heavily. But to bear in mind that we do have this lag in the impact of our consumption cost. Iron ore is around one quarter and it is longer with coking coal. We do have quite substantial inventory still. So, there is longer lag with this price impact in our result. On average level, we can say that Q1 variable costs will be on similar level during Q1 than they were on Q4. What we know is that the scrap prices in U.S. started to go up at year end and have gone up during January. So there we know that the cost will be higher during Q1 compared to Q4. I will end my presentation for this familiar graph, the cash need of the business. We were indicating that there is a need of $5 billion. For this year, we didnât quite reach that, but we plan to ramp up and pick up and we plan to spend the $5 billion during this year. Thank you, Leena. So if we take then a look at Q1 and what we expect for Q1 and start with heavy transport, we see a neutral or slightly positive outlook when we look at it sequentially. We see improved supply chain for heavy trucks in Europe. We also see improvement for railcars in U.S. Automotive we see a neutral market or a decent market going forward as well as for construction machinery and material handling. When we look at the Energy segment, we see good demand for wind power and other renewables and wind power and wind towers is a very important segment for us, for our plate business in Europe. The weak market we expect to see and see is construction, of course, both dependent on seasonality, but also on higher interest rates and much lower construction activity, especially in the Nordics, but I would say, even in Poland and other parts where we are present with Ruukki Construction. But as you know, construction is a big take of volumes for the whole steel industry, less so for us, but it will affect. And then service centers, we expect to see what we usually see lower parent demand and reducing of stocks in Q4. And then in Q1, filling up stocks a bit and having apparent and real demand meeting each other. If we look at how we guide, we of course realize that we live in an unsecured world with inflation, with the interest rates and the war in Ukraine, but we see stabilization of the European market. We see that spot prices towards the end of the quarter in Europe, is moving up. We see relatively stable demand in North America for the market for heavy plates and we see that prices towards the end of the quarter, is â we have introduced price increases from mid-March. When it looks the high strength steels slowed somewhat in Europe and the apparent demand in Q4, but we expect a stable demand there as well. And Leena covered the raw material costs, but we see that will be overall relatively stable. So when we guide for shipments, we say that in Special Steels, they will be significantly higher as in Europe and somewhat higher in Americas and then we expect realized prices in Q1 being lower compared to Q4. And there is always a lag between spot prices and our contract prices. And we have the majority a bit more than 50% for us is, as you know, quarterly prices. So if one would take the opportunity to sum up. I would say, record earnings for the full year 2022 in a very turbulent world around us continued good trend in safety. We are not yet where we would like to be with the ambition of becoming the safest steel company in the world with no accidents or incidents. We are getting there, but this is in every dayâs work, and you can never give up. You need to continue to focus and continue to strive to become better. We saw the expected release of working capital in Q4 and a strong cash flow and a strong financial position at the end of the quarter. And Iâve said it many times you should expect us to continue to deliver good and strong cash flows over the cycle, operational cash flows. Dividend, as said, a proposal is SEK8.7 per share, corresponding to 40%, so smack in the middle of the dividend policy and then asking for an authorization for a share buyback program for up to 10% of the outstanding shares. The transition, the green transition, which is mid to long term, extremely important for SSAB is moving on we have, as said, done these pilot shipments of 500 tons to grateful and happy customers, and our transformation is on plan. But we need help. We need help with, I would say, mostly the most urgent topic for us is power transmission. So as long as we get fossil-free electricity at the right time, at the right place, we will be able to deliver on this very ambitious road map. Yes. And we can just start by checking here in Stockholm, if there are any questions from the audience? Okay. Then we will turn to the telephone conference. [Operator Instructions] So by that, please, operator, can you present the instructions. Yes. Yes. Yes. Thanks a lot for taking my question. Iâm more interested in hearing Martinâs thought on the underlying demand trends in Europe, I mean, your guidance is for volumes to go up significantly higher, which is more than 10%. Can you help us put the inventory destocking tend into the perspective and how the demand for your products are shaping up for the Q1? We â As you know, we took planned outage earlier almost three quarters earlier than previous planned because we realized that the apparent demand in Q4 would be lower than the underlying demand or the real demand. And we expected to see low volumes, especially the second half of December with a lot of customers taking holidays instead of working over the weekends. And thatâs what we saw. We also expected to see steel service centers, reducing volumes and working with, call it, working capital management and when we look forward, look at the order book, look at the order intake and also volumes or yes, the volumes in the supply chain, we see that there will be higher shipments in Europe. I mean the market in Europe has been I would say, decent and fairly stable during 2022. And then it has been bottlenecks. It has been bottlenecks in transport. It has been bottlenecks in semiconductors and so on. And they are not completely gone, but they are getting better and better or easier and easier to deal with. And we see especially when it comes to transports thatâs seasoning up. Itâs not perfect yet or not normal yet, but it â and thatâs why we are then on a fairly stable market guiding for higher volumes or significantly higher volumes in Q1. I understand. And then concerning the business in the U.S., the plates business, I mean, you have recently announced a plate price hike. I mean, plate prices are relatively higher level compared to the other product into the U.S. So can you help us understand whatâs driving that spend in the plate market? Itâs supply and demand. We see a strong and stable demand in U.S. And youâre right. I mean, plate prices, even though they came down a bit in Q4, they are still on high levels and margins are on high levels. And when we look forward, we see a lot of needs for plate going forward as well with investments and see wind towers, strong demand. We see good demand from OEMs. We see railcars now starting to pick up. So it is, I would say, a function of that we see good order intake, good demand. Yes. Hi, thank you for taking my questions. I have two, please. The first one on shareholder returns, your fact that the dividend proposes in line with your policy. But can you discuss a little bit of buyback? How should this be viewed within your capital allocation strategy and explained a little bit the reason behind it. Also, as youâre soon to embark in really large decarbonization investment, what gives you the necessary confidence to launch this buyback? And maybe if you can link that to maybe the earnings power you can see on a more normalized basis if itâs higher than in the past? Thank you. I mean to start with the last part of the question, I think what we are really working hard with is to stabilize earnings and lift low point profit. And itâs a number of things. I mean, one big part is, of course, the mix. We know that the volatility more advanced products like special steels and advanced high-strength steels and so on. It is â they are lower over the cycle. So lifting low profitability points and have more stability in earnings. And we do that also by constantly looking at possibilities to create flexibility in the production system and the cost and so on. So we can adjust production, adjust the cost level and so on. And you could say, smooth out is probably a bad expression but even out a bit. So I think itâs so important to this focus to low point profitability. Then when we look forward, I mean, first of all, the dividend is, as I said, in the middle of the range. And after a record year with SEK29.3 billion in EBIT and a very good net profit you should expect us to live by the dividend policy. And then when we look at the company and the possibilities to continue to generate strong cash flows, we see that we can do the investments required. It will be more dependent on when we get the outer circumstances in place like fossil free electricity and power transmission. Then I think having a mandate of a share buyback program, is good. And then you can use that when you feel that the balance sheet is strong. And I think that the net cash position of SEK14.3 billion strong balance sheet. And for the time being, we donât need to pile up cash. We should be able to return cash to shareholders, and thatâs the main thinking and reasons behind these two proposals. Okay. Thatâs very helpful. The second question is on Special Steel. Can you discuss a little bit market conditions and how do you expect 2023 to develop in Europe and rest of the world? You mentioned that demand has softened a bit in Europe, but you only guide for 5% price decline. So â does that mean youâre continuing your price of a volume strategy there? And if thatâs the case, how should we think about the 1.6 million-ton target on the volume? Is it still achievable for this year? Thank you. I think in Special Steels, it is â I mean, itâs so easy to think that Special Steel is just Special Steels, but there is a broad variety of products within Special Steels. And what we are doing also within Special Steels we are moving the mix, and we have some products that are profitable, and we have some products that are extremely profitable and we are, I mean, launching now new products like Hardox HiTuf, Hardox 500 and they are starting to ramp up and we are introducing â I mean, what was 10 years ago niche products, 400 Brinell or Hardox 400 is now, I would say, a commodity and we donât really produce that anymore. So we are moving the mix as a total, but we are also improving the mix. We have this part of Special Steel that is we call it Specialty, which is expandable rock balls and some other very, very interesting products and we have these Armox and protection plate products as well. So it is about moving the mix. So I would say what we need to achieve is a combination of both, keeping up the stability in the earnings and the profitability and expand volumes. And we have been investing quite a lot in order to be able to do that. We are now taking into the Phase 2 of the QL6 or the next expansion of the QL6 was taking on stream end of Q4, beginning of Q1. So we can increase with another 100 â a bit more than 100,000 tons on yearly production. So we see that there is still a lot to do on the market development and product development, application development. And â if you look back in history, we have been able to grow the QT business with â I think itâs around 7% to 8% per annum, and we expect to continue to see that growth. Not every quarter, sometimes a little bit lower, sometimes a little bit more, but over time, so to say. So â and when we discuss with the customers and partners and big OEMs, there is a big interest for these kind of products. So weâre trying to keep up the profitability on a stable level. I mean last year was really, really good, but keep stability, which it usually is and continue to expand volumes and invest for expanding volumes. And we will invest when we see that production becomes a bottleneck. Thatâs the plan. Good morning. Thanks so much for taking the questions. I have three quick questions. Just again, going back to capital allocation and I guess the buyback, with the dividend and the buyback, youâll be seeing a lot of cash move out of the business in the first half of the year, so about SEK15 billion. How should we think about your thinking about the balance sheet longer term? And again, that question is really directed to the sustainability of a potential rolling buyback program. My second question is just... Please, letâs take them one at a time. No, but â we expect, as Iâve said many times now, to continue to generate good cash flow. We should be a business with good cash flow generation. And we are not planning to put the company in a situation where we have a big net debt, but we are not going to pile up unnecessary much cash either because that belongs to the shareholders. So have a balanced, call it, profile of the balance sheet is, as I see it important. And we are â even though we are working hard and striving to become less volatile, we need to remember that we are in a volatile environment and in a volatile industry. And that requires decent strength of the balance sheet. So you should put that into the equation and also see that dividend in line with the dividend policy and also a strong belief that we will continue to generate decent cash flows over time. And we have, of course, done the simulations and the planning for I mean, a lot of different scenarios for the coming transformation of SSAB, and we see that, that will not be the main bottleneck. The main bottleneck will be the availability of fossil-free electricity at the right time, at the right place. Thank you, thatâs very clear. And then just two follow-up questions on the accounts, so for Q4 within the other line, you had $323 million. Could you maybe just help us sort of dig into that number a little bit more? And how should we think about that for Q1? And similarly, working capital, big release of working capital in Q4, do you think youâre now towards the end of that inventory destocking? Can we expect maybe a little bit more working capital release in Q1? I will take the second question and then let Leena answer the first one. But we have been â for the full year, we have been building working capital and a large part of it is, of course, prices. But we have also â I mean when Russia invaded Ukraine, we bought a lot of alloys. We bought a lot of raw material from Russia especially we bought 100% of the PCI coal. We stopped that immediately. And when you do that, you need to in a hurry find other suppliers, you need to test the new material. And then you typically buy more than you will actually consume because you donât really know if the raw material as such or PCI or something else will work in the process. So when we closed â22, we had, I think, more than 400,000 tons of PCI coal in stock and we need in a normal â under normal circumstances, a little bit less than 200,000 tons. So there are pluses and minuses. Yes, if sales continue and prices continue, we will probably build some working capital, but we still have possibilities to release working capital from raw materials. So we are focusing a lot on cash conversion. I mean making sure that the result we make ends up as free cash flow. And then that will, of course, be dependent on the market and prices and so on, but some possibilities on raw material, probably building up some other stocks. So â but we should not I mean we have not done something abnormal in Q4, and we have not done something abnormal in 2022. It is, to a large extent, the price component. The working capital buildup of almost, was it SEK9 billion or so for the full year. So working capital management will always be a priority regardless if we have a high net debt or a high net cash position. And Dominic this 300 in something in the other line, being positive now in Q4, that line is related to this elimination of intercompany transactions and we have reduced the inventories in our divisions. Thus, the group level elimination is positive in Q4. So it is moving up and down, depending on the inventory levels and the transfer prices we have within the divisional transactions. Yes. Hi, good morning, all. Martin, I have a quick question on the situation and actually on your first stage of your conversion program â can you give us an update where you stand now on the permissions for the transmission lines in for Gällivare and also for the Oxelösund, I think you mentioned before that this is still a priority. So I guess this is obviously taking a bit longer. So any color where we are and when you expect the decision on the demo plant actually? Now first of all, in Oxelösund, we have got the permission from [indiscernible] in Sweden that we will get the power line that is appealed and we knew that would be appealed. I think itâs 40 people â persons that have appealed that to [indiscernible] to the lower court, so to say. And then the [indiscernible] needs to take a decision, and itâs very hard to say when they will take that decision. And depending on that decision, if they would be as positive as [indiscernible] that might be appealed to the higher court [indiscernible]. And then they could either say, well, we have a decision in [indiscernible] or they can say we will not take this up or they can say this is so important we will take it up and then it will take some more time. So, itâs very hard to say exactly when we will get the permission because we are now into the court process. So, the court process is starting. But we are working, as Leena showed, we are doing the investments and we will invest in electric arc furnaces in Oxelösund. Thatâs no doubt about it. And then we are dependent on the court process and how fast that will go and if there will be additional appeals or not and so on. So, we know at least that we have the decision for [indiscernible] which is very important. Then when it comes to LuleÃ¥ and Raahe, I would say that Raahe is moving on quite nicely. In LuleÃ¥, we are working then with the power transmission together with authorities and the municipality up in LuleÃ¥. And that work is ongoing as well. But the most important part, short-term or mid-term, is the development in Oxelösund and we are working hard with that. But now it is â that process is beyond our influence or control. Right. But based on what you are saying or not saying the plan still is that you are being available with the green steel production with the 1.3 million tons by end of 2025, I guess? Beginning of 2026, we have said. But I am saying that we are still on plan. We have not seen anything that we need to change the plans. But as I have said, the good thing is that we have already delivered 500 tons of fossil-free steel, and we start to see now the first applications also out in the market being used, not just as demonstrations and examples, but actually being used in production and being â so thatâs very positive. And that is also building the market and building the interest for these kind of products. So, we are working very hard, and I am myself spending quite a lot of time discussing with authorities and politicians and try to do whatever I can to speed up that process. But as said, it is not fully in our control. That makes sense. Then I have another question on the market outlook for Europe. So, 2022 was an outstanding year for the plate business because of what happened in Ukraine and the resulting bottlenecks from there. How do you look at the market now for 2023? So, we are seeing some easing of bottlenecks, some other suppliers are coming to Europe. How do you see â how stressed, how tight will be the market for the current year? And how do you see the demand in Europe actually moving? First of all, plate, standard plate in Europe for us is a very small segment. We only deliver standard plates in the Nordic region. And we have had good demand for the fairly limited volume we have for standard plate in the Nordics. And when we look at the order book and the visibility we have is typically one quarter that will continue in Q1. So, we are fairly marginal producer or we are a very marginal producer of standard plate. We have one plate million in Raahe and we produce what is it, roughly 250,000 tons or something on a yearly basis. Yes. And then maybe more generally on demand, I think you made clear in your remarks that the destocking process is similarly coming to an end. So, what is your thinking around the underlying demand right now, you move in the soft lending them or you are a bit more capital on the real underlying demand for â23 in Europe? Well, if you talk about strip products, I would say, for Q1, stable demand and we guide for significantly higher volumes in shipments then. So, we see that the contract prices will be lower because, as I said in the beginning, there is a lag between spot prices and contract prices, but we also see that spot prices towards the end of the quarter is starting to move up. And that is of course, a positive indication if that stands. But I would say, overall, fairly stable underlying demand with some segments being quite good and some segments like construction being quite weak, but in total, stable. So for us, itâs more a situation of what we produce and what we have in the order book. And I said it was very low volumes in Q4 due to very low apparent demand. And then the â when we took that outage two quarters, three quarters earlier than previous plan, we thought that maybe Q4 is the low point, and then itâs better to do that outage and plan maintenance instead of waiting to Q2, Q3 â23, when the market hopefully is slightly better than what we saw in Q4. Okay. Would you say that your comments on fairly stable real demand, is this just for the Q1, or is this your general income for the whole year? The visibility we have is the coming quarter. Then we have the order book and the order intake. So, that I can say for sure. Then you never know, I mean when we talked a year ago, I couldnât dream of invasion of Ukraine. So, there is always possibilities for black swans or what you call it to come up. So, it will also of course, be very dependent on the macroeconomic situation and what happens with the board in Ukraine and so on. But for Q1, then I donât know of course, but then we have the order book and the order intake, and thatâs the visibility we have. Yes. Good morning Martin and thanks for taking my questions as well. I just wanted to get back to a HYBRIT and your green transition. So, first of all, I wanted to check where do you stand on securing the additional finding support, which you talked about in the third quarter? And then also on CapEx, so beyond the SEK5 billion CapEx budget, you are guiding for, for 2023, can you please update us also on the financing for HYBRIT itself? And are there any possible additional need for capital injection into HYBRIT in 2023 and 2024 as well? Not for 2023, 2024. We donât really â well, I donât really know yet, but not for 2023. And just to be clear, what I was talking about or at least what I meant when we talked about this in Q3 is the importance of a level playing field. And we are not in that aspect, dependent on financial help. But we think itâs so important that we have equal treatment for all steel companies in Europe. And now we see some examples and some other signs that might not be the case. So, we are stressing that issue, the level playing field. But as Leena showed in her presentation, we â the capital need for â23, we are fairly certain or we know the capital need and the investments. And the investments will now in this transition start to increase a bit over â22. And that is mainly the transformation of Oxelösund. Then of course, we spend a lot of cost on the planning and on the transformation office and hiring project leaders, and so on in order to do this mid-term to long-term as well. But we will start now to invest more money in order to transform Oxelösund. But what is really important to remember as well, the option was not to do nothing because we need to do this, either do this transformation, which makes a lot of sense, and it is very profitable. The alternative would have been then to build a new coke oven battery, which makes no sense. So, we are working as hard and as fast as we can. But I said many times now, we are also dependent on things that are partly at least or to a large extent, out of our control when it comes to power transmission and those things. Okay. Thanks a lot. Just on the financing support, have you at least seen some early indications? Do you feel like the government is open to still help you on the financing side and basically close to get to what some of the other governments are doing, or is this a situation where you obviously went ahead with good intention in the sense of doing it on your own and now as they know, you want to do it on your own, they basically just leave you with it? Have you been receiving any early response on that? Itâs not black or white. And letâs come back to that question if and when we have something to say. But I must say that we â from the government in Sweden and Finland, they look at this in a very positive way. And they also realize that the steel industry needs to do their homework in order for us to meet the Paris Agreement. But they also realize that this is, at the end, also a very important matter for competitiveness, not only for SSAB, but for the value chain and the demand and the customer interest is there and that they realize and recognize. Okay. Thanks a lot. And my second question is just coming back on your cost guidance for raw material costs. You guide for costs to be flat on a group level in the first quarter. And on the other side, itâs pretty clear that scrap costs are arising. So, does this mean that on the European blast furnace operations, you are still expecting costs to come off? I think thatâs the guidance, but I just want to confirm that that assumption is correct. Well, during Q1, the cost of consumption in the beginning at least, will be on a very similar level than Q4. Minor reduction could be happening at the end of Q1, but only minor. We do have the high inventories with coals, PCI coals and the â yes, also inventory with iron ore. So, we donât see the benefit of the cost reduction yet, it will come a bit later. Yes. Good morning everybody. Martin, I have a question on the outlook regarding the realized prices, which you say will be lower in the first quarter, although the spot prices are rising at the moment, is that because the contracts are quarterly and were signed at an earlier stage. And by that logic, would that mean that in the second quarter, the price â the realized prices should be higher. No. But you are correct. There is a time lag. We have very, very limited volumes on spot. And we typically have quarterly contracts. Thatâs the majority of the contracts. Then we have semiannual contracts and annual contracts. And you typically sign the contracts, I would say, mid or early second half of the previous quarter. So, thatâs why we know where the prices will go. And then you are correct that right now, the spot prices have been improving. And if that â that is typically a good indication where the contract prices will move with a lag. Yes. Hi. Good morning and thank you for taking my questions. I have two questions. I will have one at a time. First one is on capital allocation. You now have a very different financial framework business than you have ever had in the past. Do you think itâs time to revisit your capital allocation policy? And what factors do you consider and the trade-off between dividends and buybacks? That is my first question. Without answering it, we will have a Capital Markets Day in end of March, and we might come back to that topic then. Okay. Thank you. And my second question is on the Nordic system, the transformation. So, you seem to be exclusively focused on the downstream investments in mini mills, which is somewhat different to what you are doing at Oxelösund. It seems that the value along the value chain is mostly in the green auto making or producing the green sponge iron. Are you not worried that by focusing on the downstream exclusively, you are leaving lots of value on the table further upstream? But I think that is a misunderstanding. What we are focusing on is to create the fossil-free value chain together with partners starting up when the iron ore is in the mountains beneath the ground until finished products and trying to find synergies and smarter ways of working along that value chain. How that will look exactly in the future, we donât really know. What we know today is that HYBRIT is focusing on developing the technique of producing fossil-free sponge iron is planning to do this pilot plant. And then it could, as we have discussed before, it could look a bit different in different parts of the world. I mean we are producing steel today in Sweden, Finland and U.S. And the exact setup, we donât really know yet, and that could â that might differ a little bit between regions as well. But the plans we have communicated so far, we are sticking to and moving on along to those plans. Hi Martin. Thanks for taking the question. Just on the tons of the mini mills. I mean I know you have feasibility studies are ongoing, but can you talk about the timing when we expect to see completion of those and when the spending is likely to ramp up? And annually, what sort of â whatâs your latest thinking on the scale of the total group CapEx once you get started on those projects. And thatâs the first one. I will just come back with something else. And let me pause that question until I think we will cover part of that very important question during the Capital Markets Day. But as said, I mean today, we donât really know. And the reason for that is when we will be able to execute that. And the reason for that is of course, that we donât know exactly when we will get fossil free electricity or the power transmission or the fossil fuel electricity. In Oxelösund, we are fairly certain that we will get it in time. So, that plan stands. In LuleÃ¥ we donât know yet. That work has just been started and in Raahe even though it moves on quite nicely. We donât know there either. We are working with the government and the authorities in Finland as well. So, to be honest, we donât really know. And thatâs why we have said â I think we have phrased it around 2030 or so. There are possibilities to do it slightly earlier, but we can also handle if we have to do it due to the power transmission slightly later. And when we look at it, an optimal situation for us is to do it when we in order to avoid blast furnace relinings and big investments or investments in production facilities that we will not run long-term. But then of course, it is so important with these mini mills. We reduced lead times a lot, and I mean a lot, and that will release working capital needs, but we also increase flexibility. So, this is also an integrated and important part of what I talked about before, reducing the low point profits and stabilize earnings over the cycle, which I think is also very important. And then last but not least, the huge interest from customers. And coming back to these 500 tons, which is not a lot in the scheme of it, but we see the demand, we see the interest, and we are â we could sell much more than 500 tons today, I can promise you if we have the ability. So, we are really working hard. Okay. And just as â I mean, a couple of follow-ups to that. One is just on like the pricing of that product. I mean you have been quite reserved in commenting on green premiums in the past. But I mean how are you feeling and as we go through time and you are selling more of these volumes? I mean what are you thinking about the potential for green premiums in the longer term once you have meaningful volumes of the product on the market? And also just on that issue would be permitting and so forth. Does the new government have a materially different view to getting some of these projects moving compared to what we have seen with the green party was sort of more was in the correlation. How are you seeing the sort of changing landscape with regard to regulation? To be honest, I donât see any difference. I think the new government in Sweden, they are â they understand this perfectly well, and they are very positive, and they see the same picture as we see. I think that this is â first of all, this is business development. This is developing new products. This is developing new co-operations within the supply chain. So, at the end, this is about competitiveness, and the market is there, the customers are there. And then it is also very good for the climate. So, itâs a win-win-win-win, you could say, and they realized that. And I think they are they are public, you said it. I mean we had the EU Commission together with the Swedish government, up in Kiruna a couple of weeks ago, the full year commission, and we had the possibility, me and some other Martin Lundstedt from Volvo to explain this value chain and what we are aiming for. So, I think there is a big interest and then they just need to help us with authorities and others in order to make this happen. When it comes to premium, I am convinced that there is a premium, and we see that there will be a premium. The reason why I am a bit cautious is that you never know how long that premium will be there, because I hope that this will be the new way of producing steel and then you would rather have call it, a cost advantage or I mean some advantages compared to traditional steelmaking due to emission rights, due to cost, due to flexibility and due to the market being willing to pay slightly less for traditional steel, so to say. So, in our calculations, we have been pretty cautious when it comes to premium for green steel. We think we know that it will be a premium. It depends how long it will last, but thatâs not taken into the calculation in order to justify these investments. Thank you for taking my question. Good morning all. I have just got a quick one on the timeframe of the buyback. Would you give us a bit of guidance of under what timeframe are you looking to do the share buyback? What you typically do and I guess I am not trying to tell you something that you donât really know. But the Board has decided to ask the AGM for the mandate, and that mandate they will have until the next AGM and then they need if they want to ask for another mandate. So, it could the earliest to start after the AGM. And then how you do it and how you sequence it and so on will be a later decision. But the decision is to ask the AGM for that mandate. And that mandate is valid until the next AGM, and then you need to come back. So, itâs too early to say. Yes. Operator, we did not have any more questions. Then I will thank Martin and Leena. Thank you also for all the good questions. Before we leave, just â like Martin said, we will have the Capital Markets Day here 20th of March in the Central of Stockholm. Then also site visit to LuleÃ¥ for those who are interested in that. So, please donât forget to register here on ssab.com for this event or to save your seat. We would be more than happy to host you up in LuleÃ¥ as well. And if you havenât seen this and have the opportunity, I would really recommend you to see this HYBRIT facility and this groundbreaking new technology.
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EarningCall_1275
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Thank you, Atif. Good morning, everyone, and welcome to the American Airlines Group fourth quarter and full year 2022 earnings conference call. On the call this morning, we have our CEO, Robert Isom; our Vice Chair, President of American Eagle and Strategic Advisor, Derek Kerr; and our new CFO, Devon May. A number of our other senior executives are also on the call for the Q&A session. Robert will start the call this morning with an overview of our performance and our 2023 priorities. Derek will follow with details on the fourth quarter and full year, and Devon will then outline our operating plans and outlook going forward. After Devon's comments, we'll open the call for analyst questions, followed by questions from the media. To get in as many questions as possible, please limit yourself to one question and one follow-up. And before we begin today, we must state that today's call contains forward-looking statements, including statements concerning future revenues, costs, forecast of capacity and fleet plans. These statements represent our predictions and expectations of future events, the numerous risks and uncertainties could cause actual results to differ from those projected. Information about some of these risks and uncertainties can be found in our earnings press release that was issued this morning as well as our Form 10-Q for the quarter ended September 30, 2022. In addition, we'll be discussing certain non-GAAP financial measures this morning, which exclude the impact of unusual items. A reconciliation of those numbers to the GAAP financial measures is included in the earnings press release, which can be found in the Investor Relations section of our website. Webcast of this call will also be archived on our website. The information we're giving you on the call this morning is as of today's date, and we undertake no obligation to update the information subsequently. Thanks for your interest and for joining us this morning. Thanks, Scott, and good morning, everyone. Thanks for joining us. This morning, American reported a fourth quarter GAAP net income of $803 million and a full year net income of $127 million. Excluding net special items, we reported a fourth quarter net income of $827 million and a full year net income of $328 million. Our performance in the fourth quarter and for the full year was driven by continued strength of demand and revenue environment and incredible efforts of the American Airlines team. We're tremendously proud of what the team has accomplished over the past year. We're committed to running a reliable operation, and we're delivering. Coming out of the holidays, American had the best completion factor of any major U.S. airline. We also said we would return American to profitability, and we've done that as well. Our team has delivered a third consecutive quarterly profit and fourth quarter margins that are higher than the fourth quarter of 2019 despite our fuel price increasing by approximately 70%. We generated nearly $2.4 billion in pre-tax profits over the past three quarters, and we're pleased to report a full year profit for the first time since 2019. In addition to running a reliable operation and generating sustained profits, we're making significant progress on repairing our balance sheet. We recently prepaid a $1.2 billion term loan a year before scheduled maturity date, and we have now reduced our total debt by more than $8 billion from peak levels in mid-2021. This puts us well past the halfway point of our $15 billion total debt reduction goal only 18 months into the program. Derek will talk more about our deleveraging plans in just a few minutes. Let's talk more about the fourth quarter and full year results. We produced revenues of $13.2 billion in the fourth quarter, an increase of 16.6% versus 2019 and the highest fourth quarter revenue in company history. Notably, we achieved this record revenue while flying 6.1% less capacity than we did in the fourth quarter of 2019. American also produced record revenues of $49 billion for the full year, which is a 7% increase over 2019, while flying 8.7% less capacity. Demand remains strong and our revenue performance is in line with our expectations following our strong holiday performance. Post-holiday bookings are off to a strong start. In fact, this is our best ever post-holiday booking period with broad strength across all entities and travel periods. Demand for domestic and short-haul international travel continues to lead the way. We expect a strong demand environment to continue in 2023 and anticipate further improvement in demand for long-haul international travel this year. Now turning to the operation. The American Airlines team delivered a fantastic performance in the fourth quarter. We operated more than 475,000 flights in the quarter with an average load factor of approximately 84%, and we ranked first in completion factor among the nine largest U.S. carriers. Our team delivered an even stronger performance over the holidays, despite challenging conditions in many parts of the country. American outperformed the industry over the December holiday period, ranking first in completion factor. Key to our success has been sizing our airline for the resources we have available and the operating conditions we expect to encounter. And we will continue to do that going forward. We're doubling down on our efforts to run a reliable operation in 2023, including investing in our team, our fleet and technology to support our operations and we're seeing this work pay off as our operation is off to a strong start just a few weeks into 2023, including the best on-time arrival performance of the nine largest U.S. carriers so far this year. American is proud to operate the simplest, youngest and most efficient fleet among U.S. network carriers. In August, we began taking deliveries of new 788 aircraft from Boeing for the first time in 15 months. In the fourth quarter, we took delivery of five 788s, and we expect to receive the remaining four in the first half of 2023. Our Boeing 789s are expected to be delivered starting in 2024. During the fourth quarter -- I'm sorry about that. Okay. During the fourth quarter, we also took delivery of seven A321neos, three 175s and three -- and five 737-800s from long-term storage. Devon is going to talk more about that. But what I'd like to say is that the results the American Airlines team produced in 2022 and what we are projecting in 2023 are proof positive that the actions we have taken in the recent years have put us in a position of strength and allowed us to take full advantage of the recovery. We spent more than five years on the most complex integration in the history of the airline industry. Three years navigating the pandemic and making the airline more efficient. And now we're poised to drive the business forward in 2023 and beyond. We have simplified and harmonized our fleet, modernizing our facilities, fine-tune our network to focus on the most profitable plan, develop new partnerships, introduced new tools for our customers and team and hired tens of thousands of people. During all, the American Airlines team has gone above and beyond to deliver strong operational and financial results. Now before I turn it over to Derek to provide more detail on our 2022 financial performance, I want to thank him for his partnership over the past 20 years as CFO. He is a great friend and he's been a trusted advisor throughout my career. Quite simply, he's the best CFO in the history of the airline industry. This financial leadership has helped create the largest airline in the world through the mergers of America West and U.S. Airways in 2005 and U.S. Airways and American in 2013. Derek was instrumental in raising $25 billion of capital during the pandemic to ensure American would not just survive, but also be in a position to thrive on the other side of it. And I'm very pleased that Derek will remain as American, Vice Chair and continue to lead our American Eagle and cargo teams and serve as a strategic advisor to the company. As we look forward to 2023, we remain focused on running a reliable operation, achieving sustained profitability and reducing debt. We have made tremendous progress in all three of these areas, thanks to Derek's leadership, and we will continue to sharpen that focus with Devon May as our CFO. And on behalf of the entire American Airlines team, I want to thank Derek for his leadership and tremendous contributions to the airline as our CFO. Well. Thank you, Robert. Thanks for your kind words. I really appreciate it. It's been an honor, tremendous honor to serve as CFO of American, U.S. Airways and America West over the past 20 years. I'm incredibly proud of what the team has accomplished in that time. Now on to the business of the morning. Excluding special items, we reported a fourth quarter net income of $827 million or earnings of $1.17 per diluted share. We produced our best fourth quarter pre-tax margin since 2016 when we produced roughly the same results at fuel prices that were nearly double the price per gallon lower than 2022. Throughout 2022, you heard us talk about our focus on returning the airline to profitability, and we have done that. We achieved a full year profit due to continued demand strength and the hard work of our team, despite a $1.9 billion pre-tax loss in the first quarter. Excluding net special items, we produced a full year net income of $328 million or $0.50 per diluted share. Fourth quarter revenue far exceeded our initial guidance due to continued strong demand. Revenue in the fourth quarter was higher than any fourth quarter in company history. As Robert mentioned, the domestic and short-haul international entities continue to lead the way, and we expect further improvement in long-haul international as we continue to grow back our capacity. Costs for the quarter, excluding fuel came in at the high end of our initial guidance range, primarily due to higher profit sharing expense driven by higher earnings in the quarter. American is proud to operate the simplest, youngest and efficient fleet among U.S. network carriers. In August, we began taking deliveries of our new 788 aircraft from Boeing for the first time in 15 months. In the fourth quarter, we took delivery of five 788s, and we expect to receive the remaining four in the first half of 2023. Our Boeing 789s are expected to be delivered starting in 2024. During the fourth quarter, we also took delivery of seven A321neos, three E175s and reactivated five 737-8s from long-term storage. In 2023, we expect to take delivery of two A321neos, and we plan to reactivate nine more 738s from long-term storage. Based on our latest guidance from Boeing, we now expect to take delivery of 17 737 MAX 8s in 2023 compared to Boeing's contractual commitment of 27 deliveries. This change in timings will shift planned CapEx out of 2023 and into future years. Our 2023 aircraft CapEx is now expected to be approximately $1.5 billion. Repairing our balance sheet remains a top priority, and our actions in the fourth quarter show our commitment to debt reduction. In the fourth quarter, we repaid $1.2 billion term loan secured by domestic slots. This prepayment increased estimated first lien borrowing capacity to $10.3 billion and addressed our most significant 2023 maturity. With the actions we have taken, we have now reduced our total debt by $8.2 billion or more than half of our goal to reduce total debt by $15 billion by the end of 2025, only 18 months into our deleveraging program. We ended the year with $12 billion of total available liquidity. We will continue to balance both debt reduction opportunities and investments in the business while meeting appropriate target liquidity levels. We will target $10 billion to $12 billion of total liquidity in the medium term and intend to utilize excess liquidity to accelerate our deleveraging initiative at the appropriate time. With no meaningful maturity towers until 2025, we have the flexibility as to how and when we begin to address those instruments. With that, I'm happy to turn the call over to our new CFO, Devon May, who will share our outlook for 2023. Devon has more than 20 years of airline industry experience across finance, operations, network planning and alliances, and he is the perfect person to lead our finance organization going forward. He has been an integral part of our executive team for more than a decade and has built a great team around him. The CFO transition has been and will continue to be a seamless one. Thank you, Derek, and good morning, everyone. Before we get into our guidance, I want to start by thanking Derek for his leadership over the past 20 years. I've had the privilege of working with Derek since 2002 when I joined America West Airlines. He has been a close brand and mentor during this time, and our airline is set up well for the future because of his leadership. I'm honored to be taking on the CFO role and being part of an incredible senior leadership team. I look forward to leading the finance team and building on the progress we've made on our financial priorities. For 2023, we will continue to size the airline for the resources we have with a focus on reliability and sustained profitability. We continue to expect to produce capacity that is 95% to 100% of 2019 levels or up approximately 5% to 8% year-over-year. We are on track to hire over 2,000 mainline pilots in 2023, and we expect to achieve our run rate level of training throughput in the back half of this year, allowing for further aircraft utilization improvements in 2024. We continue to expect regional pilot affordability to be constrained throughout this year and next. Demand for air travel strengthened as we went through 2022, and we expect industry revenue will return to its historical share of GDP in 2023. Given our level of capacity production, the strength of our network and industry supply constraints, we expect total unit revenue to be up low single digits year-over-year. For the full year, we expect CASMx to be up 2% to 5% versus 2022. These projections include the estimated impact of anticipated labor agreements, which account for roughly 3 points of CASMx fuel. For the full year, we expect to produce earnings of $2.50 to $3.50 per diluted share. Using the midpoint of that EPS guidance, we are forecasting operating cash flows of approximately $5.5 billion and free cash flow of nearly $3 billion. Looking to the first quarter, we expect to produce an operating margin of between 2.5% and 4.5% based on our current demand and fuel price forecast. And while we are eager to get new labor agreements ratified given where we are at in the quarter and the time required for ratification, we do not anticipate ratifying new contracts prior to the end of the first quarter. If that does occur, we will update our guidance accordingly. In the first quarter, continued strength in demand is expected to result in total revenue per available seat mile that is 24% to 27% higher year-over-year. Our first quarter CASM, excluding fuel and net special items, is expected to be flat to down 3% year-over-year. The current fuel forecast for the first quarter assumes a fuel price of between $3.33 and $3.38 per gallon and a full year price of between $3 and $3.10 per gallon. As Derek noted earlier, we'll continue to focus on debt reduction, and I'm proud of the progress we have made to date. In 2023, we expect to make further progress on our $15 billion debt reduction goal. We will use our free cash flow to pay down $3.3 billion in debt amortization this year, and we expect that by the end of 2023, we will have reduced total debt by $10 billion to $11 billion from peak levels in mid-2021. Based on the forecast I just provided, we expect that by the end of the first quarter, we will have lower net debt and better net debt to EBITDAR than we did at the end of 2019. And by the end of the year, we anticipate having the lowest net debt-to-EBITDA ratio we have had since 2017. In conclusion, in 2023, we will continue to focus on delivering on our stated objectives. We are set up to run a reliable airline, grow margins and strengthen the balance sheet. Importantly, American is uniquely positioned to deliver substantial free cash flow in 2023. The confidence in our ability to execute on these goals is due to our world-class network and incredible team. Yes. Yes. So here's my question actually. Two. The first one is on CapEx. The one -- the guidance that you gave for CapEx seems low in light of the fact that you're taking four 787-8s this year. Is that a mix where it's leased versus owned in there? Hi, Helane. Yes. This is Devon. That is what's happening with CapEx this year. So we're taking delivery of 23 airplanes, four of those are 788s, which are direct leased. So those four are not included in the CapEx guidance. Okay. All right. That's very helpful. And then just for my follow-up question. As you're thinking about long haul international, do you see in your bookings -- I think you mentioned that you think it will improve as the year goes on, do you see that in bookings that's already starting to occur at some point in first or second quarter? Hi, Helane. This is Vasu. Yes is the short answer. We very much see it in bookings. It's -- we started seeing it, frankly, in Q4 of last year. In Q1, we see continued strength across all of the geographies that we have and that's continuing out into the summer. So we are very encouraged by the trends that we're seeing, all the more encouraged because it is coming often at lower cost of sale, and we're still filling business class cabins and things like that. I also want to add my congrats to Derek on a wonderful career. And then just on your operational performance really stood out during the issues the industry experienced over the holidays. Obviously, it wasn't anything geographical considering what happens to some of your peers. So can you walk us through what you think drove it? Were there investments being made behind the scenes over the last couple of years that maybe just got smaller billing in the aircraft investments? Catherine, thanks. Hey, we're really proud of the operating performance. I'll tell you, it's something that we've been working on a long time. And it starts with making sure that we have the resources available to fly the schedule and we don't put out a schedule that we're not confident that we can really fly. That's where we start. And then, yes, it's investments in so many different places. We benefit from having the youngest, most efficient fleet of aircraft. We spent a tremendous amount of time investing in technology to make sure that we can identify where our crews and our planes and our maintenance requirements are. But really, I want to give credit to the team here. We have so much experience on board that we're just really watchful, and it all came together over the holidays. The investments that we've made, the team that we have out there, making sure that we have the right schedule. I've got David Seymour here as well. I probably want to add to it. Look, there's a lot of good decision-making going on out there, too. Yes, Robert, emphasizing the point you talked about. But another key item here is for these storms and we've been very focused on recovery after that because it's so critical to us is one that I think throughout this year, we're doing better and better on and we certainly showed that over the holiday. But the key for us, along with having more new positions that we put in that are focused when we have storms like this. We've changed a lot of our processes and procedures that we -- and how we manage these. And then we've also been partnering with our IT group and really enhancing some of the technology resources that we have to manage through these events because they change very dynamically and very quickly, and we have to stay in front of them. But more importantly is the recovery. We started looking at the forward look of what the storm potentially could be and started building our recovery plan before the storm yet, and that's where we're very focused on. So again, as Robert said, very proud of the team, very proud of the partnership with all the whole airline because it's not just operations. It's a lot of our support groups that are very critical to us getting through these. So there's a great job. We're going to continue to improve on that. And Catherine, it just -- it speaks to what we're going to be focused on going forward as well. It's still reliability and profitability here, and we're going to try to get better every day. Today, we have another 5,000-plus flights and 0.5 million customers that we have to service. And so we make it make it our business to take care of people every day. So we're back out there in business. . That's great. That's a group color. If I could just sneak one more in. Maybe for Vasu. Can you just help us think about some of the assumptions that drive your full year revenue outlook? Like what are the assumptions on business international recovery? Is there an assumption in there that the industry is going to pass on higher price of labor and fuel on a one-one basis? Just any thoughts to drive the full year revenue outlook? Absolutely. I would be happy to do that. Look, first of all, in our revenue forecast, we don't assume any change to some of the fundamentals of airline demand. We presume that airline industry revenues will regain its historical relationship with GDP, roughly about a point of percent. We also presume the same historical relationship between revenue and fuel prices. But what is very important is that as we've talked about for some time, what's different about us is that we have used the last few years to really materially change our network, our partnerships and our fleet and that really bleeds through in our forecast for next year. If you compare our capacity mix just in future schedules that we have published to what we did in 2019. We've taken 5 points of capacity out of our lowest RASM, lowest-margin long-haul flights, and we've grown 5 points of capacity in our highest-margin short-haul flights. Additionally, within the short-haul system, we've taken 5 points of capacity from some of our lowest performing, lowest RASM market and redeployed it into our Sunbelt hub, which are not just our highest RASM market, but some of the highest rosin markets in the industry. So when you think about that, that's 10 points of capacity mix that we've taken from truly the lowest RASM, lowest margin things and put into some of the highest margin things that that are out there. And you're seeing some of that trend already through '20. So that was a thing that have been in our past schedules. You see it in our quarter one schedules, and that drives a lot of our revenue performance. Now to put that into a bit of focus, 10 points of capacity in an airline of our size. You can think of that as larger than just about any airline hub with the exception of DFW, Charlotte and maybe one or two other hubs that our competitors operate. So that is a material reworking of our airline network over the last few years. But what's just as important is how we have done it, which is really to a significant amount of fleet simplification. So we -- over the last few years, we've shed 50 long-haul capable airplanes, many of which were really inefficient, like the 757 to 767. We've up-gauged both the regional jet and the main lines that we've got. And we've simplified the airline down to four fleet types. So what that enables us to do is in the fleet that's left, we can much more dynamically alter schedules to follow where the demand is. But we can produce schedules that, as you heard David and Robert talk about, are a lot more operable and frankly, a lot more efficient. So we've seen the benefits of that in our recent revenue performance, and we anticipate the benefits of that in the year ahead. First, Derek, what a run you've had, just wanted to wish you the very best from the JPMorgan team as you transition. I still remember hanging up on you on October 24, 2003. Apologies again for that. Hopefully, it's⦠A question for Vasu. So Southwest cited passenger cancellations didn't book away as part of its first quarter guide this morning. I'm wondering what the benefit for American in Dallas and Chicago might look like? And whether you see share tapering back to pre-December levels in March? Or do you think there's possibly a longer tail to any Southwest benefit that you might be picking up? After all, I mean you're on time and -- excuse me, you're on time and completion factors obviously speak for themselves over the holidays. Yes. Hey, Jamie, thanks for the question. Look, we don't see any recognizable benefit from what other airlines are doing. For us, it really is as simple as when we go put the flights in places people want to go and operate it well. The bookings come the revenue materializes. And there's really not a lot of facts that we can point to beyond that very simple truth. Okay. Fair enough. And a follow-up, Doug wasn't shy in discussing hub profitability, L.A., Miami and JFK being the real drags on margin, D.C., Charlotte, Dallas, the obvious standouts. And L.A. has obviously seen some rationalization. You have NEA contribution up here in my neck of the woods. I'm just wondering whether your internal model shows the range between your most and least profitable hubs narrowing? And if so, what the specific drivers might be? Yes. So the short story is we do see an improvement in very many of our hubs as we've gone and restructured the network. And in some cases, like look, as you think about partnerships for us, we don't see those very differently from how we think about our own airline network. But when you put a codeshare flight number or an American Airlines operated flight number, it has the same effect of creating more network for customers, and there's a real benefit for it. But as much as anything -- there's two things going on. One, demographically, we see so much growth in the interior of the country. And two, what is really driving our hub profitability is for a great number of cities American Airlines has the best network for so many customers. There's 300 cities that we serve today. In 2019, we served roughly the same amount of cities. Most of our competitors have actually shrunk the number of cities that we've served. But furthermore, within the city that we have in about 200 of those 300 cities, we have a material schedule advantage to other airlines that operate there. So that creates an effect that is actually really beneficial across all of the hubs in our network, and indeed, some of how we see hub profitability and how these hubs work together has changed materially through the pandemic. And to my earlier comment, that's why we've restructured so much of the airline network as we have. Jamie, you mentioned Los Angeles. So I'd like to pass you to expand on that a little bit. Look, in Los Angeles, we're within a limited amount of gates. And let's face it, we need to use those. We need to use those in a way that's profitable. We've taken a look at that. But we can tell you the kind of changes we make. Well, yes, look, in L.A. much like in New York, through our partnerships, we've been able to create something really cool for customers where -- if you think about it in the times past, we flew 50 seaters and small RJs in markets where we didn't really have a scheduled proposition for customers. And in both of those markets, take it L.A. and New York. Effectively, what we've done is we've turned 50 seaters, which are not particularly efficient and long haulers. 777s that are flying a whole lot further. So we've up-gauged in both of those markets materially. We've been able to use partnerships to go and offer a much broader network for customers. And now we're in this place where lo and behold, we're adding a third LA Heathrow because it's really -- to Robert's point, a very efficient way to go use gates and leverage what we've got with customers. In New York, so much of our growth is actually powered by long-haul flights that are flying within the partnerships that we have with Qatar, British Airways. And the net effect of that has been really positive outside of really good financial results, which we see in our revenue trends. For the first time ever, our top 2 markets for AAdvantage enrollments are New York and Los Angeles. We're signing up more credit cards there. We are originating -- we're having growing originating market share in those places. So a lot of what we've done is, frankly, up-gauge in those markets. We've gotten a lot smarter about what we do for customers. Yet at the same time, there are partnerships we can offer them so much more. So if I just look at the first quarter TRASM guide versus Q4 implies a much sort of bigger drop than normal sequentially Q4 to Q1. And just any thoughts, color there? And then I want to kind of ask that in the context of fuel. So spots obviously a lot higher than what you're guiding to. What's your confidence that you can recapture fuel with higher TRASM than you're already guiding to for the year? Yes. Scott, this is Vasu. I'll start. I think Devon we'll finish this one out. Look, First and foremost, as we're starting this year, we have been really encouraged by demand trends. Historically, the first three weeks coming out of the holiday season are our strongest sales weeks these first three weeks have been the strongest that we've seen in the post-merger airline. And we're really encouraged by that. And you see that, of course, in our TRASM guide out there. Now what is interesting though is as we are building first quarter, what is different from times past is we have been very conscious in Q1 about how we use the airlines resources. It's people, it's planes, it's facilities, everything, largely so that we can have as much of that capacity for the summer peak as possible. So when you look at our Q1, we have peaked the airline a lot less than what we had historically. It's at a lower percentage of Q2 than what it's historically been. And that's really a conscious design. And you see that is really what you see in our Q4 to Q1 change that's there. And that's sort of a unique thing. And to my earlier point, we don't presume any change to the historical relationship between airline revenues and fuel prices. But Devon may want to add more to that, too. Just really quick other comment on fuel price. So our -- fuel price forecast is based on Friday's close, where Brent was trading almost exactly where it's at today and then using the forward curve for Brent and he crack from there. So I think our forecast that we have delivered today is pretty much in line with where you always have or feel of that today. Okay. And then just separately, can you just give any color on what you're assuming for the cargo and other revenue and then the non-op expense is up a good amount from the Q4 run rate? Any color there? Yes, this is Devon. So just on cargo revenue, we are expecting it to be down slightly year-over-year. When it comes to non-op, the largest change we're seeing in non-op is due to a noncash pension credit that we got last year based on the prior year's market performance of our pension assets, and what were relatively low interest rates. This year, we saw interest rates increase. Pension assets came down and so this noncash credit that was fairly significant in 2022 is much smaller in 2023. And that's something that I'm sure you're hearing from other companies and seen in other industries. Hey, Derek. I'm going to miss you. I know you're going to still do the company, but we've had a lot of fun over the years. Anyway. Anyway. Just -- I have two here, if I could just start off with Vasu because I think we're trying to get our arms around the run-up in fuel and the pass-through. And I think Delta is out there sort of guiding to 50 -- or well, to exceed 60% of their revenue in premium and ancillary. And I think right now, they're in the mid-50s. And when I think about those revenue segments, many of them come with a price elasticity of demand that's less than 1. Many of them are the types of segments where you can have a fuel surcharge. And so Vasu, as you think about it, like sort of what percentage of your routes maybe are subject to fuel surcharges, whether they're international long haul or which ones are premium corporate, cargo. How should we think about like in round numbers, maybe what percent of your revenue where you stand a very good chance of passing on 100% of horizon fuel? Sort of where do you sit there? And just any color on how you guys think about it? Yes. Hey, Mike, it's a great question. Look, I would actually even simplify it further. Look, in the airline network business, if you can offer something unique to the customer, they pay you a premium for it. It is as simple as that. And so -- and we see it time and time again, we've seen it do the pandemic the most unique thing we can offer customers is to take them to places where our competitors can't have better schedules than what our competitors can do. So as long as that's the case, we find that those routes regardless of whether customers purchase a transaction, which is first class or an economy or fly for leisure business, they always have yields that index to the top of our system. So if you think about us, right, to my earlier point, in 200 of the 300 cities that we serve in the Western Hemisphere, we have a material schedule advantage. But when you look at it on the number of origin and destination markets that we make and that turns into like something like 65% to 70% of our origin and destination markets. We have a material advantage over what our competitors are. That is what drives our revenue performance. And unsurprisingly, demand at large for the airline product is relatively inelastic. But in so many of those places, it is inelastic. We're also further benefited by just general trends that we're seeing so much of what is driving the economy and likely to continue to do so, are markets in the Sunbelt and the interiors of the country and less so the coastal markets, which creates an immediate benefit for American Airlines. So we've benefited from that. We've benefited from how we can uniquely serve it, are likely to continue to be able to uniquely serve it. And when fuel prices rise, it's a really simple thing for us, with any number of ways to go and manage capacity down as the airline continues to produce. Very good. And then just second question to Robert. All the talk about capacity constraints across the aviation ecosystem. And as I think about American, it feels like things like pilots and mechanics. Maybe that's not an issue. If you sort of think about like what are the big hurdles that you have from a constraint issue? And is it just that maybe you don't have enough wide-body airplanes and therefore, it's an issue with the OEMs delivering the airplanes that you need? Is it air traffic control, like where are you -- sort of where are the roadblocks that you're running into with respect to constraint in the aviation ecosystem? Yes. Mike, thanks for that. And yes, we're in a environment of a lot of constraints coming out of the pandemic. We certainly saw everything last year, it's just things that we never thought we would have issues with pillows and link is in food and fuelers and things like that. We've gotten our arms around a lot of that. But what we have now is aircraft manufacturers that are just starting to get their feedback under them. I mentioned that Boeing is starting to deliver aircraft to shout out to the Boeing team and Dave Calhoun, we need them to keep it up. But there's constraints out there in terms of engines and aircraft. With -- at American right now, we have really an issue with regional aircraft and then some issue with mainline aircraft. On the regional side, it's largely a pilot constraint. And we're not flying the fleet that we'd like to. Vasu would actually like to deploy more aircraft. Now on that front, it's pretty explainable. It's just a shortfall in pilots. We didn't attract people into the business for a couple of years. And we're working our way through that as we have retirements that are coming out the other side. American took the monumental step last year of greatly increasing regional pilot pay. And I think that, that is the biggest thing that any company can do and has done to actually get the pump prime and people flowing back in. And we're seeing that. We're seeing that we've stabilized the pilot ranks at our regionals, and we see potential growth as we come through the end of the year. Now from a mainline perspective, look, we're going through the greatest training cycle of pilots that we've ever experienced. We had, I think, almost 900 retirements last year, probably nearly the same number this year. So we're stretching our training resources like we've never before. But fortunately, we plan for this. And so from an equipment perspective, like simulators, we've got those in place. One of the things that we're really working on is to make sure that we have the people resources and having the check pilots that we need to really address all of our training needs. And I'm hopeful that as we work with the APA and we get a new contract, but we'll be able to give even more flexibility. But overall, I do see from a mainline perspective, we should be through the constraints that related to pilots as we progress through the year. Regionals probably take a couple of years. But as we said, we have aircraft that we can deploy and will, and it's going to be done in a very efficient fashion. You mentioned some other areas that are absolutely positively out on the horizon, the large airports all have constraints, whether that's at the gate or on the airfield. And then we have aerospace issues. That clearly, we need to address. And that's going to take leadership. And fortunately, we're working with the DOT and FAA. And I know that the Secretary Buttigieg has an interest like we all do in making sure that we can invest for the future. And it's going to take a long-term view. But overall, look, these constraints right now are things that we're managing through. I think it bodes well, at least from a demand environment and being able to ensure that we can achieve profitability. And over the long run, we're going to make sure that we have a business model that works in any demand environment with any set of constraints. Thank you. And congrats, Derek and Devon. It's great to hear. Just back to Jamie's question on the operation and maybe some of the Southwest issue. I'm just curious if you could speak to the converse, how your conversation with your corporate partners has evolved given your just operational strength. Like I would imagine it would be a lot easier in these days, but can you just talk about how that's how that's changed at all and what your expectation is for new contracts and so on. Conor, I'll start, and I'm going to hand it straight off to Vasu. But I'll tell you what. One thing that hasn't changed is that reliability it translates into likely to recommend. It translates into Net Promoter Scores. And we see it over the holidays and as we really progressed through last year and and got reliability to a really high level, our scores have improved to the highest levels that we've seen. So those are the kind of things that I think that our corporate customers are interested in as well. Vasu? Yes. Robert, it's 100% right. And -- so first, I'll say, for our customers at large, they clearly benefit from a better operation, and we see it -- for the year, we -- as Robert said, we posted our best likelihood to recommend scores by a meaningful amount in any time post-merger. And that's no action. That is the operation. But what's really important out there is, yes, many of our corporate partners are encouraged. But what's really important -- and this links back to some of the other questions is that also the marketplace has changed very meaningfully. As I mentioned on our last call, we see the same trends where roughly 30% of our revenues are coming from what we've historically called leisure. About 45% are blended trips. Only about 25% of what we've historically called business trips. And of that 25% -- historically, that number would have been about 35%. So it shifted a lot. And within the 25% only about 5 to 7 points of that are coming from contracted corporations. The rest are non-contracted, unmanaged businesses who are flying on us. And what we see amongst those contracted corporations is quite striking. Almost 2/3 to 75% of our corporate contracts are actually not fulfilling the terms of their contracts for understandable reasons. For so many companies, if you're struggling to bring people back to the office, it's hard to compel them to go do a day trip to Chicago or New York. And so we see that broadly. And so even though many customers are happy with our service and many corporate travel buyers are very happy with our service. The reality is same-day corporate business trips, which used to be 3% to 4% of our traffic is less than 1% of our traffic. And that's been out there for a while, and we are planning that that's going to be the new one. Okay. Great. That's one. And then on the -- if you're talking about free cash flow, again, that's obviously great to hear. I'm just curious how your expectation for future aircraft deliveries has changed. Are you -- should we expect that we're going to start paying cash for these planes going forward? I realize that your CapEx budget is lower. But just curious on how you're thinking about financing those aircraft in the future. Yes. This year is a low point for aircraft CapEx. We'll see it come up a little bit next year and then get back to a type capital expenditures as we get out into 2024, 2025. In terms of financing, it's going to be dependent on where the market is at. And so -- yes, there is potential opportunity that we may pay cash for some airplanes, but it's dependent on what sort of free cash flow we are delivering and what sort of market rates we're able to achieve. Robert, I wanted to ask you about how we're exiting 2023 on the cost side. You guys have been running a pretty clean operation and the margins are obviously pretty healthy. I'm just wondering how much baggage are you carrying in the 2023 outlook from lower productivity, more full training classrooms. Is there a way to think about what that penalty would be from a unit cost perspective because of some of those lingering effects of restoring the network embedded inside of the 2023 guidance? Well, I'm going to ask Devon to help me ask. But David, I would tell you that I think the biggest issue that we have right now is that we have aircraft that we could be utilizing it at a much higher level. And absolutely positively we're going through some training cycles that are just unprecedented. And as the hiring is going on at American right now, that is going to over time stabilize, and we won't have to work those assets quite as hard. Biggest thing right now is aircraft. Devon, do you want to give some numbers on what you think that...? Yes. I'd just say for aircraft utilization, we are just starting to approach historical levels. So just starting to approach our 2019 levels of aircraft utilization as we get through this year. So like we've talked about, this is a fleet that should be able to produce higher aircraft utilization than the fleet we had prior to the pandemic. Just recall prior to the pandemic, we had a lot of older aircraft, smaller sub fleets that have really high spare ratios. So even though we will likely put more into operational support than we would have planned to a year or two ago, we still think this is a fleet that can produce significantly higher utilization than what we're doing today. Okay. I mean the leverage on the aircraft ownership cost is pretty straightforward. But as you think about increasing that utilization, Can you talk about the impact on the -- at the margin on costs and things like labor and the rest of the business? I'm just trying to get a lot of questions about scalability and and how unit cost should be moving as we're thinking about -- not just '23, but also '23 and '24. Any added color there would be helpful. Yes. I think just as Robert said, there's certainly some more operating leverage in the business. And I'm asking specifically about the salary line or the training headwinds. I think that is absolutely a part of it as we get through this year and get our training throughput to a level that it should be. I think we are going to see some efficiencies on that side. Through the rest of the P&L, yes, there's opportunities as we increase aircraft utilization in areas like airport rent and landing fees, and that type of thing. And in maintenance. When you have aircraft that sit on the ground, especially within our regional fleets, it's not as if those don't require maintenance. So look, the fleet meant to be flown and whether it's things like rents and landing fees, maintenance, those are the areas that I would probably look to most as being opportunities for us to see much greater efficiency. All right. And then one last real quick one. Free cash flow should be something like 130% of net income -- in this -- based on the guidance today. As you think about the go-forward look, I'm just curious about the -- whether you're able to use the losses in the last couple of years. How long is that going to affect sort of cash taxes? And where do you think cash taxes are going to start to become a part of the equation here? Is that a '24, '25, '26 thing? Or is that like any sense of when that might kick in? It's Andrew Didora. Just in terms of the balance sheet and the debt pay down, how the $8 billion gross paydown done thus far? Am I doing my calculations right, is about $3.5 billion of that coming from the pension? And then of the $15 billion kind of total gross debt paydown number, how much of that do you assume is just a reduction of pension benefit? . Yes. So that is the right calculation. So in the summer of 2021, when we had historically low interest rates, our pension obligation is obviously significantly higher. It's been around $2 billion at the end of 2022. By the end of 2025, where we've set our $15 billion goal is still right around that number, maybe a little bit lighter based on expected asset returns and the pension contributions going to make. Got it. And I know you've answered a lot of questions in terms of asset utilization, hiring and things like that. But as you sit here today for your 2023 capacity plan, do you have the pilots and the aircraft in-house to hit that plan? Or does the plan require additional hiring and additional kind of deliveries from the OEMs relative to plan in order to hit that capacity goal? We'll be hiring pilots throughout the year. We feel really good, though, about the hiring forecast we have and what we're expecting for training throughput. In terms of deliveries, as we talked earlier, we do expect to take 23 aircrafts this year. Those deliveries would be required to hit this plan. I think we've taken a pretty conservative approach to what we have for in-service dates. And we feel like this is the plan we're going to be able to hit. Yes. And Andrew, that's -- look, this is -- Vasu and Devon get together to build the network and work with David and see more on our operating capacity. We're being really mindful of making sure that we have the resources to fly the schedule. So there's a confidence factor that we're using in that as well. Congrats to Derek and Devon. Just to follow-up, just where you left off there. I think at one point last year, I believe you paused mainline hiring because of the pilot training throughput and the pilot training lead times. Can you just mark to market like did you restart hiring? When did you restart hiring? And how many incremental do you need to hire to hit your growth plan this year? Yes. So we were hiring ahead of needs and training throughput as we got later in the year. So we did pause hiring for most of the month of December, I believe. That hiring has resumed here in January. Our expectations are we're going to hire around 2,000 pilots for this year and probably a little bit on the higher end as we get through the year and training capacity continues to increase. Okay. And then just most of my questions have been asked, but just an aircraft financing question. So hypothetically, if you had $100 million in aircraft CapEx and you debt finance that, where do you see LTVs? So is it -- is it $80 million or $85 million that would go on the balance sheet. Where do you see LTVs and cost of debt today? And alternatively, if you lease that $100 million of growth CapEx how much would go on the balance sheet in the form of an operating lease liability? Okay. There's a lot to that. I'll say our treasury team right now, we have 23 deliveries, 12 of which are already financed. So our financing requirements for the remainder of this year, are pretty limited. But those are all the factors they're going to be looking at is what sort of rates are embedded in the operating leases that are in the market today, what the LTV, we can get on the debt. What's happening with the rest of the balance sheet and our free cash flow and they're going to make the right economic decision. So we have a great treasury team. They're looking at these remaining nine aircraft we need to finance for this year and looking out to 2024 as well. Okay. I mean, fair enough. It's not like if you will, or if you won't. It's -- if you do debt finance $100 million in CapEx, where is the market in terms of that LTV and cost of debt today? Yes. It's something that obviously, we expect is going to move around over the next handful of months. I don't have a number that I'm ready to give right here today, but it's something we're going to stay tight with. And we have a team that knows the market well. So one short-term and one long-term question. The short-term question is -- it's good to hear that you said you're having your best ever post-holiday booking period so far this year. Can you just expand a little bit more? Are you seeing any changes in customer behavior? Are they flying to different destinations? Are they looking to maybe kind of downgrade their tickets or look for more flexibility, kind of any signs at all of any change in customer behavior or kind of in where macro is? Yes, we are seeing some changes in customer behavior. People are -- especially leisure travelers are looking even further out. We see that the blended customers are also much more willing to book further out. And third, we see that customers, especially blended customers or people purchasing a blended trip are more willing to buy higher-value fair products and shop direct with us. So we continue to see a world where roughly 60-ish percent of our revenues are coming direct to us through our dotcom and mobile app, and we see that continuing to grow. Furthermore, as those blended trips come in to our, as we call them, owned channels, 70% of the people shopping for the lowest fare end up buying a higher fare than that. So we're encouraged by that. And then as far as where people are flying, I suppose that's pretty simple, too. They're flying everywhere they possibly can, except for places in Asia. That's great to hear. And maybe just a follow-up. You guys have come a really long way kind of in the last year kind of since where everyone was doing the pandemic. But the markets may be not recognizing that. So I'm wondering if there's any plan to kind of host an Analyst Day to kind of give us a kind of a long-term plan on strategic priorities, long-term financial guidance as such? Ravi, thanks for that question. The answer to that is, look, we've been really pleased with the work that we've done throughout the pandemic and setting American up. And the answer to your question is yes, we're going to get out and make sure that people know our story. More details on that as time progresses, but you'll hear more from us on that. At this time, we'd like to open the line to our media questions. [Operator Instructions] Our first question comes from the line of Mary Schlangenstein of Bloomberg. Good morning, everybody, and congratulations to Derek and Devon. I wanted to ask a couple of business-related questions quickly. On your business travel, whether it's corporate managed or not, do you anticipate any impact from the growing number of companies that are laying off workers, particularly in high tech, but also now extending to some manufacturing companies? And then my second question is, is your expectation that this shift to blended trip is, in fact, the structural change within the industry and will not diminish going forward in terms of at least as far out as you can see? Thanks, Mary. This is Vasu. And I'll answer the questions in reverse order. First, look, there is -- we do see a meaningful change in the trip purposes that people are booking that there's a lot more blended trips even so many people who are searching for what conventionally would have been a business style itinerary. We see it in our dot-com end up selecting something which is pretty unconventional or they stay a Saturday night or they book another person for a midweek trip or something like that. So we do see that. And our credit card partners at Citi see the same thing, too, that demand for travel is still a really strong category and as preserved -- a travel at large has preserved its relationship with GDP, if not somewhat grown a little bit. So that -- there is a meaningful thing we're coming out of the pandemic. There's clearly a value the consumer is placing on travel. Then as far as how layoffs are impacting things, look, what's really important to note about business travel is -- yes, it's 25% of our revenues, but those companies are intending to do the largest the biggest, largest ones tend to buy on a corporate contract. And that's -- so much of that business just really hasn't recovered. And we haven't built an airline plan around it. However, non-contracted business is 100% recovered, contracted business is about 75% recovered. And we don't presume that it grows much further than that. So we aren't seeing a really significant impact, but we also aren't building a plan based on a lot of that demand returning. And is that 75% recovery for contract? Is that down from prior estimates I thought that you had said perhaps 80% in the past? It's hovered in the -- sorry, Mary. It's hovered in the 75% to 80% range. And to be conservative, we build our plan around the lower end of that. Curious what your hiring needs are outside of the unionized groups like the offices? And if you're seeing any one apply or maybe you can benefit from some of the tech layoffs? And then secondly, with your plans to do this High-J configuration cabin, are you planning to increase staffing at all of cabin crews to kind of handle the more high touch service and more passengers in that cabin. Leslie, I'll start and Cole Brown, our Chief People Officer, can help me out. Look, the hiring at American is really at unprecedented levels. You mentioned our pilot hiring, yes, we anticipate 2,000 pilots this year. But over the last two years, and Cole, correct me, I think we've hired almost 40,000 people, which is across all groups. We have a view that we're going to bring folks in, make sure that they're really well trained. But it really is throughout all of our operations and headquarters and administrative staff, and we're going to bring the best and the brightest in. So Cole, do you want to add anything to that? Yes, Robert. I would just add to your point that we are taking a hard and thoughtful look as it relates to any hiring outside of operations making sure that we're bringing in the best and brightest, but also that we're thinking through not only what our needs are today or where we're going tomorrow. And some of those skill sets might evolve and change. We have an exciting new CIO that's come on board and is taking a really important look at our IT organization. And so more to come. But right now, we feel like we are focused on the right things and being very thoughtful and measured in where we are hiring at the corporate level. And certainly, the focus is the areas that we've previously discussed as well. We're really -- this is Vasu. We're really excited for the new High-J product. Our customers love our new business class. And we've gotten great feedback as we've shared concept designs with some of our most loyal customers and our flight attendants. But we haven't yet determined a number of things with how it operates, where it operates, things like that too. So it's a little bit premature right now. Hey, Claire, I'll just start. Look, our primary focus is making sure that we run the best airline we possibly can. That's the way that ultimately we address customers' needs and ensure that our customers are being treated fairly. Of course, we'll work with government authorities to make sure that we're taking care of people in the right fashion. Nate, do you want to add anything? No? Good. Okay. Okay. I've got a hugely loaded question for Devon and Derek and a super quick follow-up for Vasu if you'll let me. The loaded one. You must be relieved that you don't have to finance 100 planes this year given where interest rates are and the bigger of supplier delays. Just on that latter point, what sort of complication does the uncertainty of when you actually get planes as opposed to contractually gating them. What does that do to your ability and choices for aircraft finance options? Well, you're right. I am happy that we're taking 23 airplanes and 12 of them are already financed this year. I will say we did go through a huge wave of investment prior to the pandemic. And over that period, I think that the timing is obviously fortunate we're in a nice economic environment, a really good environment for financing those airplanes. As we look out to this year, I don't think the timing of the deliveries as it sits today is too concerning with how we're going to finance the airplane -- more than anything, we just want to make sure the airplanes are delivered and in schedule so we can run a great operation and have really solid schedules for our customers. So what we've done on that front is we have planned conservatively within service base that we believe are coming in far later than when we'll actually take delivery of the airplane. And that's something that's going to be really great for customers. Yes. And we continue to work with both Airbus and Boeing to make sure that we encourage them in an appropriate fashion to deliver on time. And I know that they're working hard to make sure that they can meet our needs. That's great. And just quickly for Vasu. Vasu, are you seeing any kind of scores on the fare and schedule or scheduling front, just given how competitive capacity trends are going? Or is demand just that strong that you aren't seeing anything anywhere? Thanks for the question. We don't comment on fair and competitive scheduling trends. But I will say we are really encouraged with the demand trends that we see and are very confident in the airline we've set up to go and take care of our customers along the way. You've had some cuts at the regional level or service to some smaller cities. What's your strategy behind the regional served locations right now? And do you think there'll be further cuts as we continue to go through this pilot shortage at the regional level? Hey, Kyle, I'll just start on this. Look, it's really unfortunate that we've had to reduce service anywhere most especially to some of the smaller communities. That's certainly a result of the issues that we faced with pilot staffing at our regional airlines. As I mentioned before, we're working really hard on it. American, I think, has taken the biggest step to get people into the industry of anyone, and I know others have followed us there. That's going to have an impact. We've seen the benefits of those efforts, and we're stabilizing the fleet, and I think that we just grow back from here. Yes. So I think from a regional perspective, it takes time to get people back into the industry. But again, for anybody that is listening and reading, it's a great time to come into aviation. These are careers. Our pilot careers are ones that are -- can be great quality of life, and also very lucrative as well. And so I think it's an opportunity that as we look to the future, that there are communities that haven't typically been places where we sourced pilots that we're going to look to in the future, we're showing great progress in hiring pilots of color and also female pilots. And I look at that as an opportunity going forward that's going to greatly benefit and really change the face of our flight crews and really looking forward to it. I think it's something that's probably over the course of the next couple of years. My question is for Robert. Robert, we've been hearing you say for a long time that you're going to make a reliable airline and a profitable airline and you seem to have done that this year or last year. So now I want to know what is the vision for the future? Can American be restored being the greatest airline as it once we perceive? And do you have a path to do that now that you've started to accomplish your other goals? Ted, great to hear from you. Let me just start with this. I'm really pleased with profitable quarters and producing a profit for the full year in 2022. The things that we've talked about doing are the right things. Getting customers to where they want to go, having the broadest network and doing it in a fashion that can produce profits, pay down debt is exactly where we need to go. And off of that platform, I see great things. But what you're going to see from us as certainly in the near term is more of the same, intense focus on reliability and profitability and accountability. And for our customers, that's going to mean we're going to deliver for them, deliver with the best network that Vasu has talked about, making sure that we have a travel rewards program that's best in the industry. We're going to operate with excellence, and it's going to require even greater planning and day-to-day execution. And when things don't go right, and let's face it. We're in a business where all sorts of things can happen. We got to be the best at recovering and you're going to see us continue to invest in that. And along the way, we have the opportunity to really make better use of technology to further digitalize our operations and our customer experience. And Ganesh Jayaram, who's our new CIO, has been charged with executing exactly that. and ultimately, put this all together in a business model that is incredibly efficient improves margins and reduces debt. That's what we're focused on right now. I want to keep the team and their head in the game every day. And really excited about what that means for the future because I do think it means that American is not just more competitive out in the marketplace, but we're going to be more competitive in terms of stock performance as well. Let me just ask a follow-up to that. When you look back at the history of the industry, the people who've been considered the greatest leaders have been the ones who have expanded the airline Wolf candle. And going forward, I don't mean right away, but over the years, can this airline expand maybe more in Asia or places where you're perceived this week? Ted, just first off, just in terms of ego around here, look, we are focused on business and really making sure that we have the capacity to address the opportunities in the marketplace. American has been around for 96 years now. We're coming up on our 100th anniversary in 2026. And I want American to be the airlines that meet the needs of our customers, our communities and our shareholders as well. And so we're focused on that right now. And look, we're really encouraged by what we're seeing. Thank you. That concludes the media Q&A. I will now turn the call back over to Robert Isom for closing remarks. Thanks for that. Thanks, everybody, for listening in. Look, American is in a position of strength, especially as we take a look at coming out of the pandemic. We're poised to recover. We're going to focus on our goals, reliability, profitability, making sure that we reduce our leverage and put American in a position to take advantage of opportunities that come about. We're really encouraged by the results and excited about the opportunities ahead. Thank you very much.
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EarningCall_1276
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Good day, and welcome to the Veritex Holdings Fourth Quarter 2022 Earnings Conference Call and Webcast. All participants will be in a listen-only-mode. Please note, this event will be recorded. I will now turn the conference over to Ms. Susan Caudle, Investor Relations Officer and Secretary to the Board of Veritex Holdings. Thank you. Before we get started, I would like to remind you that this presentation may include forward-looking statements, and those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to publicly revise any forward-looking statement. At this time, if you are logged into our webcast, please refer to our slide presentation, including our safe harbor statement beginning on Slide 2. For those of you joining us by phone, please note that the safe harbor statement and presentation are available on our website, veritexbank.com. All comments made during today's call are subject to that safe harbor statement. Some of the financial metrics discussed will be on a non-GAAP basis, which our management believes better reflects the underlying core operating performance of the business. Please see the reconciliation of all discussed non-GAAP measures in our filed 8-K earnings release. Joining me today are Malcolm Holland, our Chairman and CEO; Terry Earley, our Chief Financial Officer; and Clay Riebe, our Chief Credit Officer. Thank you, Susan. Good morning, everyone, and welcome to our fourth quarter earnings call. Today, we want to focus on our fourth quarter results, as well as our 2022 year-end results. For the quarter, we reported operating earnings of $0.74 per share or $40 million and for the year, $2.74 per share or $147.9 million. Pretax pre-provision returns were 2.15% for 4Q and 1.97% for the year. Year-over-year metrics continue to perform at levels with ROAA at 1.35%, TBV increase over the year of 6.6%, ROATCE of 16% and efficiency ratio at 48%. The quarter did have a few items of note, which Terry will give you additional detail on momentarily. Loan growth less mortgage warehouse continues to temper, trending down since 2Q to 25% for the quarter end and 34% for the year. It is clear that loan growth in 2023 will be much lower than in 2022 with our current pipelines down over 76%. We continue to think 2023 loan growth will be in the low double digits, primarily consisting of the to-be-[ph] funded construction book. The market is certainly slowing down as the borrowers are uncertain of a looming recession and the interest rate forecast. They have done a good job of self-policing their credit requirements. Payoffs for the quarter remained fairly consistent with previous quarters at $400 million, but we do feel this level of payoffs will continue to decline in the coming quarters. Overall credit trends are moving negatively as we are seeing signs of a slower economy with the rising rates, creating some level of stress. We did record a $5 million C&I charge-off of an acquired credit that we've been monitoring for several months. This loan is now fully extinguished. Our total provision of $11.8 million for the quarter accounts for the charge-off, growth and keeps our ACL at 1.01% of loans. NPAs to assets did increase 10 bps, but still remain at an acceptable level of 0.36%. Deposit growth continues to be our greatest focus and with most banks, our greatest challenge. Our deposits did grow during the fourth quarter, 17% annualized and shows our commitment and dedicated strategy to growing deposits at the same rate as our loans grow. We are investing in process, people and technology while making core deposit gathering our top strategic initiatives. Thank you, Malcolm. Starting on Page 5. Q4 was a challenging quarter on several fronts and would have been a lot better without the loss from Thrive [ph] and the charge-off on the acquired credit that Malcolm referenced earlier. The financial metrics around ROAA efficiency and ROATCE are still very acceptable. Tangible book value per share ended the year up 18.64%, 5.2% for the quarter and 11% for the year after adding back the effect of our dividend. As you look at the financial results on a year-over-year basis, remember to factor in the capital raise in the first quarter where we issued approximately 4.3 million common shares and raised $154 million in common equity. Given the current economic outlook, we are pleased to have achieved such a favorable result for the bank. The capital raise certainly weighed on the year-over-year performance and EPS and return on tangible common equity. Additionally, 2021 was a very favorable credit year as we didn't need to provide for growth given the reserves established during the pandemic. Finally, in 2021, we also had over $9 million in PPP fees that did not reoccur in 2022. On Slide 9, loan production declined 35% from Q3 to Q4 as interest rates continue to increase, economic uncertainty rose and liquidity became more of a concern. With the termination of the interLINK deal late in Q3, our focus shifted to growing our deposit portfolio through greater emphasis on C&I and a lower appetite for ADC and CRE. Unfunded ADC construction continues to drop at the rate of $300 million to $400 million per quarter. On Slide 10, you see the evidence of the greater emphasis on C&I. During the fourth quarter, the C&I accounted for 41% of our production, up from 30% in Q3. On to Page 11. Net interest income increased by $5.1 million or just over 5% to $106.1 million in Q4. The two biggest items in the increase are the Fed raising short-term interest rates, which represents $4.2 million of the increase in growth, which also accounted for about 700 -- $0.7 million [ph] The net interest margin increased 10 basis points from Q3 to 3.87%. The margin for the month of December was 3.93%. The Q4 NIM was negatively impacted by interest reversals on problem credits and intense deposit rate competition in our primary markets of DFW and Houston. This competition for deposit volume at a reasonable price is not just limited to other financial institutions. For the first time in my career, banks are competing directly with the U.S. Treasury. At the close yesterday, 3-month T-bills were paying 4.7%, creating significant rate and volume pressure on the banking system. All this to say, NIMs are likely at or very near their peak as the Fed deposit betas are going to catch up, making growth in net interest income harder to achieve. Veritex asset sensitivity is largely unchanged from Q3. We've been intentionally hedging floating rate loans to mitigate falling short rates out through 2026. On Slide 12, please note that during our - during Q4 our loan yield was up 97 basis points to 5.98%, while deposits increased 70 basis points. Q4 loan originations were 93% floating and these floating rate loans carrying an interest rate at quarter end of 7.19%. So thankful to have a predominantly floating rate loan book to offset the deposit beta impact. Slide 13, a productive quarter on the deposit front with growth of $375 million and a 16% CAGR since the beginning of 2020. Our cycle-to-date to total deposit beta is approximately 30% as total deposit rates have increased 119 basis points and the average Fed funds effective rate has moved 353 basis points. We've seen the deposit mix start to change during Q4 with DDA declining 6% and time deposits growing 25%. On Slide 14. Non-interest income increased by $1.2 million to $14.3 million. Great performance in the USDA business was largely offset by an increased loss at Thrive and lower swap revenue. We'll come back with additional comments on USDA and Thrive in just a month. Non-interest expense, including severance costs, increased $6.1 million to $56.7 million, reflecting the investments in talent we have discussed for many quarters. Salaries were up $1.7 million and variable comp was up the same. A meaningful part of the variable comp increase is due to the exceptional fee performance at North Avenue Capital during the fourth quarter. The rest of the expense increases reflect inflationary pressure and is spread across the other categories. Even though operating expenses are up, the efficiency ratio remains strong in the 47% range. Looking forward, the pace of hiring is slowing. This seems prudent as loan production and growth slow in 2023. Slower loan growth will translate into stronger capital ratios and less funding pressure. Turning to Slide 15. As I noted earlier, Q4 was a great quarter for NAC, with $75 million in USDA loans closed, and additionally, for the full year in '22, we closed $117 million. We entered 2023 with positive momentum, premiums looking pretty well and our pipeline is full. Our SBA business continues to strengthen as new leadership and recent hires gained traction. We closed almost $40 million in SBA volume in 2022, including $16 million in Q4. The pipeline is up 46% since the end of the third quarter. Gain on sale premiums in the SBA business are stronger than a quarter ago, but much weaker than the USDA side. Moving to Thrive. Veritex recorded an equity method loss of over $5 million as funded volume decreased to almost $415 million, but gain on sale margins collapsed to 1.89% due to rising rates, significant rate volatility and the impact of long-dated rate locks. Given these results in Q4, they stopped issuing mortgage rate locks longer than 90 days and initiated an effort to rightsize the expense structure of the company, given forecasted 2023 volume. We expect both actions to meaningfully improve Thrive's financial performance. On Slide 16, total capital grew approximately $41 million during the quarter and $296 million during 2022 during the year at $1.4 billion. CET1 ratios have expanded by 51 basis points year-over-year. Looking forward on capital, we believe that moderating loan growth and lower unfunded commitments, coupled with higher earnings from rising rates should allow us to achieve our CET1 target of 10% by the end of 2023. Thank you, Terry, and good morning, everyone. Moving to Page 17, you can see an increase in criticized assets during the quarter that's driven by our quarterly review process for credit. The largest change during the quarter was driven by a move to special mention of a customer in our note finance business that has experienced negative earnings, but continues to maintain good liquidity and capitalization. We downgraded three office properties during the quarter that have demonstrated underperformance. Surveillance is the word of the year for Credit team. As Malcolm mentioned, we had an uptick in NPAs during the quarter. That was driven by a downgrade in a PCD pool of loans to nonaccrual status. A single credit that made up 95% of the outstanding balance of one of our PCD pools was posted for - foreclosure because the pool is a unit of accounting for these acquired loans, they almost be great at the same. Our ACL for the quarter grew by $6 million, mostly due to the change in Moody's projections for Texas unemployment and GDP, which accounted for $5.2 million of the increase. Growth in loans accounted for an additional $6.3 million of the build offset by charge-offs. During the quarter, we had a bulge of past dues in the 30 to 60-day range. Most of the increase was created primarily by administrative past dues caused by the end of year season delays. $10.2 million of the bulge was cleared in early January. Turning to charge-offs. During the quarter, we experienced an unexpected deterioration in an acquired $5.2 million commercial credit in the power generation space. During the quarter, the borrower became unresponsive and missed several established milestones that led us to question the viability of the borrower. Given the facts that we acted quickly to remove the credit from the books and we'll treat any collection proceeds as a recovery in future quarters. Thank you, Clay. As we look into 2023, I think we all have some level of economic uncertainty on our minds. I assure you, Veritex is well positioned and remains confident in a positive 2023 performance. I wanted to start with your outlook for the net interest margin and the bottom right corner of Slide 11, where you talk about your interest rate sensitivity, you have base case interest rate scenario, and that kind of points to a 3.68 [ph] net interest margin. And you just said you did like a 3.93 in December. So I'm trying to reconcile those two numbers, but just some color on the net interest margin and how you think that will trend in 2023? Well, I think â you know, as I said, I think net interest margins at or near their peak if they haven't peaked. Our personal - our view is that, look, we did 106 in net interest income in Q4, and that model shows the basic case on a static balance sheet with you know, at 420. So that tells you that even with growth, growing net interest income is really not very possible. In large view, it's not because of where rates are going from here, it's deposit funding cost pressure. So you know, I've said, it's going to be hard to grow net interest income with deposit betas. And so that's how we get to a view that NIMs will - it will be difficult to grow net interest income, NIMs will be under pressure, downward likely throughout the year. Q1 could be flat, but I think it might also be down. It's really, Brady, it's so hard to predict. Never seen deposit pricing competition like this. And anyone who doesn't believe the U.S. Treasury is our primary competitor is kind of... Just to make sure I'm hearing you right. It's hard to grow NII dollars even including low double-digit loan growth? Or is that excluding the loan growth for the year? I mean it's a static balance sheet. So it doesn't include what - if you just took this balance sheet and roll it forward with the rate shock knowing what's going to happen to deposit betas. I'm just - I'm not - I actually think we can grow net interest income next year because of the loan growth we've been talking about low double digits, it's going to - but it's just going to be harder. You're not going to get the same level - same amount of leverage from loan growth in '23 that you've been getting because of deposit pricing pressures. All right. That's helpful. Then next on expenses, it feels like you guys are still hiring and your expenses came a little higher than my estimates. Any color on what you're investing in and how we should think about expenses in 2023? Yeah. Let me just address the hiring piece of it. We still have some replacements that we're working through. There are a couple of key positions that we still are looking at. But I would say most of them are going to be focused on the deposit generation side, almost all of them would be actually. We do have an internal audit program that we're going to put in place in 2023. Again, that's growing over $10 billion size deal. But the hiring is not going to be as it's been in the past two or three years, but there are a couple of replacements areas that we have. Cara was telling me yesterday, I think our total is down less than 50%, 60% from where it was in terms of the amount of people. But I don't think that's going to drive a huge increase in where we are from the expense base right now. Do you want to talk about expenses, Terry? Well, I mean I think - and the inflation is real, surprise-surprise. I also - in addition to - I don't see the net adds like Malcolm saying, the net adds to FTEs are not going to be that great going through '23. We just - we can't do that. But we are - one thing we're going to spend more money on this marketing dollars on the deposit side. We're staffing up that area, and we're going to put more - way more dollars focused that way to help build this deposit base in a more significant, more granular way. So I think expenses are probably - if you annualize Q4, and add a little - you're probably about in the right place. But - so... I'll just say this, too, Brady. One of the phenomenons where as I look back on 2022, you could arguably say we bought a $2 billion bank in 2022. I mean we grew $2 billion. And part of that was, I think, our expenses on the comp side, we're a little on the salary side. We're a little low in the third quarter because we had some people moving out. We had some new people coming in, in late 3Q and 4Q, just kind of all caught up to us. And so we look hard at the efficiency ratio, which has remained stable despite the spike in increases on the expense side. And so I think we're just settling into a new expense level with adding $2 billion in assets over the last year. Yeah. Let me add to that. I mean, year-over-year, total assets, not average assets year-over-year grew you know, 1. - On the average, $1.6 billion and from Q4 to Q4, they grew over - they grew right at $2 billion. And yet for the year, NIE to average assets is only up 5 bps, 1.78 to 1.83 you know, for the year. And so Malcolm is right. We grew a $2 billion bank. And our NIE to average assets is while up 5 bps, it's been one heck of an inflationary period. All right. And then finally for me, a lot of volatility with the USDA fees having a great quarter, but then Thrive not having a great quarter. Anyway, it's - I mean I know it's hard to look at those two an ongoing basis. But any idea about the forecast for those two volatile line items? I tried to say it in my comments, which is Thrive is making pretty - not pretty very significant expense changes. And while the gain on sale margin for the fourth quarter was 1.83, I think it... 1.89. The year was 3.35, okay? So if I can just - by stopping the long-dated locks, letting the gain on sale margin revert to where they've historically been, deal with their expense cuts, you should see much better financial performance out of Thrive. NAC, we -- I mean, you see their pipeline, you see their quarter. You can tell that if we close $75 million in the fourth quarter and only $117 for the year, I mean, we've got - some of that's pent-up demand after Q2 and Q3 and the USDA really came through for us. But we're pretty - we feel good about '23 in NAC. Terry, just to kind of start on your recent comment on the expense line kind of annualizing the fourth quarter and adding a little bit, as you said, in 2023. I think last quarter, you talked about kind of high single digit growth in 2023. That comment you just made sounds like you're more kind of mid to high teens loan expense growth. Is that what you kind of intended to suggest in your comment? Well, what I would - I'd say high single digits over the full year, high single, low double digits over the full year 2021 is more what I'm thinking right now. But certainly, look, I was surprised by Q4. Just that it was across the board. So I'm not trying to go as high as it maybe it seems. So let me - I hope I cleared that up, more high single, low double from 2022 levels. Okay. Thank you. And then also on Thrive, I mean, based on your comments you just made, is there visibility - to the degree there is visibility in mortgage at all, is there visibility in '22 based on or in '23 based on what you were talking about on the expense side to where at least Thrive would be a breakeven scenario in 2023 to where it's not a headwind for VBTX? Absolutely. That's - look, we spent a lot of time over the last 60 days talking to the - some of the best people in the industry and what the success for Thrive look like in '23, and it's exactly what you just said. It's kind of where the industry is based on all the feedback we can get. And they have put together a clear road map to get there. It's not a hope and a prayer. They're making the appropriate expense reductions. Candidly, they have some really nice volume. They did a small acquisition at the end of the year that was not very costly that helped on the volume side. And so we feel pretty darn confident in a breakeven year for Thrive. Okay. Great. And then last for me. Just on the deposit side and the growth there, I think last quarter, you talked about probably utilizing some more in the way of brokered time deposits in the fourth quarter. I didn't see it called out anywhere. I wonder if you could kind of talk about what your activity was on that side of things in the fourth quarter? Like I've seen many peers report. It was - the brokerage side was very meaningful in the fourth quarter. We still grew - absent brokered, we still grew - we still grew 4% or 5%. I haven't done the math, and I'm doing my head. I'm somewhere on the linked quarter annualized, absent brokered. But so that kind of tells you that, yes, that's the right number, 4% to 5%. And if we did 17 [ph] that tells you where the rest of it was. Okay. So can you talk at all about how you kind of laddered those out in terms of maturities. So we've got a... We are - from an interest rate risk, I would like to keep them under 12 months. From a - just thinking about the overall balance sheet and how we balance out liquidity, we're going out 18 to 24 with some. So I'd say it's skewed to 12 months and under, but there is some that we're doing that's a little bit longer. I don't want to go real long because - and customers are way more frequently asking for longer term CDs, and that's just not where we're pricing aggressively or as aggressively. We're trying to keep everything 12, 15, 18 months and end. I wanted to circle back on credit and just a few pieces to it and just make sure I understood the - I know you guys make downgrades pretty quick and you're aggressive with that. But just the three office properties, can you maybe talk about that and what you've done taking a look at your commercial real estate portfolio and maybe what led to those downgrades? Yeah. So that's a great question, Brett. Thanks for the question. We did a deep office dive during the quarter that we looked at every loan over $1 million in the book. And just to make sure that we appropriately had everything graded and we're addressing anything that we saw that had any weakness in the deal. So we looked at every credit over $1 million in that portfolio. And that's just part of our surveillance process for the entire year. Loss of tenants. And then one has just been a historical problem asset that came out of the PCD acquisition of Green Bank that has been - had some damage to it from Hurricane Harvey that has never really recovered from that. So... And in issues with. Do you guys have any color on how much Class B office space you might have kind of inside the loop? None that I'm aware of, we have no CBD office exposure. Class B in general, that makes up 33% of our office book today, 62% of our office book is in Class A, which is encouraging to me because that's where I will - I think we'll see the least amount of stress. Okay. And were these - and sorry for some of the questions on this, but were these three credits, the bulk or all of the increase in criticized assets linked quarter? No, that's not all of them. The largest one that I discussed within our note finance group, a move to a special mention [ph] of one of those borrowers. That's actually the largest office was second [ph] and then, yeah. So those are the two largest areas of downgrade during the quarter. Okay. And then back on deposits for a second. Obviously, you funded the balance sheet in the fourth quarter with CDs. And last year, there were some various efforts to find alternative sources to grow funding that would maybe be market-oriented, but maybe not be CDs. Given the environment and Terry, you guys sound a little shell-shocked with just the competition from the treasury market. Has your view changed or could you maybe pivot to a different strategy in terms of looking for alternative sources to grow deposits, whether it be fintech or other sources that might not entail CD funding? Yeah. I mean to answer your question, strategy hasn't changed. It's just ramped up. As we - I think we said in the third quarter that this was a multiyear strategy. Canada, we just hired one of our lead guys. They just started this week. We hired a consultant in the fourth quarter, and he's now producing some really good work. There is no magic pill or magic vertical that's going to solve this funding problem. It's about 6, 7 and maybe 8 different things, and we're pulling every single one of those levers. And I think you're starting to see some movement. You can see back - we did grow deposits. I know the industry shrank. But we did grow deposits, albeit not what we wanted to, but some of our efforts, a lot of our efforts are moving in a very positive direction. It's just going to take some time. And so as - when Terry talked about short-term funding in these CDs, these are - we're hoping these are GAAP fillers as we continue to be successful in our strategy. The fintech piece specifically, I mean, when we talk about hires, there's a couple of hires that we're making in that area. We have a specific group. They have some opportunities, as of this week that are going to be nice funding opportunities for us. So we continue on that strategy. We haven't diverted off of it. We think it's the right one. It's just going to take a little bit more time. And Brett, those - there are meaningful opportunities there, but they are going to be high beta. But if you're thinking about rates down, that's not a bad thing. So, yeah. Okay. And maybe just one last follow-up on that. As we think about betas, as you just mentioned, do you guys feel like you took - what percentage of the pain do you guys think maybe you took in the fourth quarter versus where you might have to get to in terms of the relative treasury curve? Sorry. So just looking at the slide on deposit growth in the deck and showing rates in average Fed funds effective. And there's an obvious upward movement in 3Q and then in 4Q, your interest-bearing rates and your total deposit rate accelerated 3Q to 4Q. And I don't know if it has to go to the effective Fed funds rate, but do you feel like you've taken a meaningful portion of the hit that you need to in terms of deposit pricing pressure? No, I think it's still coming just because I think you've got time deposits, you've got money market customers that you're going to fight hand-to-hand combat to retain these customers, these relationships and these dollars. And I think the deposit beta - pricing on the margin every day gets more aggressive is what I would tell you. It's just the way the environment is. The Fed got another 50 or another 75 somewhere in there, I would say, and then they're going to hang out there. It seems like for the balance of the year. And that's why I think there's going to be NIM pressure as we get maybe in Q1, but certainly as we get later in the year. Hey. Good morning, guys. Most of my questions have been kind of asked and answered. But just on credit, you guys have found in a pretty cautious tone. I think that's your conservative nature. But the loan loss reserve was only up a basis point despite the increase in criticized classified. Why not just build that a little bit more, now just given the cautious tone? And would you expect to see that ratio build as we move through the year? Thanks. I mean, we'd expect to see it build. But we do have - CECL is a pretty constraining metric. And there's a lot that goes into it, as you well know. And so it's not - we can't tweak here and tweak that. Candidly, we've done a fair amount in changing our weightings on some of the possibilities that could happen. We haven't messed with our Q factors. And so we work pretty hard to keep it at those levels because the model just spits out a much lower number sometimes. And so it's going to be difficult. But certainly, our desire is to have a little bit more in there. And going forward, yes, we hope to accomplish it, but we're not certain. Let me just to add to that, which is year-over-year our allowance to loans went down from 115 to 104. But our general reserve, excluding specifics, went up from 82 bps to 90, and I would expect that trend to continue. Does that make sense, Michael? Yes. Got it. And then maybe just back to Thrive. Obviously, the outlook, I'm just looking at the MBA forecasts are down a significant amount in '23. Obviously, this is a tough quarter. I understand they're making expense structure changes, kind of et cetera. But do you actually expect that you can actually earn money from the investment this year? No, I would go back. I mean, I think success, I mean, is it possible? Yes. With - and success would be a positive number. I think target is a breakeven. And look, the only reason this option is available to them is a small acquisition Malcolm referenced that brought on $3 billion in volume at good margins. The margin was 3.33 for the year, where they've had significant expense cuts. They've been able to strip out close to 60% of the cost of the company to bring the volume onto their platform. And so that's what, without that and without fixing the long-dated locks and rightsizing the expense structure of legacy Thrive than do I think that was - do I think breakeven or better is achievable? No. But that's where we stand heading into 2023. And December was a good month. They closed 567 units in December, which was above their average for last year. And always remember, close to 65% and 70% of their business is in Texas. The three key markets, DFW, Houston, San Antonio, and that's why it's encouraging. And I've already seen I've seen the result. I know what the results were for December, obviously. And so that's what tells me that this idea about where we can get - where Thrive can go is you can see it from here from the December results. All right. Helpful. And then just finally for me, stock trading by 1.5 times tangible. You noted earlier that you expect capital to grow as kind of loan growth and balance sheet growth slows. Any thoughts around a buyback at this point? And what you could do there? Thanks. I think that's something we think about in the back half of 2023, when the recession outlook is clear, credit is - the situation is clear and capital has built close to this 10% - if it's a 10% CET1 or better. And credit - the recession looks mild and credit looks fine, it's something we'll think about. But I mean it's not that we don't like the valuation. I just don't think now is the time to be right now, especially in the first half of the year. It's just not the time to be looking at it. I just wouldn't rule it out for the back half. But right now, we have no plans in the back half. It's just something that we could get to if everything goes as planned. You've addressed most everything, just a couple of maybe housekeeping questions. Terry, and so apologies if I missed it, but what was the spot rate for the loan portfolio at the end of the year? And then - okay. And then just curious, you mentioned the increase in expenses was somewhat tied to the big quarter you had at NIC. Just kind of curious, is that - trying to think about those numbers going forward? Is that kind of a 40% or 50% payout on that revenue? Is that how to think about it? Or is it - just wanted to see how much of it is actually tied to the good USDA performance? No, no, it's not nearly that much. It's in the low double digits, but it meaningfully moved the variable comp. And that's just the - given the go-sell premiums and dollars in that space right now, that's just a market if you want to attract the really good producers and we have some. Okay. And then would this maybe say - I've noticed the securities yield was up quite a bit as well. Any kind of one-timers in there? Is that just you lower yielding start rolling off and just general improvement? Yes, I apologize. The securities portfolio yield was also up quite a bit. Just kind of curious if there's anything in there that would be onetime in nature or if that's just... They're not materially different, to be honest with you. They are definitely in the 6s, but that rate just excluded them. Okay. Great. And then final bigger picture question. You guys do a lot of construction. Some of these projects are coming to an end. Can you talk about the environment for other folks providing permanent financing? Are you guys doing that? In some cases, I know you're pretty capped out on CRE. But just curious kind of what the environment is out there for some of these construction projects, finding a new home once they are completed? Yes. I mean there's still commerce going on, especially in our specific markets. You read the paper every day about a new industrial - I read one this morning, a huge industrial deal, which is sold because Nike became the tenant there. And so people are still selling industrial. The cap rates certainly have increased a bit, but there is absolute commerce going on. I think in the fourth quarter, we sold - or paid off about $400 million. Half of that was about - it was a CRE projects. Just we do see that slowing down. But in terms of us doing more term, we haven't really seen the requests come in. A lot of this stuff is coming out of the REITs and the bigger fund type people that are buying this stuff because they're quality assets, mainly multi and industrial. But we haven't seen it slow down, but we are certainly anticipating it slowing down. And the agency CMBS is a much more viable outlook than it has been. You can get 10-year fixed rate in the 70 - 575 [ph] range. Also, I mean, the big payoff yesterday in Craig Davis' portfolio in Fort Worth, about $25 million. I mean just - I just saw it this morning. But they're going to slow, but there's viable ways and then there is a lot of commerce going on. I want to go back to the credit discussion. And I think Clay referenced a note financing as one of the primary sources of the downgrades in the fourth quarter. Just remind me exactly what is your financing in these types of loans? And what was the size of the specific credit that was downgraded in the fourth quarter? So thanks, Matt. It's very, very granular exposure financing, this particular borrowers financing, small fix and flip, single-family residences. So that is - give you some color on the actual - what we're talking about there. The overall note finance portfolio is made up of a broad categories, you know, touching various product types, but this particular borrower is very granular exposure in the single-family space. And then the size of that was the total commitments on a $100 million facility. Okay. And so I guess something to think about the risk here of those types of loans. Is it more - it sounds like it's more residential, single-family in the metro, Texas markets? And everyone's got to do it. You have hundreds of borrowers very, very granular, and we're financing a percentage of what they finance. So it's a 65%, 70% advance on an already 80%, 75%, 80% advance. So collateral values are way down there. The reason that one hit there was that they had an operating loss, right, but remain heavy on cash and very strong on capital. This is a very strong company, but we think it's - we're quick to put stuff on special mention when they need to be. And when they showed the loss, that's why they ended up there. We don't have any - we're not - there's not much anxiety on our side that we'd ever get to the collateral. This is a very, very strong company. Okay. Great. Appreciate the color there. And then I guess, shifting back on deposits, I think the average deposit - I'm sorry, the average noninterest-bearing deposits were down quite a bit in the fourth quarter, and we're seeing this across the industry with all your peers. And I guess the message we're getting from others is there could be more headwinds there in the first half of the year from the NIB. So I'm curious kind of what your expectations are of the outflows there for the bank? And what do you think those could stabilize? Well, I think the outlook you just described is accurate. I think it's going to continue to trend down. I mean customers are as aware as I've ever seen of rates and there's so much incentive to aggressively manage liquidity. So I don't think we have found - we're at the end of that mix shift going on. But I think that's why the whole importance of our C&I business, and we've been investing in that heavily over the last year. You see it in the production side. And it's our community and our C&I that are going to help us stabilize and get the deposit growth going. And even - and they had good years. They had good quarters, but it's just - and especially in community and commercial. It's just a harder time. Yes. Okay. Thanks for that Terry. And then thinking about funding securities portfolio, any material cash flows coming off that in '23 that could help kind of fund the loan growth here? Well, I mean, I think - here's what I would say. If you look at the loan growth minus - the loan growth was $445 million roughly deposit growth was 375. The difference between those - and we only borrowed $25 million from the FHLB. So we funded $45 million of loan growth from the securities book and earnings. That $50 million a quarter type should continue. Is that helpful? I mean there's going to be - it's going to be $100 million to $120 million for the year in terms of cash flow projected to come off on the base case of rates. And so it's going to continue to meaningfully help us - and earnings as well.
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EarningCall_1277
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Good morning, everyone, and welcome to the Citizens Financial Group Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Keeley, and I'll be your operator today. [Operator Instructions] As a reminder, this event is being recorded. Thank you, Keeley. Good morning, everyone, and thank you for joining us. First, this morning, our Chairman and CEO, Bruce Van Saun; and CFO, John Woods, will provide an overview of our fourth quarter and full year results. Brendan Coughlin, Head of Consumer Banking; and Don McCree, Head of Commercial Banking, are also here to provide additional color. We will be referencing our fourth quarter and full year earnings presentation located on our Investor Relations website. After the presentation, we will be happy to take questions. Our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are outlined for your review on Page 2 of the presentation. We are also referencing non-GAAP financial measures. So it's important to review our GAAP results on Page 3 of the presentation and the reconciliations in the appendix. Okay. Thanks, Kristin. And good morning, everyone. Thanks for joining our call today. We're pleased with the financial performance we delivered for the fourth quarter and the full year and we feel well positioned to navigate through an uncertain environment in 2023. We are playing strong defense with a robust balance sheet position and highly prudent credit risk appetite. At the same time, we continue to play disciplined offense with continuing investments in our growth initiatives. We are focused on building out a prudent, sustainable growth trajectory over the medium-term. I'll comment briefly on the financial headlines and let John take you through the details. For the quarter, our underlying EPS was $1.32, our return on tangible common equity was 19.4% and the efficiency ratio was 54%. Sequential operating leverage was 1% and sequential PPNR growth was 2.6%. Leading our performance was 2% sequential NII growth, reflecting NIM expansion of 5 basis points to 3.3% and relatively stable loans given the impact of a $900 million reduction in our auto portfolio. Growth was 1% ex this impact. Deposits were solid with 1% sequential growth, and our LDR remained stable at 87%. Our fee businesses showed resilience and diversity given a challenging environment, down about 1% sequentially. A number of M&A fees pushed into Q1 and mortgage results were softer than expected. We maintained stable expenses in the quarter, and credit metrics remain good. We boosted our allowance for credit losses to 1.43% of loans, which compares with pro forma day 1 CECL levels of 1.30%. We restarted our share repurchase activity in Q4, buying $150 million of stock and we ended the year with a CET1 ratio of 10% at the top of our targeted range. For full year 2022, we delivered underlying EPS of $4.84 and ROTCE of 16.4% as we captured the benefit of rising rates and our strengthened deposit base. The results handily exceeded our beginning of year guide, which we included in the appendix of the presentation. With respect to our guidance for 2023, we assume a slowdown in economic growth to 1% for the year, two early Fed rate hikes and a Q4 cut and inflation getting below 3% by Q4. We project moderate loan growth, partially offset by continued run off in our auto book of close to $3 billion. Overall, we see solid NII growth as NIM gradually rises to 3.4% over the year, a roughly 8% growth in fees to kind of rebound in capital markets fees over the course of the year, solid expense discipline with core expense growth ex acquisition and FDIC impacts of 3.5% to 4%. We announced today our TOP 8 program, which targets $100 million in run rate benefits and about 80% of that is expense impact. Credit should be manageable with net charge-offs in the 30 to 35 basis point range and we expect to build our ACL to 1.45% to 1.5% of loans. We expect to repurchase a meaningful amount of stock given strong profitability, modest loan growth and limited expectation for acquisitions with our CET1 ratio forecast near the high end of our 9.5% to 10% range. Capital return to shareholders should approach 100% and yield to investors of our dividends plus capital return via repurchase put TOP 12%. So all in all, a very strong year of execution and delivery for all stakeholders by Citizens in 2022, and we feel we are well positioned in 2023 to continue our journey towards becoming a top-performing bank. We continue to make good progress in executing on our strategic initiatives across consumer, commercial and the enterprise. We've transformed our deposit base and are reaping the benefits. We've adjusted our interest hedging to protect against lower rates through 2025. Given the improvement in our ROTCE over time, we are raising our medium-term target to 16% to 18% from 14% to 16%. We've stayed focused on positive operating leverage. We've captured the benefit of moving to a more normal rate environment, and we still have plenty of upside in our fee businesses as market conditions improve. Exciting times for Citizens. I'd like to end my remarks by thanking our colleagues for rising to the occasion and delivering a great effort in 2022. We know we can count on you again in the new year. And with that, I'll turn it over to John. Thanks, Bruce, and good morning, everyone. Big picture, 2022 was a strong year for Citizens with significant delivery of strategic initiatives against the backdrop of uncertainty and volatility in the macro environment. Most notably, we closed our acquisitions of HSBC and ISBC. We captured the benefit of higher rates with strong NII and NIM, and our balance sheet and interest rate position were well managed. While fee revenues were impacted by the environment, we are very well positioned across our businesses to capitalize on the upside potential when markets normalize, particularly in capital markets. Mortgage margins and volumes should recover over time, and we are excited for the growth prospects arising from our wealth investments. We are actively managing our loan portfolio, focusing on allocating capital where we can drive deeper relationship business into 2023 and beyond. We continue to maintain good expense discipline, delivering in excess of $115 million of pre-tax run rate benefit through TOP 7, generating 4.7% underlying positive operating leverage for the year and 16.4% full year ROTCE. Let me give you the headlines for the financial results, referencing Slide 5. For the fourth quarter, we reported underlying net income of $685 million and EPS of $1.32. Our underlying ROTCE for the quarter was 19.4%. Net interest income was up 2% linked quarter with 5 basis points of margin expansion to 3.3% and relatively stable loans given a planned reduction in our auto portfolio. Period ended average loans are broadly stable linked quarter, up 1%, excluding auto runoff. We grew deposits up 1% linked quarter and our LDR was stable at 87%. Fees showed some resilience in a challenging environment, down 1% linked quarter. We saw a modest improvement in capital markets fees driven by underwriting and M&A, but this was more than offset by a drop in mortgage fees and a CDA DDA impact in our FX and IRP business. Expenses were broadly stable linked quarter. Overall, we delivered underlying positive operating leverage of 1% linked quarter, and our underlying efficiency ratio improved to 54.4%. Our credit metrics were good, with NCOs of 22 basis points, up 3 basis points linked quarter. We recorded a provision for credit losses of $132 million and a reserve build of $44 million this quarter. Our ACL ratio stands at 1.43%, up from 1.41% at the end of the third quarter and approximately 13 basis points above our pro forma day 1 CECL adoption coverage ratio. Our tangible book value per share is up 5% linked quarter. Next, I'll provide further details related to the fourth quarter results. On Slide 6, net interest income was up 2% given higher net interest margin. The net interest margin of 3.3% was up 5 basis points. As you can see on the NIM walk on the bottom left-hand side of the slide, a healthy increase in asset yields continues to outpace funding costs, reflecting the asset sensitivity of our balance sheet. With Fed funds increasing 425 basis points since the end of 2021, our cumulative interest-bearing deposit beta has been well controlled at 29% through the end of the fourth quarter. Moving on to Slide 7. We posted solid fee results despite headwinds from continued market volatility and higher rates. These were fairly stable, down 1% linked quarter with lower mortgage and FX and derivatives fees, partly offset by an improvement in capital markets fees. Focusing on capital markets. Market volatility continued through the quarter. However, underwriting and M&A advisory fees picked up. We continue to see good strength in our M&A pipeline, including several deals that were pushed into Q1. Mortgage fees were softer as the higher rate environment continued to weigh on production volumes. We have seen pressure on volumes moderating and size of the industry reducing capacity, which should benefit margins over time. Servicing operating fees were stable. Card and wealth fees posted solid results for the quarter. On Slide 8, expenses were well controlled, broadly stable linked quarter. Our TOP 7 efficiency program delivered over $115 million of pre-tax run rate benefits by the end of the year. We are excited to announce the launch of our new TOP 8 program, and I'll cover that in a few slides. On Slide 9, average and period-end loans were broadly stable linked quarter but up 1% ex auto runoff with 1% growth in commercial, reflecting demand in asset-backed financing and growth in CRE, primarily reflecting line draws and slower paydowns. We have seen commercial utilization moderate a bit over the quarter as inflation and supply chain pressures continue easing and clients are adjusting inventories to reflect this as well as lower CapEx in anticipation of a softer economy. Average retail loans are down slightly, but up 1% ex planned runoff in auto, given growth in mortgage and home equity, which bring an opportunity for deeper relationships and better risk-adjusted returns. On Slide 10, average deposits were up $1.4 billion or 1% linked quarter, with growth primarily coming from term deposits, money market accounts and Citizens Access Savings. Overall, commercial banking deposits were up 2.4% and consumer banking deposits were broadly stable. We feel good about how we are optimizing deposit costs in this rate environment. Our interest-bearing deposit costs were up 67 basis points, which translates to a 29% cumulative beta, broadly consistent with our expectations. We began the rate cycle with a strong liquidity and funding profile including significant improvements through our deposit mix and capabilities. We achieved overall deposit growth this quarter, and we will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits. Overall liquidity remains strong as we reduced our FHLB advances by $1.3 billion and increased our cash position at quarter end. Our period-end LDR improved slightly to 86.7%. Moving on to Slide 11. We saw a good credit results again this quarter across the retail and commercial portfolios. Net charge-offs were 22 basis points, up 3 basis points linked quarter, which is still low relative to historical levels. Nonperforming loans are 60 basis points of total loans, up 5 basis points from the third quarter, given an increase in commercial, largely in CRE. Retail delinquencies continue to remain favorable to historical levels but we continue to closely monitor leading indicators to gauge how the consumers vary. Although personal disposable income remains strong, debt service as a percentage of disposable income has essentially returned to pre-pandemic levels while consumer confidence has stabilized as inflation has eased. Turning to Slide 12, I'll walk through the drivers of the allowance this quarter. While our current credit metrics are good, we increased our allowance by $44 million to take into account the growing risk of an economic slowdown. Our overall coverage ratio stands at 1.43%, which is a modest increase from the third quarter. The current reserve level contemplates a moderate recession and incorporates expectations of lower asset prices and the risk of added stress on certain portfolios, including those subject to higher risk from inflation, supply chain issues, higher interest rates and return to office trends. Given these pressures, we are watching our loan portfolio very carefully for early signs of stress, in particular, CRE office. Back on Slide 32 in the appendix, we have provided some additional information about the CRE portfolio. Our total CRE allowance coverage of 1.86% includes elevated coverage for the office portfolio while the multifamily portfolio has a much lower reserve requirement. The $6.3 billion office portfolio includes $2.2 billion of credit tenant and life sciences properties, which are not as exposed to adverse back-to-office trends. The remaining $4 billion relates to the general office segment for which we are holding a roughly 5% allowance coverage. About 95% of the general office portfolio is income producing and about 70% is located in suburban areas. Moving to Slide 13. We maintained excellent balance sheet strength. Our CET1 ratio increased to 10%, which is at the top end of our range. Tangible book value per share was up 5% in the quarter, and the tangible common equity ratio improved to 6.3%. We returned a total of $350 million to shareholders through share repurchases and dividends. Our strong capital position, combined with our earnings outlook, puts us in a position to continue to return capital to shareholders through additional share repurchases. Shifting gears a bit. Starting on Slide 14, we'll cover some of the unique opportunities we have to drive outperformance over the next few years. We have tried to be very disciplined in prioritizing the areas that we think have big potential and where we have a right to win. So in Consumer, we've got four big opportunities. First is our push into New York Metro. We are investing in brand marketing, doing well in the technology conversions and putting our best people against the market opportunity. We are encouraged by our early success with some recent client wins in commercial and the HSBC branches driving some of the highest customer acquisition and sales rates in our network. The full ISBC conversion is just around the corner on President's weekend, and we look forward to making further strides as we leverage the full power of our product line-up and customer-focused retail and small business model across the New York market. You will see more details on Slide 28 and 29 in the appendix. Importantly, we achieved about 70% in run rate of our planned $130 million of investors' net expense synergies as of the end of the year and we expect to capture the rest by the middle of the year. We also continue to expect that the integration costs will come in below our initial estimates. Moving to wealth. We've launched a number of exciting initiatives with Citizens Private Client and CitizensPlus as we orient the business towards financial planning led advice. These should really help us penetrate the opportunity with our existing customer base. On Slide 15, our national expansion is another area where we have a great opportunity to build on our digital platform that has been focused on deposits for the last few years. We've moved that to a cloud-based platform, and we are adding our other product capabilities so that we can offer a complete digital bank experience to serve customers nationwide with a focus on the young mass affluent market segment. Where we might have only had a lending or deposit relationship before, our vision is to build a national platform that allows us to serve our customers in a comprehensive way. And we have also been very innovative in creating distinctive ways to serve customers. Citizens Pay, for example, is an area where we have significant running room. We've attracted many new partners, up about 150 versus a year ago, which should really ramp the business. And we built an industry-leading home equity business, powered by our innovative fast line process, which is enabled by advanced analytics and digital innovations that have drastically reduced originations time. Moving to the Commercial Bank on Slide 16 and 17. We filled in all the product gaps. Acquisitions brought us M&A and other advisory capabilities, and we built out debt capital market capabilities organically. We've hired some great coverage bankers and we are focused on high-growth regions around the country and the right industry verticals to serve larger companies. We also have a very strong sponsor coverage and are well positioned to support private equity capital. Bottom line, we have aligned ourselves with the attractive opportunities with a full product set to drive significant market share and fee revenues. Moving to Slide 18. We are excited to announce the launch of our latest TOP program. Even as we push forward on offense with our strategic initiatives and acquisitions, it is important to remember that a key to Citizens success since our IPO has been our continuous effort to find new revenue pools and realize efficiencies and then reinvest those benefits back into our businesses so we can serve customers better. We've effectively executed our TOP 7 program achieving a pre-tax run rate benefit of approximately $115 million at the end of 2022. And we've launched TOP 8 with a goal of an exit run rate of about $100 million of pre-tax benefits by the end of 2023, with that split about 80-20 between efficiency and revenue-oriented initiatives. Moving to Slide 19. I'll walk through the outlook for the full year, which contemplates an economic slowdown and the end of December forward curve view of two 25 basis point Fed hikes before an expected 25 basis point cut in the fourth quarter. We expect solid NII growth, up 11% to 14%, and we project our NIM to gradually rise towards approximately 3.4% for the fourth quarter of 2023. Our overall hedge position is expected to provide a NIM floor of about 3.2% through the fourth quarter of 2024 and a gradual 200 basis point decline across the curve, commencing in Q4 2023. In the fourth quarter, we took actions to transition $3 billion of active swaps from 2023 to forward-starting positions in 2024. And we've done even more so far in January to rebalance the distribution of down rate protection. You'll find a summary of our hedge position in the appendix on Slide 30. We expect moderate loan growth with average loans up 4% to 5%. We are targeting about $3 billion of spot auto runoff as we shift the portfolio towards products with more attractive risk-adjusted returns. We expect total average earning assets to be up 3% to 4%. On the deposit side, we see 3% average deposit growth and a 2% to 3% spot deposit decline with cumulative deposit betas at year-end reaching the high 30s. These are expected to be up 7% to 9% with a capital markets rebound building over the course of the year. Noninterest expense is expected to be up roughly 7% or about 3.5% to 4% if you adjust for the full year effect of the HSBC and investors acquisitions and the FDIC premium increase. If the year unfolds as we expect, we should be able to drive about 400 basis points to 500 basis points of positive operating leverage. Given current macro trends and portfolio originations, we expect that our ACL ratio will rise to the 1.45% to 1.5% level, depending upon how the economy fares. We expect our CET1 ratio to land at the upper end of our target range of 9.5% to 10%, even with our target payout ratio approaching 100%. All of this translates into a ROTCE in the high teens for 2023. On Slide 20, we provide the guide for Q1. Note that Q1 is seasonally weak for us with the day count impact and seasonality impacting revenues and taxes on compensation payouts impacting expenses. Moving to Slide 21. As Bruce mentioned, we have completely transformed the franchise since the IPO, executing well against our priorities and achieving our desired performance targets, and we are ready to raise the bar, lifting our ROTCE target of 16% to 18%. The key to the further ROTCE improvement is continuing to deliver positive operating leverage. As we look out over the medium term, we should see a recovery in loan and deposit growth and we will continue to be balance -- continue our balance sheet optimization efforts to focus on deep relationship lending to maximize risk-adjusted returns. We are well positioned to grow fees meaningfully. And even if rates come down a bit, we expect NII to benefit from the protection we have put on through the swap portfolio. You should expect us to stay disciplined on expenses. Credit is projected to be stable as the economy strengthens. And we continue to focus on returning a meaningful amount of capital to our shareholders through our repurchase program and targeting a dividend payout of 35% to 40%. Over this timeframe, we would expect our CET1 ratio to remain within our target range of 9.5% to 10%. To sum up, Slide 22, we delivered a strong quarter against the backdrop of a dynamic environment, and we have a positive outlook for 2023. We are ready for the uncertainty of an economic slowdown in 2023 with a strong capital, liquidity and funding position. We've taken actions to protect our NIM and we are being prudent with respect to our credit risk appetite and loan growth. At the same time, we are moving forward executing against our strategy and making important investments in our business that we believe will deliver sustainable growth and outperformance over the medium term. It sounds like you guys rebalanced some of the hedges in the fourth quarter and are continuing to do so year-to-date so far. I was hoping you might please just expand upon how you're thinking on how those changed since last quarter and sort of how you intend to position yourself? Yes, I'll go ahead and start off. I mean on the big picture, we -- asset sensitivity last quarter was around 3%. We're a little bit below that this quarter just given the way the outlook for the balance sheet appears to be playing out in 2023. So as we're -- as you've seen over time, we've taken our asset sensitivity down. We are -- most of that asset sensitivity is really driven by the short end of the curve, which we expect to remain elevated throughout 2023. And as a result, we're looking at some of the down rate protection that we had in place in 2023 and just repositioning that out of spot-starting active swaps into forward-starting swaps into 2024 and beyond. So we're looking to looking to basically push that out and basically get that down rate protection smoothed out into the '24 and '25 periods rather than holding on to all of that down rate protection here in '23. That's the main objective in what we were doing in the fourth quarter, and we've done a little bit more of that in early 1Q. And then more broadly, we're looking at net interest margin, that corridor, if you will, we're trying to protect that corridor with -- at the low end, if rates were to fall by 200 basis points out in 2024, that you'll see a floor of around 320. So you see that 320 to 340 corridor being something that over time is more narrow than you would have seen from us maybe in past cycles. So that's the main objective. And I would just add to that, Scott, in our view in the macro is that the Fed likely moves maybe most or twice the forward curve as they'll move up 25 basis points a couple of times and then stop. And then typically, they would pause for six or seven months before they would cut. And so if there's a cut happening, it likely happens very late in the year and maybe it could be early next year. So guided by that view, that's kind of why we're pushing out that downside protection a bit. Terrific. And then just a separate question. It looks like fees will need to rebound fairly meaningfully following the first quarter to hit the guide? I know, Bruce, you had mentioned an expectation for improved capital markets through the year. Maybe just a thought or two on how you see the main drivers of that fee guide as the year progresses, please? Sure. So I think really, you put your finger on it there, Scott, is the capital markets business. We've had really strong pipelines this year. But because of the volatility because of the fact that the Fed is still moving higher, that's created uncertainty and just an inability to actually get the money to work from private equity or some of the deals done because the financing hasn't been there the way it's been in the past. And so I think as you -- going back to that macro forecast as the Fed is likely nearing kind of the destination in terms of peak rates. I think that starts to loosen up the markets, the financing markets, you'll see less volatility and a lot of the business is kind of clocked into our pipeline will start to print and get delivered, and we'll start to see more transactions. So just by reference, most of the quarters this year, our capital markets revenues were at $90 million to $100 million. If you go back to the fourth quarter of 2021, we had $184 million of fees, so roughly double that level. So we thought coming into this year that we'd have much stronger levels of revenue generation. But the good news is we still have a great overall focus on the right sectors in the market. We've got a great team. And so I think you'll see that start to rev up as we see the market conditions improve. Beyond that, I'm also quite optimistic. We've made a lot of investments in the wealth business. And again, there, if you start to see some stability in the asset markets, we should get a kind of tailwind from that plus the investments that we've made. So feel confident about that. And then I'd say mortgage is so washed out. I keep thinking it can't go any lower, and it did in the fourth quarter. But I think you're starting to see people exit the business and coming out of the business. And so you'll start to see margins expand, and I think volumes will tick-up as we go through the year, again, linked back to the Fed reaching the destination and some stability on rates. So those would be the big things. I'm happy to pass the horn here. Don, do you want to say anything else...? Yes. I think you've pretty much covered it on cap markets. I said this last quarter, I'll just remind people, again, we are a middle market investment bank. So we're not dependent on these giant transactions that need $5 billion of financing. We do singles and doubles all day long, and our pipelines are reasonably strong with a very heavy content of private equity who is a watch with cash. So there will be transactions. If you don't get regular way transactions, you're going to get a lot of restructuring transactions. So there's minority capital. There's a lot of different ways to skin the cat. So we're relatively optimistic about what's ahead of us in the coming year. I think you nailed that pretty well. I'd say well for the year, we're projecting slow and steady, continued progress, and it's a bit of a hopeful coiled spring when the equity markets really come back. But as long as they're stable, we should see some growth. I'd say the other bright spot is debt and ATM fees that continue to hit records both through customer engagement and primacy and all the investments we made in the health of the franchise that's also translating into our deposit quality, also some restructure on vendor relations and such that's giving us a bit of a boost there, too. So that should be a continued area of slow and steady progress. On the other side, there will continue to be a little bit of pressure still on overdraft income and service charges, but we're sort of near the -- that's in the run rate. Most of that's in the run rate. So we're sort of near the bottom, which is good that we'll move away from being a headwind for us, real soon. I wanted to ask on credit. John, you mentioned that most of the increase in nonperforming loans was commercial real estate. I was just wondering, was that office related? And if you can just give a little bit more color on what your outlook is for office? Yes. Maybe I'll just talk about the coverage levels. Just broadly, as you may have seen in our materials that the CRE coverage from an allowance standpoint is around 186 basis points. But when you carve out some of the really high-quality stuff in multifamily and credit tenant lease and life sciences, you get to our general office segment, where we have very healthy coverage of around 5%. So there are some -- we are seeing some trends there that are telling us that we should be putting away some reserves to deal with the back-to-office trends that are a headwind in that space. So you got good healthy coverage of around 5%. We are seeing some of that tick into the nonaccrual space. I would say more broadly, that will -- even though that goes into nonaccrual, our overall pre-LTVs are typically around 60%. And so you got to distinguish from non-accruals for actual loss content. And so even though we're putting some allowance away, we feel like that's commensurate with the loss content that we see in the book. And I'll just stop there and⦠I'll just say for the office portfolio, but CRE in general, it's first and foremost, who's the sponsor and who's the investor, and we have a very high-quality group of investors that we do business with, which are largely institutional. Second is what MSAs are you in and where are you? And we think suburban will do better than urban. As we said in the comments, we're heavily weighted to suburban. So we're going through every single property in the office portfolio. We'll restructure a lot of them with the sponsors. We restructured one already this year where the sponsor-contributed equity. So we're comfortable around where we are with the coverage ratios right now, but we'll be active in restructuring the portfolio. But we kind of like the contours of what we've got. Got it. And then just as a follow-up, can you just talk about what changed in the updated margin guidance of towards 3.40 versus the prior guidance of 3.50? Is it just the higher deposit beta outlook? Yes. I'll go ahead and cover that. I mean I think more broadly, it's two overall comments, really the -- just given the pace and speed of rate changes and the impact on the migration of the deposit mix that we expect as you get into 2023 is really most and the majority of what we're looking at. So -- and that migration manifests itself in two ways. It's really the amount of DDA migration that we see as well as the cost of our relatively low cost deposits that we're seeing not only within our platform but across the industry. So from that perspective, just kind of marking that to market with respect to what we're seeing in the trends in the fourth quarter and the rate and curve outlook that we see going throughout the rest of '23, I would hasten to add the -- what's embedded in there nevertheless, is a transformed deposit platform that back -- prior to the pandemic, we would have had DDA percentages that would be in the low 20s compared with a majority of the portfolio being outside of DDA, of course. But you fast forward to where we are in the fourth quarter, and we're at 28% of our deposit franchise is sitting in DDA. That's a significant increase versus pre-pandemic. And we expect to end the year in the sort of the mid- to high 20s in the DDA space, down a little bit from where we are today, but nevertheless, still very high quality. When you add in consumer CRE and consumer savings, which is other low cost, you end up with still about [15%] or more of our deposit portfolio sitting in low-cost categories. That's up from the low 40s prior to the pandemic. So this has been a multi-multiyear transformation of the deposit franchise. So I think we're basically just calibrating what we expect in 2023, which is with the majority of what we saw in terms of the decline from 3.50 to 3.40. I think you could also add in what's going on with the curve and front-book, back-book as well. When you look at it just how quickly rates are rising, the front book originations take a longer time to contribute. And from that perspective, we're seeing that being a driver as well. And then not only the speed of -- I guess, the last point I'll make is not only the speed of rates rising, but the inversion of the yield curve is something that is also pretty -- is a headwind to front-book, back-book. Just to end it with nevertheless, front-book, back-book is a positive tailwind over time. We're seeing 300 basis point of positive front-book, back-book across securities and our fixed rate lending businesses, that's still a tailwind. And that's going to be a driver into 2023 with net interest margins rising just not by quite as much as we thought last quarter. Wondering, Bruce heard your earlier comments about we're at 1.30 ACL day 1 adjusted for the deals in the low 1.40s now and your comments about 1.45, 1.50 year-end. I'm just wondering if you can help us, given that you're slowing loan growth and letting the auto book run out, how do you just help us understand what you're seeing in terms of what your CECL impact might be looking ahead versus the impact of slower loan growth in terms of that endpoint that you're expecting? Sure. I'll start. John, you can pick up. But I'd say what we've done for the past several quarters is kind of keep looking forward as to what's the macro forecast and are there any particular segments of the portfolio that could come under stress given that the Fed has continued to push higher and the economic growth has been downgraded. So I think there's -- like I read today that over 60% of the leading economists are projecting a forecast for this year. So the reason that we've been building gradually is just taking that into account. I think at some point, you kind of get the cards turned up in 2023, and you'll have more information and less uncertainty, but we don't see that where we sit today. So I think it's prudent to continue to view the course -- likely course, is that the ACL will go up a couple of basis points a quarter like we've done and get into that 1.45 to 1.50 range. At some point, then you'll have seen whatever the recessionary impact is, and then you'll be looking forward and then you may get to the point where you can release some of those reserves depending on what your charge-off experience is. Clearly, Ken, the slower loan growth plays into that, to some degree is mitigating what the build could have been, but anyway, those are the dynamics that like, John, I don't know if you want to add to that? Yes. I'll add that. I mean just for the last couple of quarters, we've had a mild-to-moderate recession built into the. And so our peak-to-trough GDP decline that we have built into our models are 1.5%. That would be a moderate recession at this point. I think the changes you may have seen in the second half of '22 were not quite as much on the expectation that there would be a recession as much as what the collateral value outlook really impact was. So when you think about house prices and used car prices, et cetera, we've been increasing the amount of decline expected. So you've got sort of the low to mid-teens declines now built into our models for both house prices and auto prices over the foreseeable and kind of period. And so that's really -- and that's not really driving a lot of losses, just we've been having a lot of recoveries in the portfolio over the last year or so. And so you may then -- you might see some lower recoveries and that will have the -- you saw our loss that's built into our loss forecast for '23. But I think that's an important item that you saw in 4Q in terms of our outlook for 2023 and 2024. Got it. Okay. And just one quick follow-up on the capital point. You're nearing 100% implies a nice incremental step up in the buyback. I'm just wondering how you're thinking about the mix of the dividend versus the buyback going forward, yet you obviously moved to $0.42 in the third quarter. Should we also think about that you would be moving the dividend up in line with increased earnings potential as well within that context? Yes. I'd say what we do here is every year, we're on a cadence where post-CCAR, we basically take that as the opportunity to broadly update our capital return profile. Over the medium term, we're looking at 35% to 40% dividend payout. And you saw that in some of our medium-term outlook. We've updated that this is going to be more of a buyback return year in '23 because of the outlook for RWAs. But we take a look at a dividend policy and earnings outlook and update whether there should be a change in the dividend after CCAR. Yes. And I would just add to that, Ken, that clearly, with the uncertainty in the environment, we are being cautious in terms of the lending of kind of risk appetite. And so I think that, in and of itself, creates some additional capital versus what we've had in prior years. I also think we still have our plate full integration of existing acquisitions and we haven't seen a whole lot that's attractive at valuations that we're interested in on the acquisition front. And so I think the combination of operating at very high profitability levels with ROTCE returns in the high teens plus more modest loan growth than historical, more modest acquisition activity than historical creates the opportunity. And I think it's appropriate given the uncertainty and chance for recession that returning capital to shareholders is the right course of action here. So you could expect we would like to raise the dividend during the course of the year, and we'd also like to get close to that 100% return of capital to shareholders. On the overall deposit dynamics, I know you expect a 2% to 3% year-over-year spot decline. Can you maybe give us a little more color on how you expect overall deposit trends to progress through 2023 to get to that 2% to 3% spot decline? Maybe help us with the magnitude of declines that you think is reasonable here in the coming quarters as you look at deposit flows? Sure. Yes. That sounds good. Yes. I mean, I think overall, as I mentioned before, we're seeing deposit migration from a DDA perspective as well as from some of our lower cost levels. But broadly, the mix is superior and improved compared to pre-pandemic. I think we're around 28% DDA in 4Q, that's probably going to tick down a bit, call it to maybe 27% or so by the end of the year. That's part of the story. I'd say the -- some of the higher cost deposits in money markets and savings will be part of the runoff as well such that you get to something along the lines of 2% to 3% declined spot-to-spot end of '22 into '23. And so I'd say that you end up with some, again, improved mix compared to pre-pandemics, but a little bit of mix softening as you get throughout '23. And I'll just... I would just add -- I would add to that is that I'd say we did not take in as much surge deposit as many in our peer group. We have a consumer-tilted deposit base, which tends to be more stable. And so we've been monitoring that surge deposits quite carefully. And we have seen it actually be more sticky than we initially expected. I think where you'd see a slight runoff probably is more on the commercial side where treasurers have other alternatives besides bank deposits to move some money out. But again, we're relatively protected there because we didn't take in a lot of that money in terms of search deposits. So maybe, Don, you could comment here or Brendan? Yes. I think our spot is down a little less than 2% year-to-year. We actually ended this year a little higher than we thought we were going to because we had some nice inflow at the end of the year. But back to -- I think John said it in comments, we've really transformed our deposit base really off the back of our treasury services business, so both specialty deposit offerings, we've got two that we're now in the market with around ESG, green deposits and carbon offsets and then just the strengthening of our DDA deposits with our treasury services business gives us more stability than we would have had in prior years. So we feel pretty good about that projection. And we're -- in general, we're really managing the balance sheet from a BSO standpoint and really we're avoiding most new transactions given just the shyness around the credit environment and the uncertainty, and we're moving clients who aren't generating positive returns off the franchise and off the balance sheet. So it gives us a little bit of a dynamic that we don't really need to go chase deposits because we're keeping the loan side relatively modestly in terms of how it grows. Yes. Without being too redundant to what John mentioned, I'd say consumer has been broadly stable on deposits, which is a really good thing. And the story for us is going to be controlling the mix, but all indications are quite positive. We look at a lot of benchmarking data, and we're pretty confident that we're performing in the top quartile of our peer banks in terms of retention of low-cost deposits as well as interest-bearing deposit costs so far in the cycle. It's sort of midway through the cycle. So we've got to stay disciplined and manage it well, but it's been driven by a lot of health improvements, household growth, improvements in primacy, mix shift to Bruce's point, we were 45% mass affluent and above five years ago, we're now 60% of our customer base is mass affluent and above. So the quality has been quite good. On the stimulus front, what we're seeing is the bottom two deciles of our customer base is essentially at the paycheck to paycheck. So that stimulus has already burned off and is in the rearview mirror. So the stimulus that remains with us tends to be with the more affluent customers, whether that's actual stimulus check. So that's balance parking that happened during COVID for not making mortgage payments and not traveling, et cetera, et cetera. We're not actually seeing that burn off as much as we're starting to see that rotate out of low-cost deposits into interest-bearing, which is natural given the stated interest rate. So we're managing that really tight. All the investments we've made in the franchise, whether analytics, new products, the introduction of CitizensPlus in our Private Client Group as well as having Citizens Access to fence off interest-bearing deposits to maintain discipline in the core have all been really big levers for us to manage well. And all indications we see so far is that we're right on track with where we want it to be and dramatically outperforming where we were last time and up rate cycle and at worst, in line with peers, but some signs that we may be doing a bit better, which is a big turnaround from where we were five, six years ago. Okay. Great. That's helpful. And then separately on the commercial real estate front, I know you stated 60% LTV on overall commercial real estate. Is that origination? And then do you happen to have refreshed LTV? I know you mentioned that a lot of your deals have sponsor participation, but we're hearing that with sponsors exiting or refinancing out certain deals that's impacting the LTV, so the refreshed LTVs may be a better read, particularly on the office front. Yes. The office -- the 60% was the office LTVs in terms of not the overall CRE book. So we think those are still pretty good. We're refreshing the property by property. We haven't gone through and done a total refresh on the entirety of the book yet, but we're kind of working on the maturing quarter-by-quarter maturities and working with the sponsors to either refinance out, inject equity or adjust the value of the portfolio. And that's what drove the NPL this quarter. It was really one real estate deal. This is [Megan Stein] on behalf of Matt O'Connor. On capital, so the 9.5% to 10% medium-term CET1 target range, that's well above the regulatory minimum. You've built reserves a lot, and it seems like the conversion time line of ISBC is going really well. So I guess my question is, I hold so much capital down the road given solid reserves and successful deal integration time line? Yes. I would say part of it is just the philosophy of liking to have a strong balance sheet. And so I think 9.5% to 10% is a strong ratio. You've seen over time that we've originally had a target of 10% to 10.5%, and we've been kind of sliding that down as we -- our profitability goes up. And I think the stakeholders gain more confidence that we have a good strategy, and we're executing well. So it wouldn't surprise me at some point where we start to manage down in that range. I think the time of 2023 today, we're looking at a potential recession to be at the top end of that range makes sense. But once we get to the other side of that to start to move that down and maybe manage that closer to the bottom end of that range will provide more leverage. And then at that point, I think we could step back and say, do we still need 9.5% to 10% or can we skinny that down a little bit? So I think that's all in front of us, we thought at this point, given the dynamics around 2023, it wouldn't make sense to actually move that target range down. Okay. And just a -- second question is just on loans. So the $3 billion auto runoff will offset growth in other areas this year. What are your expectations for other loan categories in 2023 coming off of a strong 2022? Yes. I'll go ahead and start there and others can chime in. But I mean, I think when you look out into 2023, we still see very, very strong opportunities in the commercial space and within C&I. And I think something to always keep in mind is our utilization is well below where historical levels would imply we should be. And so as you get into the later part of the year, you see some recovery in investments, in inventories and CapEx and possibly M&A, which actually provides financing opportunities. We see lots of opportunities across commercial. And that's really one of the main drivers. When you get into consumer, we're looking at home equity being a place that a place that we like and card and Citizens Pay would contribute as well. So that wraps up to a stable year-over-year loans and back to the point around that being taking that otherwise RWA that would have been deployed against auto and some other categories with lower risk-adjusted returns and giving that back to shareholders. I just wanted to follow up on the NIM line of questioning. I think you brought down the floor for NIM from 3.25% to 3.2%. Is that also a function of what you mentioned on the DDA migration and the curve and also the fact that you pushed out the forward swaps. Is the biggest variable on that number, mostly the cost of funding side? Or I guess would there be any changes to that 3.2% number, the Fed cuts rates sooner? Yes, I'll start and flip to John. It's Bruce. But I think the two numbers are tethered together. So if the 3.50% is now seen to be 3.40%, then your floor is going to also commensurately move lower. The good news is, in a way, is that we've tightened the bottom side of that range. So previously, it was 3.50% down to 3.20%, 3.25%. So it was 25 basis points and now it's 3.40% to 3.20%. So it's 20 basis points. So anyway, I think we -- certainly, John's initial answer on the movement down has been focused more on migration, the DDA and low-cost migration, but then also some of the impact from the yield curve on front book back book has been the other dynamic. So those are the things that we're watching. But John, you can out from there. Yes. I'd say the only thing I'd add, just to remember, we constructed -- we modeled that 3.20% and there's a lot of assumptions that go into that with respect to what the mix of the balance sheet would be, et cetera. And what we're assuming is a 200 basis point gradual decline in 2024 that would get you down to that 3.20%. And given that we are still asset sensitive and we haven't closed out that position, that's really what you're seeing in terms of the decline in net interest margin. So as and when we continue to look at ways to lock in protection against down rates, you could see that 3.20% move around based on hedging activities as well as updated views on what the mix of the balance sheet is likely to be in the context of what's the Fed... It's a very dynamic process. So we look and see where the forward day rates are going to be. We have our own view of that. We see what the valuations we can get in the hedge market are. And you can be assured, I think we played our hand quite well so far, and we'll continue to stay really focused on. I appreciate that. And then separately, just on the program. Can you unpack some of the drivers there of the $100 million in pre-tax benefits and maybe how quickly those can come out from the expense base over the course of the year? Yes, I'll go and cover that. I'd say the one dynamic to keep in mind is that we tend to form these programs and generate a year-end run rate benefit that will contribute for each of them. Mostly on the one hand, the $100 million will build throughout '23 so that it gets to a run rate when you get to the fourth quarter of '23. But keep in mind, we did the same thing with TOP 7. So there's a full year effect of TOP 7 that comes in. And so when the programs are reasonably similarly sized, you can almost use that as an estimate of what the contribution is in any given year. And so you have maybe a combined $100 million plus contribution from the full year effect of TOP 7 hitting '23 and the in-year effective TOP 8 hitting '23. And so the big drivers of that really you've got the traditional areas that we focus on, which is third-party costs and vendor cost management, which is an area that's been contributing over the years as well as continue to optimize the branch network. And just being really careful about ensuring that our organizational approach is fit for purpose with respect to what we're trying to accomplish in '23. So those are more traditional areas. The other places we're looking at that have been more recent include maturing our Agile delivery model away from a waterfall approach to agile and next-gen technology initiatives continue to contribute as well. We're working towards a data center exit in 2025. We're looking to migrate to the cloud from our internal applications, and that's contributing in '23 as well. But there's a lot of very strategic sort of initiatives that are built within the TOP 8 program and we're excited about it. It's part of who we are, and we're looking forward to deliver against that next year. A couple of questions for you folks. Firstly, the deposit betas that you expect to get to the high 30s. Given the pace of change in the fourth quarter, should we and your expectation for rate hikes early in the year and not after that, should we expect you get to that in Q1? Any color on that, on the pace of it, especially given how rates have been going up? Yes. I mean I think we'll not get there in Q1. That is an over-the-year expectation in terms of the cumulative growth. I mean I think you'll see the growth in cumulative betas begin to moderate and flatten out. You have the big jumps early in the cycle. So we began and go way back to the second quarter of '22, our cumulative beta was 6%. And then you get to the fourth quarter, the cumulative beta is 29. So you've got 23 points just in '22 and you'll have -- and then we're looking for in '23 is another 9 points. So this -- and it will increase over time. You won't get to 38 in the first quarter and will gradually... Deposit tend to replace reprice with a lag. So even after the Fed pauses, you still see a little bit of upward pressure on those betas. But I would -- okay. But then does that mean, Bruce, the bulk of it is probably early on and just a little further increase after that, after the Fed is done? Okay. Different question, a second one. Fee income, your guide of about 7% to 9% growth in full year '23 versus '22. How much of that would you expect would come from capital markets or at least what's in your forecast that you're thinking how much comes from capital markets? Yes, I think there's a big part of it. I mean, back to the big drivers, you had capital markets, and you heard about card fees from Brendan and wealth from Brendan as well. So those are the three big ones. You see mortgage really potentially rebounding as well. But a big part of it would come from capital markets from the underwriting perspective and M&A advisory, just as we may have mentioned in the fourth quarter, we saw some deals pushed from 4Q into 1Q. So that's going to support the capital markets business, which, by the way, over the years, has really become a very diversified capital markets business itself. I mean just broadening out M&A advisory, underwriting and loan syndications. Those businesses really tend to really diversify our overall fee outlook. But yes, a good part of it and a good chunk of the growth in '23 comes from capital markets. There are no further questions in queue. And with that, I'll turn it over to Mr. Van Saun for closing remarks. Okay. Great. So thanks again, everyone, for dialing in today. We certainly appreciate your interest and support. Have a great day.
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EarningCall_1278
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Good day and welcome to the WesBanco, Inc. Fourth Quarter 2022 Earnings Conference 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. I would now like to turn the conference over to, John Iannone, Senior Vice President of Investor Relations. Please go ahead. Leading the call today are Todd Clossin, President and Chief Executive Officer; Jeff Jackson, Senior Executive Vice President and Chief Operating Officer; and Dan Weiss, Executive Vice President and Chief Financial Officer. Today's call, an archive of which will be available on our Web site for one year, contains forward-looking information. Cautionary statements about this information and reconciliations of non-GAAP measures are included in our earnings-related materials issued yesterday afternoon, as well as our other SEC filings and investor materials. These materials are available on the Investor Relations section of our Web site, wesbanco.com. All statements speak only as of January 25, 2023, and WesBanco undertakes no obligation to update them. Thank you, John. Good morning, everyone. On today's call, we'll review our results for the fourth quarter of 2022, and provide an update on our operations and current 2023 outlook. Key takeaways from the call today are our operational strategies and core advantages were evident throughout 2022, and were highlighted by our earning numerous national accolades. We had a solid financial performance demonstrated by loan growth, net interest margin expansion, and discretionary cost control. We remain well-positioned for continued success and are excited about our future growth opportunities. WesBanco had another successful year during 2022 as we remained focused on ensuring a strong organization for our shareholders, and continued to appropriately return capital to them through both long-term sustainable earnings growth and effective capital management. Through successful operational execution we generated solid annual net income, while remaining a well-capitalized financial institution with strong liquidity, balance sheet, and credit quality metrics built upon our well-defined strategies and core advantages which will ensure success regardless of the economic environment. We are pleased with our performance during the fourth quarter of 2022 as we continued to deliver loan growth, controlled discretionary expenses, and maintained our reputation for credit quality. For the quarter ending December 31, 2022, we reported net income available to common shareholders of $49.7 million and diluted earnings per share of $0.84 when excluding after-tax merger and restructuring charges. On the same basis, for the full-year, we reported net income available to common shareholders of $183.3 million, and diluted earnings per share of $3.04. Furthermore, the strength of our financial performance this past quarter is further demonstrated by a return on average assets of 1.18% and return on tangible equity of 16.05%. And our capital position remained strong and continues to provide financial and operational flexibility. Throughout the year, we accomplished several milestones and continued to receive numerous national accolades that resulted from our performance, operational strengths, and community focus. I'd be remiss if I do not congratulate our employees for these recognitions as they are a testament to their hard work and dedication. Just to highlight a few, WesBanco remains the leader in an advocate for its communities, and we continually look for ways to expand our outreach and involvement, including the issuance of our initial sustainability report. We launched new loan production offices in Cleveland, Indianapolis, and Nashville, complementing our existing LPOs in [Akron-Canton] [Ph] and Northern Virginia. Based on customer satisfaction and consumer feedback, WesBanco Bank was named by Forbes as the number one bank in Ohio, and the number two bank in Kentucky, including high scores for trust, branched services, terms and conditions, customer service, digital services, and financial advice. For the fourth year in a row we were named one of the world's best banks, which was also based on customer satisfaction and consumer feedback. For the third year in a row in the top 12, WesBanco Bank was once again named to the Forbes list of the best banks in America based upon growth, credit quality, and profitability. We were named to the Forbes list of America's Best Midsized Employers, earning a spot within the top 10 percent of all companies recognized, as well as securing the number two spot out of 30 companies included in the banking and financial services category. In fact, we were the only midsized bank making the top 10 for both financial performance and employer of choice. Finally, WesBanco was recognized as one America's most trustworthy companies, as well as being one of only 20 banks to earn this nationwide honor for three touch points of trust; customer trust, investor trust, and employee trust. The key story this quarter was the strength of our lending teams as we demonstrated strong loan growth for the third consecutive quarter, combined with solid credit quality measures which continue to remain relatively low from a historical perspective, and consistent through at least the last 10-plus quarters. Reflecting the strength of our markets and lending teams, we again reported solid broad-based loan growth during the quarter. Total loan growth, excluding SBA PPP loans, was 11.7% year-over-year and 4.2% or 16.8% annualized when compared to September 30, 2022. While key credit quality measures such as total loans past due and criticized and classified loans declined both year-over-year and sequentially to 0.19% and 2.34%, respectfully, of total loans. Despite mortgage originations of just $179 million during the fourth quarter, 90% of which were either purchase or construction, residential real estate loans increased more than 20% both year-over-year and sequentially annualized through the retention of approximately 80% of the 1-to-4 family residential mortgages generated by our team of mortgage loan originators. Total commercial loan growth continues to benefit from our teams and markets that have been enhanced by our hiring efforts over the past two years. For the fourth quarter, total commercial loan growth was 9.6% year-over-year, and 4.1% from the third quarter or 16.2% annualized. Our commercial teams continue to find new business opportunities to replenish the pipeline. In addition to new loan originations of approximately $490 million during the fourth quarter, our commercial pipeline has remained relatively consistent since last quarter, at approximately $900 million. The strength of our pipeline represents the talent of our lending teams as well as early success from our loan production office strategy which only account for approximately 13% of the pipeline. While we will see what the economy will provide this year, I am encouraged about our future commercial lending prospects as our newer lenders continue to gain traction, our recent LPOs gain market share, and we hire additional lenders. Through the last few years, we have transformed our company into an evolving regional financial services institution with a community bank at its core. We have done this through the successful expansion in a higher growth market spanning six states, with the majority of our company now located within these markets, while adhering to our foundation of disciplined, discretionary cost control, risk management, and credit standards. As we have discussed before, a key investment in support of this evolution has been and will continue to be the investment in our employees as they are critical to our long-term growth and success. During both 2021 and 2022, we focused on improving retention and boosting morale by implementing increases in the hourly wage, which was very well-received. In addition, we developed plans to increase the depth and strength of our teams across our business lines and markets. We successfully executed upon these plans by hiring more than 45 revenue producers during 2021, and more than 50 during 2022, and have begun to see the growth and positive operating leverage from these investments. We will continue to enhance our evolution into a solid and sound growth story combined with our strong foundation and core advantages through an ongoing lender hiring strategy. While we will continue to evaluate existing lenders to ensure appropriate productivity, we plan to annually add high-value and productive individuals to enhance our ability to leverage growth opportunities across our markets. We remain focused on ensuring an organization with sound credit quality, solid liquidity, and a strong balance sheet. We have the right markets, teams, leadership, and strategies to provide long-term success for our shareholders, customers, and employees. We're excited about our opportunities for the upcoming year. I would now like to turn the call over to Dan Weiss, our CFO, for an update on our fourth quarter financial results and current outlook for 2023. Dan? Thanks, Todd, and good morning. During the quarter, we recognized strong loan growth, continued stability in our credit quality measures, improvement in our net interest margin, and maintained discipline over expenses. As noted in yesterday's earnings release, during the fourth quarter, we reported improved GAAP net income available to common shareholders of $49.7 million, and earnings per diluted share of $0.84, and net income of $182 million, and earnings per share of $3.02 for the full-year. Excluding restructuring and merger-related charges, results for the three and 12 months, ending December 31, 2022, were $0.84 and $3.04 per share, respectively, as compared to $82 and $3.62 last year, respectively. It's important to note that the 2021 was favorably impacted by a negative provision of $51.6 million net of tax or $0.79 per share, as compared to a benefit of $0.02 per share during 2022. Total assets, of $16.9 billion as of December 31, 2022, included total portfolio loans of $10.7 billion and total securities of $3.8 billion. Loan balances for the fourth quarter of 2022, which grew both year-over-year and sequentially, reflected strong performance by our commercial and consumer lending teams and more 1-to-4 family residential mortgages retained on the balance sheet. Furthermore, as we expected, commercial real estate payoffs moderated this quarter, totaling approximately $63 million. We also reclassified $86 million of consumer loans secured by residential real estate to the HELOC category to better reflect the underlying collateral. SBA PPP in the prior-year period totaled approximately $163 million, as compared to $8 million this period. Importantly, reflecting the strength of our underwriting standards, our key credit quality measures continue to remain at relatively low levels, and is favorable to peer averages. Robust deposit levels remain a key story as total deposits as of December 31st 2022 were $12.2 billion excluding CDs. Essentially flat compared to the prior year as growth in non-interest bearing demand deposits and savings accounts offset the decline in interest bearing demand deposit balances. Further, our non-interesting bearing deposits improved to 36% of total deposits. Total deposits at yearend were $13.1 billion, down 3.2% year-over-year due to a $407 million reduction in CDs. The net interest margin in the fourth quarter of 3.49% increased 16 basis points sequentially and 52 basis points year-over-year. This increase reflects our successful deployment of excess cash into higher yielding loans combined with 425 basis point increase in the federal funds rate throughout the year. Our core margin continued to increase quarter-over-quarter from 3.27% to 3.44%, which excludes purchase accounting accretion of 5 basis points for both periods for SBA PPP loan accretion with a basis point or less for both periods. Our robust legacy deposit base provides a pricing advantage as compared to peers, especially those primarily in major metro markets. We are not immune to the impact of rising rates on our funding sources. Deposit funding cost for the fourth quarter of 2022 increased 44 basis points year-over-year to 57 basis points or 29 basis points when including non-interest bearing deposits. This reflects a total deposit beta of 8% as compared to 375 basis point increase in the federal funds rate throughout the year, excluding December which did not meaningfully impact the year-to-date average. For the fourth quarter of 2022, non-interest income of $27.8 million was down $2.9 million year-over-year, primarily due to lower mortgage banking income which decreased $2.3 million due to reduction in residential mortgage originations consistent with the industry in general, and the retention of more loans on our balance sheet. Securities brokerage continued its organic growth trend as net revenues increased $1 million year-over-year to a record $2.6 million. Our commitment to discretionary expense control in an inflationary environment combined with loan growth and net interest margin expansion resulted in an improved efficiency ratio of 56.9%. Excluding restructuring and merger-related expenses, non-interest expense for the three months ended December 31, 2022, totaled $90.4 million. A 2.6% increase year-over-year and a 1.6% decrease sequentially. It's important to note that the fourth quarter included a couple of large credits totally approximately $2.5 million which are not expected to repeat in our expense run rate going forward. Within salaries and wages, there was a $1.8 million downward adjustment to bonus expense mostly related to lower mortgage lending commissions and annual volume based incentives. And with an employee benefits, there was a $600,000 credit related to the deferred compensation plan which fluctuates based on movement in underlying equity securities. Adding these two items back, non-interest expenses for the fourth quarter would have been approximately $93 million. Turning to capital, during the fourth quarter the quarterly dividend was increased from $0.34 to $0.35 per share, representing a 2.9% increase. Our capital position remains solid is demonstrated by regulatory ratios that are above the applicable well-capitalized standards and our tangible common equity ratio improved to 7.28% as of December 31st 2022. Now I'll provide some initial thoughts on our current outlook for 2023. We remain an asset-sensitive bank. And currently, model fed funds to peak at 5% during the first quarter. And then, hold steady throughout remaining quarters of 2023. We are modeling a couple basis points of margin expansion in the first quarter and hold relatively flat for the remainder of the year as deposit pricing continues to rise. We expect purchase accounting accretion to be approximately four to five basis points per quarter and no meaningful SBA PPP accretion. As mentioned, a robust legacy deposit base provides pricing advantage for the industry. And we anticipate our deposit betas to continue to be lower than peers and to generally lag the industry. Residential mortgage originations should remain positive relative to industry trends due to our new loan production offices and hiring initiatives, as well as the anticipated stabilization in interest rates, and should begin to rebound as the year progresses. While it is dependent on origination production, we continue to expect to move, over time, to selling approximately 50% into the secondary market subject to customer preferences and pricing. Trustees will continue to benefit slightly from organic growth, as well as be impacted by the trends in the equity and fixed income markets. As a reminder, first quarter trust fees are seasonally higher due to tax preparation. Securities brokerage revenue should continue to benefit modestly from year-over-year organic growth. Electronic banking fees and service charges on deposit will mostly likely remain in a similar range with the last few quarters as they are subject to overall consumer spending behaviors. In addition, we anticipate an increase in new commercial swap fee income above the approximate $4 million we've earned annually over the last few years as we have implemented improvements in our training and strategy. While we remain diligent on discretionary costs to help mitigate inflationary pressures, we intend to continue to make important growth-oriented investments in support of long-term sustainable revenue growth and shareholder return. This will include ongoing efforts to attract and retain employees, in particular commercial lenders across our metro markets as we continue a similar hiring strategy that we implemented for 2022. We'll continue to make improvements to infrastructure, which will include upgrading about a third of our ATM fleet with the latest technology, as well as other digital product enhancements. We anticipate higher pension expense of approximately $1 million per quarter within employee benefits based on an expected lower return on plan assets, and expect to be impacted by the industry-wide FDIC insurance rate increase. To support our growth plans across our markets, we anticipate investing more in marketing with a focus on revenue-generating campaigns. We will also continue to evaluate our financial center network to identify cost-saving opportunities which could provide a benefit in the second-half of the year. Based on what we know today, we believe our quarterly expense run rate to be in the mid $90 million range. We believe that these investments are appropriate in support of long-term sustainable revenue growth and associated shareholder return, and will continue to drive positive operating leverage. The provision for credit losses in CECL will be dependent upon changes to the macroeconomic forecast and qualitative factors as well as various credit quality metrics, including potential charge-offs, criticized and classified loan balances, delinquencies, changes in prepayment speeds, and future loan growth. Lastly, we currently anticipate our full-year effective tax rate to be between 19% and 20% subject to changes in tax legislation, deductions in credits, and taxable income levels. We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Daniel Tamayo with Raymond James. Please go ahead. Maybe we start on the loan growth expectations, it's -- just interested in what you're seeing and what you're expecting for the coming year. And then with the loan deposit ratios still relatively low, how much are you willing to let that rise and fund from securities runoff? Yes, okay, well, I'm glad to answer that, Dan. It's -- obviously, loan growth is going to be economy-dependent, right? So, a lot of mixed signals out there right now with regard to what the economy is going to do. I think we get the GDP number this Thursday, but I think in looking at kind of -- our comments in the past have been upper single-digit growth on a long-term basis is kind of what we've been striving towards, and feel I guess where we were last year, yearly, in the upper single-digit low double-digit range. And that's what we're comfortable with, I think, on a longer term basis. Yes, pipelines continue to stay consistent, as I said in my comments as well too, so that looks good. And I think we've built the right organization in our growth markets to be able to finally achieve that path that we've been building for the last number of years on the upper single-digit growth rate. So, I feel good about that, but I just don't know what the economy is going to bring us right now. When I look at the deposit side of things, and Dan might want to jump in here as well too, and along the deposit ratio. It is an advantage that we have right now; we don't want to give that all away, obviously. But we do expect to continue to have some solid loan growth over time, and the deposit base we're going to need to build along with that. So, it wouldn't be the plan to let that run too far, but at the same time we want to take advantage of that deposit funding advantage that we have. We'll probably get into more deposit discussions in a little bit here, I would imagine. But when we really look at deposits, in general, obviously the CDs, we let those run off, we replaced those with some federal home loan bank borrowings. But we are reintroducing some CD specials, nothing like you would see at some of our competitors in the higher growth markets. We think we can generate some CD business or at least slow the runoff of CDs in our legacy markets by just being a little more aggressive than we've been. But I would think that loan-to-deposit ratio may drift up a little bit more, but we really don't want to give that all away. We're comfortable in that 90% to 95% loan-to-deposit ratio over time. And when we were there a few years before the pandemic, I imagine we'll get back to that point. So, how quickly we get there will be dependent upon how aggressive we need to be on deposits, and so really be driven by what kind of loan growth that we see. So, that's a longwinded answer, but that's kind of the best way I see it right now anyway. No, that's terrific, I appreciate all the color. And then maybe my follow-up just on credit quality, you've seen the reserve ratio come down here a decent amount over the last few quarters, settling around 110. Just curious what the big drivers are there? And then what would you need to see to have reserves grow from here, outside of an increase in loss content within the portfolio? Yes, I would say if you look I slide nine you can see there's a waterfall chart there that kind of shows the reserve build in dollars. Obviously, we saw a $3.1 million provision this quarter. That's actually the first time in six, seven quarters that we've recorded a debit to the provision; the last seven quarter had been negative. And so, I think what we've seen kind of since the pandemic, we've seen a number of qualitative factors related to some of those higher-risk areas continue to roll off over the last seven quarters. And we're to the point where I think those are more or less behind us. So, the drivers of the reserve, the provisioning, going forward, really are going to continue to be more normalized, future macroeconomic forests, loan growth, and then, of course, to the extent that we would see any charge-offs, that would also impact provisioning and reserve levels. But I think those are the drivers probably going forward. And I would say that that $3.1 million that we recognized here in the fourth quarter is probably kind of the more normal run rate going forward total. I guess I wanted to start your expanding cost, and you mentioned in the prepared about not being immune to higher interest rates. Can you expand on that a little bit and maybe where you are you starting to see signs of pressure? And do you think that can ease as the Fed slows or do you think there's some expectation of lagging pressure as we move through 2023? Yes, that's a really great question, particularly when will the Fed start to drop rates, right? I mean our forecast, as Dan mentioned, is to go to 5% in the first quarter, and stay there throughout the year. So, that's kind of what we're anticipating right now. If rates do start to drop toward the end of the year or into 2024, I think what we saw on the last time there was a drop, we were able to continue to have that deposit advantage by being able to be aggressive in dropping our funding costs because that deposit advantage really is throughout all different rate cycles. So, we would be in a position, I think, to be able to bring deposit costs down if the Fed starts dropping rates at some point in the future. I guess the question here now is we -- we're not immune to deposit cost increase, but because of our strong core funding base, it allows us to lag. And we've had that historically, that benefit. And we're seeing it again now. And obviously rates moved up a lot faster, a lot quicker than anybody in the industry really has seen before. So, relying on betas from years ago really may not be very applicable to now. So, we're watching it pretty much on a weekly, if not daily basis, what's going on with deposit cists. We've been proactive with some of our higher-tier savings rates, some new CD specials, giving some pricing authorities in our markets, and things like that. So, we are addressing that, but how quickly we need to address that, how much we need to address that would really be dependent upon what we need for loan growth, but also what we see happening in the economy here over the next month or two. And I still don't think that you'll see us on the lower side from a beta perspective of peers. We expect that advantage to continue right through the rate cycle that we're in right now. Okay, that's helpful. And then I wanted to pivot here to talk about loan growth a little bit too. I get that you're reluctant to provide a full-year view kind of the economy and what that might mean for loan growth. But could you help us understand the quarter a little bit better, of the trends for 4Q, is that new offices and execution or do you think it's also strong loan demand or is it more moderating payoffs, just help us break out those pieces a little bit so we can think about where to go from here? Sure. Well, that 13% of our pipeline is from the LPOs, right? So, they're showing up in the pipeline, but we're not seeing, really, loan growth in any material way at this point from the LPOs. We should see that, I think, this year or next year, again economy dependent. So, that is something that's going to be a benefit to us. But I would not say that the loan growth that you saw last year from us was based upon new LPOs because that wouldn't be accurate, it was a minor part of it. I think it was more of just hiring into the markets that we've already been in. And as you guys know, over the last decade or so, even longer than that, we've been acquiring into higher-growth markets like Louisville, Lexington, the Mid-Atlantic markets. So, put a little more of a growth profile on WesBanco, while still keeping our core advantages on the credit deposit side and everything else, I think this is just the fulfillment of that, at least that's way I look at it, was we had to acquire into those markets, and then assimilate those organizations and then hire additional people into those organizations. And now we're seeing the benefit of that starting to show up, which is why, and really looking at the upper single-digit loan growth going forward is because we've been building this for quite a long time now. And I think our organization is positioned well to take advantage of that. With regard to the fourth quarter, we did get some benefit from a lower level of commercial real estate payoffs of about $60 million. And we had $160 million, I think, in the quarter before that. So, we expect about $80 million to $90 million to kind of be our normal quarterly commercial real estate payoff rate. So, we did get a benefit from that. And as Dan said in his comments, we are putting 80% of our resi mortgage on our books as well too. We typically would do about 50%. So, I think if you were just to roll the resi mortgage back to 50%, and look at that, assuming we had done that last year, we would have had a loan growth of about 8% or 9% because we put more resi on, and that bumped us up to a little over 11%, but that's market-dependent based upon what's going on with what consumers want. But that's why I really feel like we're more at an upper single-digit loan growth rate, which I think is sustainable over time. Any quarter can be up or down. A couple $100 million is going to move the needle a lot with a bank our size. And you really need to look at it, I believe, on an annual basis or two to three-year basis to really get a good idea of what the franchise run rate is. Morning. I guess, as moving on to think about capital here, first, can you touch on your appetite for buybacks going forward and how price-sensitive you are there? And then the follow-up would be just sort of give us an update on how you're viewing M&A for you guys this year? I'll start off on the capital side, and let Dan jump in on that, and then I'll hit on M&A as well too. But I think from a capital perspective, we were watching what was going on in the last couple quarters with AOCI, some say it matters, some say it doesn't. But we were paying a lot of attention to it. And we did slow back the buybacks. The buybacks we did do in the fourth quarter were at the early part of the fourth quarter. And part of that was because we wanted to watch to see what happened with AOCI, and trying to stay in our 7%-ish type of range. But also, the price to the tangible book was up close to 200% or so, and we felt that was a pretty big number. I think as we look at this year, some of the things -- I think AOCI is moderated; we don't see that, we don't know that. I'm not sure that's going to be as big of an impact on peoples' planning this year, maybe it was last year. But when I really look at the whole buyback piece of it, it's something we're going to have to evaluate. I mean I know a lot of people are looking through AOCI. So, if you look through AOCI, maybe you're not at the 190% or 200% of tangible book, maybe you're at a lower number. So, that's something that we'll evaluate. We haven't made up any firm decisions yet, but we still have 1.2 million share authorization, and we'll pull on that when we think it's appropriate. That could be this year, we may start doing some of that, but I think that's going to be dependent upon what we see over the next couple of months. On the M&A side, I would tell you that we're not actively looking at anything right now. We're doing a lot of introductions. Jeff's sitting next to me here, and he and I are making a lot of trips to the markets that we have a lot of interest in, and introducing him to some of the key executives at some other banks, people that I've known. And he's introduced me actually to some people he's known as well too. So, we're definitely interested if the right thing were to come along. We think we've got the capital, the liquidity, obviously got a new core operating system we put in place a year-and-a-half ago now. So, we feel like we would be ready to do something, but we don't feel like we need to. I think we've finally been able to realize the loan growth that we've been working towards for a long time. It's kind of nice to be in that position and just focus on organic growth. So, we may very well just decide to do that. But also, at the same time, if we had the right opportunity come along I think we'd be prepared to act on it. But at this point, we're not actively looking at anything. Yes, I think it's the markets that we're already in and where we have LPOs, right? So, part of our idea with the LPOs is to get to know some of the markets a little bit better, and then do a follow-on acquisition, potentially. We did that in Pittsburg, set up LPOs 15, 18 years ago, and then ended up buying two banks, eventually, up in that marketplace once we got to know it. So, I think that the -- outside of the existing footprint that we have, we have LPOs in Northern Virginia, Indianapolis, Nashville; I think those would all be interesting markets that would still be within that geographic timeframe or geographic drive distance that we're looking at. So, finding something that would be in those growth year markets, try to continue to story that we've been working on, which is to have us be a little higher-growth profile company, while still maintaining good -- obviously good credit quality. Wouldn't be opposed to doing something that was in market already if there was decent expense takeouts, right, branch overlap, that kind of stuff, I think that would be interesting to look at if something like that came along. But the focus really is on higher-growth markets, Pittsburg, Columbus, Cincinnati, Louisville, Lexington, the suburban D.C. market, but throw Northern Virginia, throw Central Tennessee, throw Central Indiana in the mix as well too; those would all be areas of interest to us. Wanted to go back to the margin and funding conversation. And I know you mentioned, Todd, that you added a little bit of borrowing this quarter but you continue to see CD balances decline, so kind of chose FHLB over CDs. But do you think, as we move into 2023, that changes? And so, if we look at the balance of FHLB at quarter-end, should we model that to decline a little bit at the end of the year, and maybe grow CDs, just curious how you're thinking about the higher-cost more pull sale-ish funding strategy to fund growth? Thanks. Yes, so I would say, Catherine, a couple things. Obviously, the securities portfolio right now represents about 22% of our balance sheet. That's a little heavier than where we've maintained it historically. So, we do expect to get some funding from that securities portfolio and reinvest into loans. So, right now, that's kicking off about $50 million per month, $150 million per quarter. And so that would be where the first dollar would come from. If we look towards CDs as relative to FHLB borrowings, as Todd mentioned, we do have some CD rate specials. So, we expect that that, more or less, will slow down some of that CD runoff. But I would say to the extent that we see -- if we did see deposit growth, let's say, and fund growth were within that $150 million per quarter kicking out of the CD portfolio, I think we would continue then in that case to leverage the wholesale parts. Of course we have some other levers that we can pull, but I think, today, we would be, to the extent if we needed more than, let's say, that $150 million per quarter plus the slowdown in CDs, we would be -- we would continue to leverage those wholesale parts. Okay, great. And then I think you mentioned in your prepared remarks about -- I think you said that the margin, you expect to be flat for the rest of the year. Can you just circle back on your expectations for the margin this year? And if feels like everyone is thinking about this margin -- this quarter's margin as the peak. But I think you could argue that you might be different than that of your peers, just given your ability to lag funding costs. So, just kind of curios how you're thinking about peaking [indiscernible] Yes, so the way we think about that really, and as I mentioned, a couple basis points of expansion here over the next three months or so. Certainly, we're not expecting that double-digit expansion that we saw here in the fourth quarter, 16 basis points, or anything like that. But I think it'll be very much dependent on deposit inflows and outflows. Again, going back to that wholesale borrowing discussion, it would be dependent on what loan growth looks like and how much we can fund through deposits, and CD retention versus FHLB borrowings. But generally speaking, we do expect, for example, loans to continue to reprice upward in the second quarter off of those first-quarter rte hikes. So, we're -- we've got in our model 50 basis points of Fed fund increase in the first quarter. But we really expect the funding cost to rise as well such that they more or less will kind of offset or net to zero. And so that's where we look at kind of a stable NIM kind of in the second quarter, going forward. Again, that's assuming a 5% Fed funds rate that holds stable as well throughout the year. But then once you get past, call it, second quarter; I think we've got a lot of momentum. We're going to begin to reprice fixed-rate loans that are maturing. We'll still have the variable rate loans that have repricing terms beyond just the three months it'll be repricing as well. And I think those tailwinds will really begin to kind of offset the rising deposit costs from a margin -- NII standpoint. So, that's how we -- that's how we look at the margin, basically from second quarter forward, a stabilizing, taking advantage of the pricing or the increase on the asset side, with basically an offset on the deposit -- or the funding cost side. Yes, and we're going to -- obviously, the strategy gently is to get to probably mid 90s. Who knows when that will happen, down the road obviously ways, but we are going to be tactical about how we do that. And that's going to be based on things that are going to reveal themselves to us and the industry over the next couple of months, the next couple of quarters. But, the plan wouldn't be to keep deposit rates so low that we use up all that that extra balance sheet capacity too quickly. At the same time, we want to make sure that we capitalize on the advantage that we have as well too and make sure that we are raising rates appropriately. Not too fast, not too slow. Kind of slowly let the lion out so to speak until we start to creep up to the upper 80s and then lower 90s and then eventually mid 90s. That may take a few years to materialize. That's going to be dependent on large part, I think, on what we see on loan growth side. Yes. So, we do have one slide for which show kind of a the new loans that are coming on the [indiscernible] coming on right around 6.25%. And if you look at kind of a spot yield for the month of December we call it, loans were coming around 679. So, that's about a 55 basis point increase the month of December versus the quarter. So, that's kind of about where we are at. Hey, good morning. Could you add any color on what you are thinking -- I know it's early stages for kind of rethinking the branch network in the back-half of the year. Is that more kind of fund investment? Have it dropped to the bottom line? Modernize the network? Just kind of expand on any early thoughts and early goals there. Obviously, it's not -- not set in stone yet. Sure. We've last couple of years -- number of years actually, we have been what I would say rationalizing the branch network or optimizing it. We build a branch here or there every once in a while. But, we have been optimizing 10 to 15 branches or so a year. And using those excess, I guess, I would say reduction of expenses to fund all the above. So, some of the technology spend, Dan mentioned the ATM network we are upgrading. So, some of the money is going towards that. Also, the new lenders that we have hired and that we anticipate hiring, the LPOs, so we have been able to redeploy those savings into those areas and really drive I guess a significant amount of current and future positive operating leverage from those investments. We are going to continue to do that. Looking at the whole branch distribution system, obviously, we have got a big advantage in our legacy market. So, don't want to give that up. So, those branches and some of our world markets are important to us. Customers are important to us. Deposits are important to us. But at the same time, we want to make sure that that we are balancing out the right way, so that we could invest when we need to invest. And, still keep the efficiency ratio where we want it to be. And to keep as Dan mentioned kind of the quarterly run rate and expenses at least for the next couple of quarters in the mid 90 range. So, that's kind of the balance that we are doing. But, don't know how much longer we will continue to do, 10 to 15 branches a year but again that's somewhat dependent on M&A as well too and buy other banks that have a branch network that could be rationalized too. That's helpful. So, it's kind of already in the run rate that type of savings and investment at the same time? That's the way to think about it? Okay. If the economy slows down a bit and you have a little bit slower than high single digit kind of near-term loan growth, would that impact kind of your hiring plans? Or, any of these somewhat like expense initiatives? Well, I would say if we see deposit cost increase quicker than we are anticipating, then I think we've got some expense things that we talked about that we could do to try to still come through at the same net income we would like to come through with. So, we have been kicking around some ideas on the expense that are not baked into the run rate. We are not really ready to talk about it. They are not people related. But there are some things that we could do if the economy slowed, if we entered a more severe recession and everybody thinks we might, or if I think loan growth slows down though, the plan would not be to abandon our strategy to build capacity for loan growth. I mean we have been doing that for awhile, really building that for awhile. I know that's something that's to Jeff as he succeeds as well too as is that we have that put in place. So, the context that he has, the context that I have, the work that we have done over time with regard to the markets and lenders, I don't think we want to slow that down. Would like to continue to move that forward. But we don't show a big expense number in any quarter or two. We want to make sure that we are getting the positive operating leverage from the teams that we are hiring, the people that we hiring and things like that. So, that's kind of the way I guess I would answer at this point is that our strategy to get that up a single digit loan growth, we really don't want to abandon it. Obviously, if we hit a real severe recession, then you really start to get more focused on cost control, but at this point, slight recession or soft landing, maybe no recession. We just think power right through it because we've got some good momentum going. Also the first quarter, second quarter of the year is the time to hire lenders because they are all kind of getting their bonuses and they are all pre-agents at that point in time. The back-half of the year is a little tougher people because then you've got a -- obviously you got to cover some out of pocket numbers to get people to move. As we continue to talk about loan growth here, are there are any categories that maybe you are approaching more cautiously now than say versus a year ago? Well, I would say that it goes back even more than a year ago. At the start of the pandemic, obviously we got very cautious on hospitality and office. The hospitality portfolio has come through in a really great shape. No issues that we see in the office portfolio either. But, that's the one everybody is watching for the next couple of years is really what happens to the office portfolio. So, we are not doing much in the way of office. It would have to be really low on the value with strong guarantors with a lot of liquidity. So, not a lot of office at all at this point in time, not a lot of hospitality either, still being very cautious on that. Those would be the two areas that I would mention. We have seen a lot of really good C&I business. Lot of the lenders that we brought on in our legacy markets have really started to bring us some nice C&I business. Commercial real estate is still a big part of who we are. But, it's nice to see that the C&I business as well. But outside of the two real estate categories, office and hospitality, I would say the other areas we are continuing to lend in. So, we don't do much in energy as you know. We are less than 1% energy. So, that's not a factor for us. But, other businesses seem to be pretty good. I'll let Dan jump in here as we are obviously we are impacted by the lower residential mortgage production than what we had in the past and obviously put more on our books. We have benefited to some degree higher securities revenue. Lot of that's coming from the CD book. Putting fixed annuities out there and getting the commissions off of that. So, that's I think part of the reason why securities are up so much. And then, we are seeing more business activity occurring and even consumer activity which is driving more service charges on the consumer side. Dan, any comments you would make on fee income? The only thing that I would add maybe is that if you look at trust fees, first quarter our trust fees will be a little higher due to the tax corporation fees that's kind of an annual thing. And then, thinking about swap fee income that's been a pretty big focus here since Jeff has come on board and he has been very focused on that. So, we need a lot of training and strategy around how to kind of better deploy and kind of tap into that little bit more. So, I think that's probably going to be other area that we will see some -- as we go through⦠Yes. And the markets that we have acquired into, again we are still driving additional new products and training in those markets as well too because number of the banks that we acquired in Kentucky and then the mid Atlantic market, did not offer some of the things that that we offer, swaps being one of them, but also on the trust fees and having securities reps and Series 7 as well six to eight people in branches. Things like that. So, there continues to be upside opportunity there similar to what we are seeing on the loan growth side in those markets. I think we will continue to see some better fee growth side because again these were new products and new businesses that we have introduced into those markets through the banks that we bought. This concludes our question-and-answer session. I would like to turn the conference back over to Todd Clossin for any closing remarks. Great, thank you. I appreciate everyone's time today. I know a lot of earnings meetings are taking place. Appreciate your joining ours and look forward to speaking with you in the near future in one of our upcoming events as well too. So, please stay safe. And have a good day. Bye-bye.
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EarningCall_1279
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Good morning, and welcome to the Plexus Corp. conference call regarding its fiscal first quarter 2023 earnings announcement. My name is Liz, and I will be your operator for today's call. [Operator Instructions]. I would now like to turn the call over to Mr. Shawn Harrison, Plexusâ Vice President of Communications and Investor Relations. Shawn? Thank you, Liz. Good morning, everyone, and thank you for joining us today. Some of the statements made and information provided during our call today will be forward-looking statements, including, without limitation, those regarding revenue, gross margin, selling and administrative expense, operating margin, other income and expense, taxes, cash cycle, capital allocation and future business outlook. Forward-looking statements are not guarantees, since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in the forward-looking statements. For a list of factors that could cause actual results to differ materially from those discussed, please refer to the company's periodic SEC filings, particularly the risk factors in our Form 10-K filing for the fiscal year ended October 1, 2022, and the Safe Harbor and fair disclosure statement in yesterday's press release. We encourage participants on the call this morning to access the live webcast and supporting materials at Plexus' website, www.plexus.com, clicking on Investors at the top of that page. Joining me today are Todd Kelsey, Chief Executive Officer; Steve Frisch, President and Chief Strategy Officer; Pat Jermain, Executive Vice President and Chief Financial Officer; and Oliver Mihm, Executive Vice President and Chief Operating Officer. Consistent with prior earnings calls, Todd will provide summary comments before turning the call over to Steve and Pat for further details. Thank you, Shawn. Good morning, everyone. Please advance to Slide 3. Our fiscal 2023 started strong, as we capitalized on the momentum built during fiscal 2022. As I reflect on the market conditions and supply chain dynamics of 12 months ago, I'm quite pleased with our performance in the fiscal first quarter. Amid unexpected demand volatility, we met our guidance and delivered 34% year-over-year revenue growth, generated an industry-leading GAAP operating margin, and nearly doubled our GAAP earnings per share year-over-year. We also advanced our efforts to be an ESG leader, an endeavor that our customers are taking notice. Our fiscal first quarter revenue of $1.09 billion, reflected strong demand from many customers, even as we experienced unexpected volatility from others. Semiconductor capital equipment demand was lower than our customers anticipated 90 days ago due to weakness in the memory market, paired with the effects from the US export control order. In addition, we experienced new program ramp schedule changes, a dynamic that is expected to be resolved as we move through fiscal 2023. Finally, we continued to have unfulfilled demand by more than $100 million, given ongoing supply chain challenges associated with lagging edge semiconductors. I would note that our average semiconductor lead time declined only 4% from last quarter, and remains in excess of 300 days. We delivered GAAP operating margin of 5.2%, inclusive of stock-based compensation expense and the cost associated with the ramp up business at our new facility in Bangkok, Thailand. With strong customer interest, we continue to anticipate our operations in Bangkok will be profitable exiting this fiscal year. Finally, we delivered GAAP EPS of $1.49, which included $0.21 of stock-based compensation expense. We won 29 new manufacturing programs during the quarter worth $158 million, including several programs associated with secular growth markets. As we discussed in recent quarters, supply chain conditions continue to slow the decision-making process for some customers that we anticipate will partner with Plexus. However, we see this trend reversing during our fiscal second quarter, driving increased wins for the remainder of the fiscal year. Our funnel of qualified manufacturing opportunities expanded nearly $250 million sequentially to a record $3.6 billion, reflecting the delayed decision-making and significant potential to increase our wins. Please advance the Slide 4. We continued to demonstrate our commitment to be a leader in environmental, social, and governance, through how we innovate and operate. Late last year, we joined the Semiconductor Climate Consortium as a founding member, partnering with many of our SemiCap customers and industry-leading technology firms that are focused on accelerating the reduction of greenhouse gas emissions throughout the semiconductor value stream. In addition, we received ASM International's PRISM Award For Supply Chain Sustainability Innovation. The award was given as a result of our global internal competition called BEST, which fosters team member innovation and continuous improvement. This competition has highlighted ESG initiatives such as smart metering, water usage reduction, and implementation of alternative energy sources, all of which are helping to reduce our environmental impact. We are proud that our efforts were recognized by an important customer and SemiCap industry leader. Please advance to Slide 5. We are guiding fiscal second quarter revenue of $1.02 billion to $1.07 billion, GAAP operating margin of 4.5% to 5%, inclusive of approximately 60 basis points of stock-based compensation expense, and GAAP EPS of $1.06 to $1.24, inclusive of $0.21 of stock-based compensation expense. Our guidance reflects the continuing impact of the near-term demand dynamics that affected our fiscal first quarter, including weakness in SemiCap demand, a near-term slowdown in certain new program ramps, and well in excess of $100 million of unfulfilled customer demand. Our operating margin guidance reflects reduced fixed and administrative cost leverage, coupled with our typical seasonal cost increases associated with merit-based salary adjustments, and US payroll tax resets. We expect to overcome both as we move through fiscal 2023. Finally, our fiscal second quarter EPS guide is impacted by higher interest expense and tax expense compared to our fiscal first quarter. I continue to see the potential for strong performance in fiscal 2023 and beyond. While recognizing macroeconomic and geopolitical uncertainties, we have the opportunity to deliver industry-leading profitability and revenue growth rates significantly in excess of the markets we serve. We expect to return to quarterly sequential revenue growth beginning in our fiscal second half associated with robust Healthcare/Life Sciences and Aerospace and Defense market sector demand, normalizing existing program ramp schedules, additional new program ramps as we benefit from share gains, and participation in secular growth markets, and continued backlog conversion, given our focus on resolving supply chain challenges. In looking at our end markets for fiscal 2023, our Healthcare/Life Sciences market sector is poised to have a tremendous year. The sector is benefiting from a sustained recovery and demand for elective procedures, numerous new program ramps that have yet to reach steady state, and our continued efforts to mitigate supply chain challenges. We see the opportunity for healthy growth from our Industrial sector due to our participation in secular growth markets such as warehouse and factory automation, our continued efforts to clear supply chain challenges, and new program ramps in developing markets such as electrification. While supply chain demand - or while SemiCap demand is much weaker than 90 days ago, we continue to anticipate we'll outperform the market, given share gains and new program ramps. Finally, demand from our Aerospace and Defense market sector continues to recover, particularly in commercial aerospace. Supply has been the gating factor for several quarters now, but our progress in resolving those challenges, provides the potential for sequential revenue growth throughout the remainder of fiscal 2023, resulting in robust sector growth for the fiscal year. With the anticipated return of sequential revenue growth for our fiscal second half, we are focused on achieving our 5.5% GAAP operating margin goal exiting the fiscal year. I will now turn the call over to Steve for additional analysis of the performance of our market sectors and operations. Steve? Thank you, Todd. Good morning. I will start on Slide 6, with a review of the fiscal first quarter performance of our market sectors, as well as our expectations for the sectors for the fiscal second quarter of 2023. Starting with the Industrial sector, revenue declined by 9% in the fiscal first quarter. The result was lower than our expectation of a mid-single-digit decline. Although we anticipated forecast reductions from our SemiCap customers as we started the fiscal first quarter, almost all of the SemiCap customersâ adjusted demand lowered during the quarter due to softening end markets and the impact of the recent export control order from the US Department of Commerce. For the fiscal second quarter, the export control order and the softness in the memory market, is pressuring demand in the SemiCap sub-sector. As a result, we are forecasting approximately a 10% decline in the Industrial sector for the fiscal second quarter. As we look to the second half of fiscal 2023, we expect sequential growth in the Industrial sector, as new program ramps within the sector start to materialize. On top of the exceptional growth of 17% in the fiscal fourth quarter of 2022, our Healthcare/Life Sciences sector grew an additional 4% in the fiscal first quarter. The result was in line with our expectation of a mid-single-digit increase. Contributions from new program ramps supported the growth. As we start the fiscal second quarter, we are working with our customers to implement engineering changes on active program ramps. The short-term impact is that we expect our Healthcare/Life Sciences revenue to be flat for the fiscal second quarter, before the sector returns to healthy sequential growth in the fiscal third quarter. Our Aerospace and Defense sector declined 2% in the fiscal first quarter. The result was in line with our expectations of a low single-digit decrease. Improved shipments for several customers could not offset the revenue headwinds from the end of life program we highlighted last quarter. Although fulfillment of our customersâ overall demand is still hampered by supply chain constraints, our procurement team has made meaningful progress. As such, we anticipate a low single-digit increase in the Aerospace and Defense sector for the fiscal second quarter. We believe our ability to fulfill demand will continue to improve throughout fiscal 2023. Please advance the Slide 7 for an overview of our wins performance. We won 29 new manufacturing programs during the fiscal first quarter that we expect to generate $158 million in annualized revenue when fully ramped into production. Although the result was below our expectation, we believe that near-term macroeconomic and geopolitical uncertainties are extending decision-making cycles. We highlighted this view in our previous earnings calls, and as we exit the fiscal first quarter, our funnel of qualified opportunities illustrates this dynamic. As shown on Slide 8, our robust funnel of qualified manufacturing opportunities jumped by nearly $250 million to $3.6 billion in the fiscal first quarter, easily surpassing the record levels of fiscal 2023. As we look at the metrics within the funnel, our program win rates continue to be high, and cancellations of programs within the funnel remain normal. Based upon current visibility into the funnel, we anticipate a noticeable rebound in our new program wins in the fiscal second quarter. Going back to the fiscal first quarter manufacturing wins, Slide 9 has a few sector and region highlights. The wins were spread across the sectors. Our Industrial sector won 14 new programs, including two new logos valued at $74 million. Our Healthcare/Life Sciences sector won nine new programs, including one new logo valued at $61 million. And our Aerospace and Defense sector won $23 million in new programs. Wins for the EMEA region were exceptionally strong for the third quarter in a row. With the additional $93 million in wins in the fiscal first quarter, the region is poised for significant growth. I'll provide insight into some of their recent wins next. Please advance to Slide 10 for highlights of the fiscal first quarter wins. I'll start with two significant wins from our Industrial sector. The first product is used in factory automation and process control. We expect to start ramping this program from a new logo into our Oradea, Romania facility by the end of this fiscal year. The second Industrial sector win is a next-generation 3D printer from a current customer. This new additive manufacturing system will join the family of products already manufactured by our team in Appleton, Wisconsin. Our Healthcare/Life Sciences team expanded our market share with a customer who produces infusion pumps. This takeaway from a competitor was a direct result of our Oradea manufacturing team's exceptional performance for this customer during the pandemic. The Healthcare/Life Sciences team also won an ultrasound system used for cardiac care. This product will also be produced by our team in Oradea, Romania. Finally, our Aerospace and Defense wins include the brake controller for commercial aircraft. This program will be added to the platform of products we build for this customer in Neenah, Wisconsin. Next, I would like to turn to operating performance on Slide 11. During our fiscal first quarter, our team experienced demand volatility in SemiCap customer forecast, continued challenges in securing supply of lagging edge semiconductors, and engineering changes within process new program ramps. In spite of these challenges, they delivered strong GAAP operating margin performance of 5.2%. These challenges, combined with seasonal impacts, are putting short-term pressure on operating margin in the fiscal second quarter. As we look beyond the current quarter, we see the potential for fiscal 2023 revenue growth that exceeds our 9% to 12% annual target. With an unfulfilled backlog of more than $100 million, stabilizing customer forecasts, new program ramps, and continued action to improve supply constraints, the team is focused on delivering the revenue potential, while achieving 5.5% GAAP operating margin as we exit fiscal 2023. Thank you, Steve, and good morning, everyone. Our fiscal first quarter results are summarized on Slide 12. Gross margin of 9.3% was at the midpoint of our guidance and slightly below last quarter, due to ongoing investments and fixed costs, including our new Thailand facility. Selling and administrative expense of $44 million was favorable to guidance, primarily due to lower incentive compensation expense. As a percentage of revenue, SG&A was 4%, which was consistent with expectations. GAAP operating margin of 5.2% was also at the midpoint of our guidance, and included 53 basis points of stock-based compensation expense. Non-operating expenses were favorable to expectations as a result of additional interest income and lower factoring fees due to a near-term reduction in receivables factored. GAAP diluted EPS of $1.49, met the midpoint of our guidance for the reasons previously mentioned. Turning to our cash flow and balance sheet on Slide 13, as anticipated, for the fiscal first quarter, we made investments in working capital to align with our customersâ demand. Cash investments in operations totaled $49 million, while capital expenditures totaled $23 million. During the quarter, we purchased approximately 116,000 shares of our stock for $11.5 million at an average price of $99.12 per share. We have approximately $35 million available under the current $50 million authorization, and expect to execute repurchases on a consistent basis throughout fiscal 2023. With a strong and liquid balance sheet, investments in operations and our share repurchase program, were funded through a combination of cash and borrowing under our revolving credit facility. Our quarter end balance sheet included cash of $248 million and debt of $516 million. At the end of the quarter, we had $180 million available to borrow under our credit facility. For our fiscal first quarter, we delivered return on invested capital of 13.8%, which was 480 basis points above our weighted average cost of capital. Strong operating performance this quarter, compared to the prior year fiscal first quarter, led to an improvement in ROIC of 380 basis points. During the fiscal first quarter, we experienced an increase in working capital requirements, which led to cash cycle days above expectations and sequentially higher by six days. Please turn to Slide 14 for more details on our cash cycle. Sequentially, gross inventory dollars increased by less than 3%, while inventory days increased by seven. The increase in days resulted from strategic investments to support new program ramps and the impact on inventory from demand volatility within the quarter. Partially offsetting the increase in inventory days was a four-day increase in customer deposit days. We now have over 30% of our gross inventory covered with cash deposits. This compares to less than 15% four years ago. Accounts payable days sequentially reduced by three days related to earlier procurement of inventory and customer demand fluctuations. As Todd has already provided the revenue and EPS guidance for the fiscal second quarter, I'll review some additional details, which are summarized on Slide 15. Fiscal second quarter gross margin is expected to be in the range of 8.8% to 9.2%. At the midpoint, gross margin would be approximately 30 basis points lower than the fiscal first quarter. Seasonal compensation cost increases, as well as the reset of payroll taxes for US employees, will negatively impact gross margin by approximately 50 basis points. We expect selling and administrative expenses in the range of $44.5 million to $45.5 million, sequentially higher primarily due to the seasonal compensation headwinds, which total about $1 million. Non-operating expenses are expected to be in the range of $10.2 million to $10.7 million, sequentially higher, primarily due to increased borrowing under our revolving credit facility, along with the impact of rising interest rates. Our tax rate for the fiscal second quarter is expected to be in the range of 15% to 17%, while the full year tax rate is projected at 14$ to 16%. Our expectation for the balance sheet is that working capital investments will modestly increase compared to the fiscal first quarter. Based on our revenue forecast, which has been impacted by near-term demand volatility, we expect cash cycle days in the range of 110 to 115 days. With modest working capital investments, coupled with capital expenditures to support anticipated fiscal 2023 revenue growth, we expect breakeven to a slight usage of cash for the fiscal second quarter. A few comments on the full year. We continue to expect capital spending in the range of $110 million to $130 million, and plan for free cash flow to improve as we move through fiscal 2023, targeting to end the year with close to $50 million of free cash flow. Hi. Good morning. I was hoping to get some additional color on the schedule changes you alluded to with some of these program ramps. And you may have elaborated that. I may have just missed it, but I wonder if you could talk in terms of the market verticals where you're seeing this, and whether this is something that you see as company-specific, or potentially just a reflection of the more uncertain macro environment. Thank you. Yes, Jim, so this is Todd. Iâll start out with this question, but if we think about program ramps in general, it's common for them to be a bit lumpy in the way that they progress over time. And if you recall back to a year ago when we started to talk about this small number of very large program ramps that we had underway, we talked about it, or I talked about it being in the range of $25 million to $50 million of sequential growth per quarter. And the reason for that range, part of it is because you can expect that there could be changes to the product as you go through this. So, and if you recall our results, we ended up overshooting the high end on this, so they were progressing extremely well, and now itâs paused, I would call it just a bit, not that the ramps have stopped. They've just slowed a bit as a result of some changes that need to be made on the engineering front within the program. So, nothing out of the ordinary, other than perhaps it happened a bit later than we had anticipated when we were looking at this, but the programs still have a great potential and will continue to ramp aggressively and I'd expect as we - we'll be moving ahead, at least on a good portion of that through our fiscal second quarter as we exit it, and then through the remainder of fiscal 2023. Is there a way to think about this in terms of the number of programs? I'm curious how spread out this is among different customers or different ramps, specific. It's a small number of significant programs. So, that's the reason for the impact. So, I'd call it - it's not market dynamics. Itâs essentially product dynamics that we have right now, and you can see that at least - from Steve's commentary, that at least some of it impacts our healthcare sector, and that's why it's flat this quarter rather than continued sequential growth because they're on a tear right now. Okay. And one final question, and I'll jump back in the queue. I'm not sure how to - what to make of what you're seeing in terms of supply chain. It sounds like it's getting a little better, but it's still, yes, pretty significant headwind for you. As you think about the sequential improvement that you're anticipating in this second half, what are some of the assumptions that you're making with respect to some of the supply chain challenges? Yes, I would say that we're assuming it stays about the same. So, one of the things, though, that we'd anticipate is within Aerospace and Defense, we'd continue to clear more supply challenges in aerospace, because it's getting - if you recall, our other demand from our other sectors, it ramped faster, the demand curve. So, we were able to clear a significant amount of that demand in the late fiscal 2022 timeframe. Aerospace and Defense was about a half a year to three quarters of a year behind in the demand increasing. So, we're getting to the point where we expect we'll be able to be clear in some of those challenges, but we don't expect the supply chain to change meaningfully. Hey, good morning. I think she said David. I think she said my name. She cut out there. So, thanks for taking the question. And maybe, Todd, first, previously I think you guys have talked about on the SemiCap equipment business, you expected maybe a 10% drop would be kind of reflect a 2% headwind to the overall revenue base. Do you think that what you're seeing now in that SemiCap equipment is significant, and do you think it rebounds? And then, of course, in the past, I think you've had less exposure on the logic side. So, just kind of curious maybe any of the dynamics around that and any other color you could provide. Yes, I'll start with some of this, David, and then I'll pass it off to Steve for additional color. Last quarter, we talked about kind of a worst case scenario for SemiCap. We thought it - our SemiCap could be down 10%. Itâs close to that range, but I call it in the single-digits down is what we're modeling right now. So, I think we've captured it pretty well. We still believe that 10% number is about right, and that would have about a 2% ballpark impact to our revenue expectations. Now, granted, they're still quite strong. So, I would say the 2% is on the - I don't want to call it negligible, but it's not a significant portion of the growth we're expecting. And maybe just to add on to that, there's the existing products that we have. We've also been successful in winning new programs. And so, we have, and we do expect some new program ramps with SemiCap in fiscal â23, which will offset some of the softness with the current demand. So, from our perspective, we're still expecting sequential growth in this area as we go through â23. Yes. And I would say we're cognizant that the experts are projecting anywhere from high teens to 25% down in the SemiCap equipment space. So, we're conscious of that, and that is reflected in our forecast. Okay. All right, fantastic. Thank you. And then maybe just on the Aerospace and Defense demand, it seems to be strengthening just kind of from what you've talked about, but the funnel trunk sequentially and the revenue was down sequentially. Do you see - is this more new program ramps that are coming in, improving demand maybe around the periphery, or maybe it's just a signpost that you're reading that looks like the demand is set to improve? Yes. So, I mean, just to be clear on demand, demand has been exceptionally strong through â22, and even as we go into â23. Itâs really - we've really seen it come back from a demand standpoint for several quarters. It's really more associated working with our customers as it has come back to get the supply pipeline correctly. And so, our challenge has really been getting work with our customers to get the pipeline of materials flowing to meet that demand. And so, we're starting to see some of those efforts of fiscal â22 starting to pay off in terms of getting the right quantity and types of materials pipeline. And so, that's why we believe we're making a bit of a turn on the growth in Aerospace and Defense, as opposed to what we saw as we went through the back half of â22. Okay, very helpful. And maybe just one last one here is just kind of thinking about the $100 million of unfulfilled demand. It's been rolled forwards for several quarters here. I'm thinking that's just more related to the supply dynamics, but does the guidance factor in maybe fulfilling any of that or capturing that demand, or do you expect that to continue to roll forward for a few more quarters? Yes, at this time, it continues - I would say it continues to roll forward, but what I would highlight is that's a different $100 million every quarter. So, we continue to fulfill other demand, but there's new unfulfilled demand that creeps in as well. But I expect that'll continue as we progress through â23. Yes, thanks. Good morning. I wanted to ask about the commentary from Steve regarding the wins, which were, I think, below expectations. And Steve, you talked about customers extending their decision-making on, I guess, new programs. Is there anything unique or common in terms of reasons that you're hearing from customers, whether or not they're pushing out new product introductions, or delaying a decision-making in terms of moving from one region to the other? Anything common about what you're hearing there? I wouldn't say there's common across the sectors, but as it relates to what we're seeing in the individual sectors, in Aerospace and Defense, we talked about the fact that they have this pent-up backlog and everybody's been focusing on supply chain and making sure that they can deliver the orders that they have today versus moving product from potentially one supplier to the next or even changing their outsourcing strategy. So, in Aerospace and Defense, I think itâs just a matter of them catching up with the demand that they have. And we saw that four to six quarters ago, that was a similar phenomena that we saw in some of the other sectors. As we look at like Healthcare/Life Sciences, I would say now with the kind of the demand returning for them, them looking at the macroeconomic uncertainties, we are seeing and having more conversations associated with changes in supply strategy. And specifically, we have a few customers we're talking to about, are they going to shift their strategy from doing it internally to outsourcing their manufacturing? We see a few larger opportunities like that starting to pop up. And then in industrial, again, I think it goes - itâs mixed across the sub-sectors. In semiconductor capital equipment, the whole issues associated with the geopolitical environment in China, is causing several of those suppliers to look at their sourcing strategies, and we have benefited from companies that want to exit that market and move into some of our southeast Asia locations. And so, I wouldn't say there's a common theme. Itâs really a bit of a mix, but I think the supply chain constraints and the macroeconomic uncertainties is causing everybody to think just a little bit differently. There was a bit of pause around the holidays as well too. I suspect it had a bit to do with that. And we're off to a good start in Q2. So, we're seeing some signs that there was a bit of pent-up demand and delayed decision-making around those holidays. Okay. Thank you for that. And then I wanted to just ask about the inventory and the working capital and the cash flows, which have also been, in terms of free cash flow, obviously below where you could be. And I know Pat, you're expecting net inventory days or inventory or cycle days to be up again, up significantly year-over-year, despite the cash deposits being up. So, how should we think about that inventory position as we get through the rest of the year, given that you look like you're looking at sequential growth in the back half. And then what could we think about free cash flows as we get through the year? Yes, okay. So, I'll start by saying, I think we're starting to level off our inventory, Matt. If you look at the increase from year-end to Q1, we were up $42 million in inventory. Really good to see cash deposits up $31 million, so almost a full offset. Q2 could see increase of $25 million to $50 million in inventory to support new program ramps. I think the back half, as we see more sequential revenue growth, is an opportunity to bring down our days. And let me step back and just - we ended fiscal 22 at 100 days of net cash cycle days, and our goal is to finish fiscal â23 down five to 10 days from that. So, even though Q2 is forecasted to be higher, we expect reductions in the back half of this year. It'll come mainly from inventory reductions. I think inventory could come down 10 to 15 days from where we ended fiscal â22. But it's important to keep in mind, some of that inventory weâre liquidating, there's cash deposits associated with that inventory, that those deposits will be returned. So, again, net-net, I think we can reduce our cash cycle five to 10 days from the fiscal â22 level of 100 days. By doing that, we'll see free cash flow generation in the second half of the year and approaching that $50 million of free cash flow. The last thing I'd say is, Oliver is working with our regions and the supply chain teams on a number of initiatives, which he can touch on, but it revolves around aged inventory, demand signals from customers, and obviously trying to secure those golden screws from our suppliers. So, there can be a lot of variability with mix and demand that could change our projections, but that's what we're forecasting at this point. Oliver, anything you want to add? Yes, Iâll add one thing there just to note that I think we previously talked about our variable incentive compensation program, and that has a 20% component that is aligned to essentially a management objective. And so, for that population of individuals, a significant portion of that population, either a significant piece of, or all of that 20%, has been aligned to inventory reduction targets through the fiscal year. Hi. Thanks for taking my question. So, just on Warehouse and factory automation, can you speak to kind specific products you're seeing demand strength? How's the firm positioned kind of versus competitors in the market? And are you seeing any pauses in demand from - after strong investments by end customers over the past couple of years? This is Steve. I'll take that one. I wouldn't say we're seeing any significant changes, positive or negative, with the ramp of the factory automation products. Obviously, we see a few ebbs and flows with specific customers as they get new orders and do new installs. And so, I guess from my perspective, we have several programs we talked about ramping. They continue to ramp, and we always anticipated and knew that some of these would be a bit bumpy as they get orders for new installs. So, I wouldn't say there's any specific trend that I could highlight, positive or negative, with that area. Okay, thanks for that. And then just on guidance for â23, you mentioned sequential growth in the back half. You've seen somewhat of a wide range of sequential growth into fiscal third quarter in the past. You're also now facing some difficult year-on-year cost, but can you help us frame the pace of growth into the third quarter and given the visibility you have today? Thank you. Sure. Thanks, Paul. This is Todd. Iâll take that one. I think itâs best to maybe start out with the fact that our markets, exclusive of SemiCap, are strong right now. I mean, they're solid and they're very good. Healthcare, Aerospace in particular are exceptionally strong. So, when we think about our outlook for the back half, itâs not much different than it was 90 days ago. It looks pretty similar to what it did 90 days ago. We have a little bit of a blip in Q2 because of the situation with SemiCap dropping rapidly, and also the new program ramps that we're working through right now. But we work through those and then the back half looks a lot like it did before ex the impact that we're expecting from SemiCap, which again, could be a couple of percent. So, when we think about sequential growth in the back half, I would say $40 million to $50 million per quarter, give or take, is what we're thinking as we look at Q3 and Q4. So, we expect it to be meaningful. And when we add that level of revenue, that puts us in really good position to achieve our 5.5% operating margin goal as we exit the fiscal year. Oh, that's super helpful. And then for the 5.5%, is that the pace or is that for the full year, just to be clear? I would call it exiting the year at this point. So, it'd be a good goal for us for Q4. I think Q3 might be a bit aggressive. Possible ⦠Yes. I would say it's in the early stages. The demand for commercial aerospace is quite strong, but the supply has not caught up to the demand yet. So - and Iâd kind of equate it to where we were at with elective healthcare or SemiCap 12 to 18 months ago. Okay, thank you. And in terms of EMEA and new program wins there, it looked very strong in the presentation. Can you just elaborate on which regions within EMEA that you see strength in? Yes, this is Steve. I can touch on this. So, we've got a couple of facilities over there, obviously. One is in Scotland one is in Oradea, Romania. Our facility in Romania is the one that's benefiting the most from these wins. As I highlighted, three of the wins of the five that I highlighted were headed for Oradea. So, the team over there has just been doing an exceptional job. And quite frankly, a lot of these wins are being rewards for the execution that we had through the pandemic. So, the Oradea facility is projected for significant growth as we go through the next few quarters. I'm showing no further questions in queue at this time. I'd like to turn the call back to Todd Kelsey for closing remarks. All right. Well, thank you, Liz. Again, I'd like to thank everybody who joined our call today. We appreciate your support and interest in Plexus. In closing, I'd like to reiterate that we remain quite bullish in regards to fiscal 2023. Thank you. Have a nice day.
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EarningCall_1280
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Hello, everyone, and welcome to Mobileye's fourth quarter and full year earnings conference call for the period ending December 31, 2022. As a matter of formality, please note that today's discussion contains forward-looking statements based on the business environment as we currently see it. Such statements involve risks and uncertainties. Please refer to the accompanying press release, which includes additional information on the specific risk factors that could cause actual results to differ materially. Additionally, on this call, we will refer to both GAAP and non-GAAP figures. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release. 2022 was a really important year for Mobileye. We executed a successful IPO at a time when this was only possible for very unique companies. I see many benefits to being public again, but most important is we have already seen a big increase in visibility of Mobileye from our customers and partners, driven by more focus and attention by the broader media and analyst. This drives incremental business opportunities by amplifying attention on our advanced solutions and we think this plays into the incremental momentum we are experiencing. Financial results in 2022 were clearly very good. Revenue grew up by 35%, adjusted operating profit grew by 25% and we generated almost $550 million of operating cash flow. More important than those headlines is that the source of our growth started to shift from pure volume to a combination of volume and higher content per vehicle. Our advanced products carry a much higher price per vehicle than our historical products, and we saw a clear evidence of that in 2022, where one-third of our revenue growth came from higher ASPs. In terms of future business generation, 2022 was a record year. Just in that year alone, we generated new business representing $6.7 billion of estimated future revenue at about $105 per unit on a content per car blended basis. This is about 3.5 times our actual revenue in 2022 and double our current ASP. Overall, we estimate that our current book of business represent over $17 billion of total future revenue through 2030. As long as our new business wins continue to outpace our actual shipments in a particular year, this number will continue to grow. Also to be clear, this number excludes our consumer AV and Mobility as a Service backlog. Beyond the high-level numbers, we saw positive business trends across all businesses. The front-facing camera, single-chip ADAS business continues to run like a machine. We grew revenue with every one of our top 10 customers in 2022, and continue to win significant new business in this segment. A key development in 2022 is that many large-volume ADAS platforms now have a variant that includes cloud-enhanced ADAS to our REM map. This volume will drive higher ASP and recurring revenue from maintenance of the map. We also saw a very significant uptick in interest and secured volume in our SuperVision product in all regions from both traditional and start-up OEMs really across the Board. There are many reasons for the increased traction. There is a big difference between a development product and a launched product. Launching SuperVision with ZEEKR in China was a major catalyst in driving interest from other OEMs. A program like SuperVision is a major commitment from an OEM in time and capital. Offering a solution that is already in production means that the investment will result in a valuable product with high probability. This is very important in the current environment. Number two, we now have the ability to demonstrate the full feature set of a SuperVision anywhere, not just in Israel. Our REM map now cover nearly all roads in the U.S. and Europe. As a result, we have been able to execute long-distance expeditions with carmakers, customers covering thousands of miles in both U.S. and Europe with little human intervention. This ability to show that the technology truly works everywhere has been critical in moving discussions to the decision phase. Mobileye's EyeQ Kit, software development tool is another important development. The ability for an OEM to take Mobileye's truly differentiated asset like surround computer vision, REM mapping and our decision-making software as is, but then customize the consumer-facing part of the system with their own software is something we couldn't offer until recently. It has served as a catalyst for strategic partnership discussions for SuperVision and beyond with many of our OEM customers, particularly one that began their own software development at the earliest. In the meantime, the competitive environment among OEMs has ramped-up with Chinese automakers and Tesla, benefiting from surround camera-based systems both in profit and technology prestige. This is creating an overall sense of urgency among other OEMs to invest in wide operational design domain, eyes-on, hands-off systems that have high probability of success in terms of performance and validation. We expect SuperVision to be a very large growth driver in 2023 and beyond, and shared our expected volume forecast in our CES presentation, which is available at our IR website. But this product also served as a launch point for our eyes-off Consumer AV product super. Because SuperVision operates across a very broad operational design domain, it makes the transition to experience of eyes-off ODDs and incremental and modular step instead of a series of moonshots. In other words, all the heavy-lifting of describing the environment in great detail, the driving policy require to maneuver the car in any traffic scenario and the requirement for high-definition maps covering all types of roads are all done in the SuperVision system. From here, adding redundancies to the perception system to take eyes-on to eyes-off becomes incremental work. The successful productization of SuperVision with ZEEKR and this concept of modularity to eyes-off has created a lot more interest from our customers to develop Consumer AV products. Essentially, every SuperVision discussion we're having now is also including top five follow-on Chauffeur eyes-off the program. We saw recent evidence in this with a premium European OEM, which kicked off a SuperVision program in Q4. During discussions, the scope of the program expanded to include a Chauffeur program that will launch in 2026 timeframe. The Chauffeur portion of this program alone represents an expected $1.5 billion opportunity through 2030. Finally, on Mobility as a Service, our plan continues to develop relationships on the supply and demand side, and then use our self-driving system to enable supply and demand to come together into a scalable business. We have many relationships on the demand side with transportation network companies and public transit operators. We also have engagement with three vehicle builders, which are developing purpose-built vehicle platforms that integrate our Mobileye Drive self-driving system. We expect to generate our first revenue in this business in 2023 and our supply side relationships have orders for self-driving systems that total an estimated $3.5 billion of future revenue through 2028. So, overall, 2022 was the year where traction for SuperVision really accelerated and this led to an increase interest from OEMs for eyes-off systems as well. Continuing the productization process of these solutions and supporting testing and launch, of course, requires resources. This is why our operating expenses growth in 2022 was unusually high and it will be again in 2023. This growth is supporting areas like growth in terms of -- in teams to support SuperVision launches with OEMs, radar and lidar productization and expansion of Mobility as a Service validation and testing site and development works of our next-generations of EyeQ chip. I would note that approximately 70% of our R&D expenses is related to products that are either just beginning to generate revenue like SuperVision or a still pre-revenue like Chauffeur, Drive and active sensor-ready product. Before I begin, please be aware that all my comments on profitability will refer to non-GAAP measurements. The primary exclusion in Mobileye's non-GAAP numbers is amortization of intangible assets, which is mainly related to Intel's acquisition of Mobileye in 2017. We also exclude stock-based compensation and IPO-related expenses. Starting with a few words about the full-year. Revenue growth of 35% year-over-year in 2022 continued our consistent track record of top line growth. Compared to 2018, our revenue is up 170% and global production is down 13%. As Amnon mentioned, our advanced portfolio made a meaningful impact on average system price, which rose to $53 in 2022, up from $47 in 2021. This alone drove about 13 points of revenue growth in 2022. The increase in average system price was mainly driven by SuperVision, as well as to a lesser extent the rise in chip cost which we passed along to our customers. The addition of SuperVision to our product mix led to a certain decrease in gross margin as we deploy a full system solution which contains higher hardware content. But more importantly, SuperVision generates much higher gross profit per unit than our core EyeQ product. As a result, EyeQ and SuperVision combined gross profit per unit grew by 9% in 2022. Turning to Q4. Revenue grew 59% year-over-year. Our EyeQ related revenue was up 48% with the SuperVision product driving most of the remainder of the growth, despite being less than 1% of our overall volumes. Q4 operating margin was 38%, up from 34% in prior year. This was above our guidance expectation due to a better-than-expected revenue growth, but also due to about $14 million of R&D expenses that we expected in Q4, but shifted to 2023. Turning to 2023 guidance. We are pleased that the midpoint of our guidance remains in line with the internal expectations at the time of our October IPO, despite of our macro assumptions for 2023 coming down since spin. On the revenue side, I'll give you a sense of our assumptions. Focusing on the high-end, we are assuming EyeQ volume that is somewhat below the commitment that we've received from our customers for 2023. We want to remain conservative and acknowledged that the macro uncertainty remains elevated. That volume level corresponds to about 1% global production growth, 4 to 5 points of ADAS production growth, which is somewhat lower than the prior few years, and consistent market share. On the SuperVision side, we are assuming a bit more than 100% growth versus 2022, which was about 96,000 units. Demand is higher than this, but we are still experiencing some supply chain constraints in one particular component of the ECU. On the positive side, we have commitment from our suppliers at the level we are focusing, including a second-half run rate that supports our 2024 forecast as well. In terms of quarterly cadence, historically, our revenue has ramped up over the course of the year. This year is expected to be even more pronounced with around 41% of revenue expected in the first half of the year. On both the EyeQ and SuperVision businesses, volume and revenue are expected to be lower in Q1 2023 versus Q4 2022. This appears to be general conservatism on the part of our customers, as well as some impact from elevated purchases ahead of the EyeQ price increase that went into effect on January 1. On SuperVision, the low volume in Q1 and Q2 versus Q4 2022 is related to the key ECU component mentioned earlier. On the average system price side, we expect Q1 and Q2 to be a bit lower than Q4 due to the SuperVision constraints, but we expect to exit 2023 in the low-$60, which is an excellent trajectory. On the operating income side, there's a few things to point out. Gross profit per unit will increase again year-over-year, but the percentage gross margin is expected to be down due to the higher mix of SuperVision revenue mentioned above. On the OpEx side, as Amnon mentioned, we will continue to invest heavily in our high ROI advanced portfolio, which is only beginning to impact our results. We estimate operating expenses to grow in the low-30% range in 2023 versus 35% growth in 2022. OpEx growth rate are expected to moderate in 2024, which combined with operating leverage is expected to lead to higher operating margin during that year, also consistent with our internal expectation at the time of the IPO. Before taking your questions, I just wanted to thank my team and many others at Mobileye for supporting what is a pretty accelerated earnings timeline for a newly public company. Great. Thanks. Hello, everybody. Just two questions, one financial and one on SuperVision. On the financial, maybe for Anat, hoping to maybe talk about what you're expecting for gross margins, kind of core ADAS and enhanced ADAS business in 2023? And then on SuperVision, hoping you could talk about what portion of customer engagements there are perhaps looking at a camera-only solution for SuperVision, as well as what you're seeing for the SuperVision Lite offering versus the full ODD SuperVision offering? Thank you. Okay. So on the EyeQ side, we are seeing consistent gross margin through 2023. And on SuperVision side, we're seeing approximately 35% for this year. Okay. I'll add a bit more that with the SuperVision there are two drivers to increase our gross margin there. One is efficiency of production, we're creating a new version, an evil version, with the lower cost, that will increase our margin. Second is the customer bundles. The launch of the SuperVision in China at the moment at highways, the urban and arterial roads would be unlocked during 2023 and that would also increase our revenue per content per car, and of course, naturally will increase the gross margin. We are targeting reaching between 50% to 60% gross margin of SuperVision kind of in the long-run. In terms of your second part of the question about camera-only, SuperVision is a camera-only plus a front-facing radar. So for example, on the ZEEKR vehicle there is a front-facing radar as well. Although we can satisfy all the functionality without the radar, but having a front-facing radar add another element of redundancy, which can improve the MTBF of the system. In terms of SuperVision Lite, this is a product offering which has been done very recently. So we don't yet have the traction for -- all traction that we have and is growing is for the full SuperVision with two EyeQ 6 and the full camera suit. Yes. Thank you very much for taking the question. With respect to the opportunity for Mobileye versus your more advanced solutions like SuperVision. Can you elaborate a bit more on the breadth and depth of the discussions you're having with OEMs to use those products relative to say 90 or 180 days ago? And if you're seeing that traction improve with just a few programs in OEMs or perhaps this is broader based? As I said, we have now SuperVision design win into six carmakers, nine brands. The scope is expanding towards Chauffeur, the eyes-off system. And additional SuperVision traction we expect to come out in the second half of the year. We have customers that we haven't named yet, but I think the additional traction in the second half would be ones outside of those six OEMs. That's very helpful. Thanks. And one more from me please, if I could. The Company said the supply chain limit including for SuperVision and you called that a ECU component. Do you have a bit more on the steps that Mobileye and your supply chain partners are taking to alleviate that and your visibility in potentially having that supply chain constraints alleviated intermediate to longer-term. Thank you. So we have an issue with one component in the SuperVision motherboard. This is why we have out of the full volume of the SuperVision, it's really tilted towards the second half of the year rather than the first half of the year. It's one component from a particular supplier, and we're confident that in the second half of the year that constraints will be alleviated and we can deliver the rest of the volume. Yes, maybe if I could just add a couple more words on this. So in 2022, we delivered every ECU we could possibly produce. And in the fourth quarter, it was a little bit more than we had expected to be able to access. We have so much additional demand in 2023 that in order to satisfy that the supply really needed to sort of take-down the production for a period of time in order to install more capacity, so we can get to much higher levels and just really reiterate what I said in the second half, we have commitments to be at a run-rate; that would satisfy not only the 2023 demand, but also gas to a capacity where we could satisfy 2024 as well. Hi, guys. Thanks for taking my questions and congrats on the result. I guess, I wanted to ask first about the premium European automaker that you announced for SuperVision. Any way you can give us sort of a, I don't know, a scope first is what you're currently doing with ZEEKR and Geely and in particular, how much does moving to it sounds like hands-off, eyes-off with that program, how much can that be a material needle mover, the potential for that program? Thank you. With respect to eyes-off, we announced with the ZEEKR, we streamlined the hardware at the time when we announced it, it was with six EyeQ 5 chips, we are now streamlining it to one piece of hardware called CH663, so three EyeQ 6, that will be in the 2025 timeframe. We have additional OEM with an eyes-off and an additional one, this European, which is not yet named for 2026 timeframe, and there is a potential additional one, which I believe that could be announced in the second half of the year for an eyes off-system based on the three EyeQ 6. Hi, appreciate the color. And then so I wanted to ask about your R&D and OpEx spending. You called out, it was helpful color, giving the 70% number on forthcoming product, but you have a lot of irons on the fire. And I was wondering if you could rank order where you're spending priorities, which ones are the ones that you're particularly focused and excited about between, let's say, AMAS, Consumer AV, but even bringing your own internal lidar and radar to market, as well as just broader software adoption like mapping. Thank you. Our expenses is very diverse and you mentioned a number of them. We have expense on active sensors, radar, lidar, there we are working on productization middle of a 2024 timeframe, both of the radars and the lidars. So this is ongoing. We have expense on mapping on the REM mapping, this is mostly a compute. The headcount is not much increasing, it's really the compute that is increasing based on more and more programs that require mapping. We have the expense in R&D as we go forward from SuperVision to Chauffeur to Drive, which is the Mobility of the Service, that's another source of expense. We have expense on SuperVision to support those six carmakers, this is very diverse, it's hardware, just like as a Tier 1, it is software, not algorithmic software, but more infrastructure software. There's a lot going on there to support six carmakers with SuperVision, all coming around the same timeframe, starting from 2024 till 2026. So this creates also a need for investments. So, our investments are very diverse. We think that now last year 2022, we made a jump on investments, this year another jump, and it will taper off from 2024 forward. And I'd just say, you know, the last thing I'd say on that is it's all supporting the portfolio that we've talked about for the last few months with so much value and additional content per vehicle. Thanks so much team. Quick one on just the numbers and one on orders, so just on the timing for gross profit progression in 2023, it looks like you're going to be down something like 400 basis points. And I think you've explained that that's the STM increase on the chip side. Could you just help us do, does that pass-through happen as early as Q1, Q2, obviously doesn't matter for gross profit dollars, but just for the gross profit margin walk, could you just help us on the timing? Yes so the timing is from January 1. We are testing already over this cost that we - and those increase at the beginning of the year, we're testing it over to our customers and without additional margin, but this is the reason for a slight decrease in our margin for EyeQ. Yes and then the second thing that we mentioned in the prepared remarks was SuperVision becoming a bigger mix of our revenue as a kind of a mathematical effect on the percentage margin, gross profit per unit is much higher, but gross margin is lower, but that will be a bigger effect in the second half because the volume of SuperVision is significantly higher in the second half. Great. And then on the - did the Chauffeur win, obviously congrats is it to the - scale of OEM that a lot of us think that - itâs a huge deal. But can you talk a little bit about just the timing of some of these - SuperVision walked into Chauffeur. I mean, if you're talking about launches in SuperVision in '25, what's the typical sort of conversation around that transitioning to Chauffeur is it '27, is it '28? And then any idea of - we talk, we starting with level three and then working up to level four, it obviously such an important sort of part of the - later half of the decade just curious when these programs may launch? Yes, so - now with taxonomy, there is no difference between level three and level four, it's been eyes-off or eyes-on system that this is what I spoke about us at the CES. So on eyes-off system with OEMs except ZEEKER that starts in 2025, the rest of the OEMs are starting in 2026. So we have quite a nice traction, as I said three OEMs and the fourth one should be - should be closed second half of this year for eyes-off systems for 2026. Yes, because SuperVision - really serves as the baseline - the timing gap between the SuperVision launch and a Chauffeur launch doesn't have to be a significant number of years. That's great. And just to confirm, in the prepared remarks, you said that most of your SuperVision conversations you're having discussion of this walk to Chauffeur? Yes, yes, it's not most all every, every customer that bought and into with SuperVision. We have a meaningful indeed discussion about expanding to Chauffeur. Hi thank you for taking my question. Maybe a quick one first, I was wondering where you stand on deploying the key mapping base features where the OTA update to declare users in China on what features that will unlock exactly what additional features we should expect in the upcoming update as well? So, in China with ZEEKR about three months ago we OTAed highway assist, recently we OTA to leading customer the full SuperVision limited to highways, this is including the REM maps as part of it. And we believe that in the next month or two months, we'll be able to do the OTA for the entire fleet with full REM - with full REM capability of SuperVision for highways. And then throughout the 2023, together with ZEEKR as our map coverage we'll increase - we will start unlocking additional road types like arterial and urban. Okay, thank you. And maybe as a follow-up - rather follow-ups so, I think one important differentiating factor that Mobileye has is that you offer an end-to-end solution, while your main competitor today offers really like a reference platform. Can you help us better understand how in practice, the integration work differs when you kick-off a development project versus when your main competitor doesn't? I'm assuming that in the case of the other offering out there, there is still some significant development work that needs to get done by the OEMs themselves, but anything you can tell us on how things typically happen in practice would be very helpful? Mobileye - and the SuperVision is not - is offering an end-to-end system. So the ZEEKR as an end-to-end system, all the other SuperVision launches that I talked about the six OEMs and nine brands is still an end-to-end system. Vertical handle of an end-to-end system, I think, is crucial, because you're talking about perception you're talking about integrating with a map. The map is built together with the teams that are building the perception. So if you try to separate the map from perception to two different suppliers, you get into a sea of issues, either it will be over-engineered or be under-engineered cost-wise, it could be crazy. The fact that now the same team is integrating both the sensing both the perception and the way the map is being built and served is crucial. Then you have driving policy. The driving policy is also integrated with the perception. But again, if you try to separate that into a supplier doing the driving policy and other supply doing the perception, you end up with an over-engineered system and in some places it will be under-engineered be too conservative and too slow. So I think in such a complex system an end-to-end where everything is done by one supplier has a lot of advantages and has also not only performance advantages, but also cost advantages. Everything under one house under one chip is - it offers incredible cost advantages. But we are not shy from cooperating in other ways. For example, there are OEMs that would like to take control of the driving policy, where Mobileye provides only the perception, we're open to that. This is why we offer the EyeQ Kit, which enables the OEM or a supplier to write code on to our chip on top of our software, whether it is fusion with other sensors, whether it's driving policy, we don't resist that. But having an end-to-end system can be much more efficient than we can get down to different suppliers. Yes hi, guys, great quarter and guide here. Just a quick question on â SuperVision just to go back to that in terms of the six OEMs outside Geely and ZEEKR, can you give us some idea of, as they ramp in the second half. And you talked about significantly higher SuperVision volume there. What kind of volumes are you looking at the OEMs outside of the two Geely and ZEEKR for the other OEMs? Yes, but do we say the number at the [bottom] no we said. We did not reveal the actual - volume, but I think. What did we revealed there. Yes, we're not - we're not revealing specific for quarterly. But - we talked about revenue being about 40%, 41% in the first half versus the second half. That's a combination of EyeQ and SuperVision, but yes the second-half ramp up of SuperVision is significant. Because of the new capacity that's coming online. Got it. And then as you have these OEMs accelerate into '24, we should probably expect and you talked about kind of building capacity for that we should expect that safe to kind of grow and then pretty nicely in '24 as well, right? Yes, so 2024 there will be additional OEMs it's not only ZEEKR, ZEEKR it's not - currently its ZEEKR 001. That's one brand, there's another brand of. ZEEKR coming to launch throughout end of 2023, beginning of 2024 and then there are additional Geely OEMs that are kicking-in in 2024 and then 2025. We're talking about OEMs outside of the Geely outside of the Geely Group. Got it. And just quickly on the - I know in '23 you have on the core EyeQ side you have Toyota ramping. Can you talk to what drove the win, how you were able to kind of displace incumbent, what really drove that win that will then help all of us? Thanks. With Toyota that was a design win of - two years ago I don't think we displaced anyone it was a bid and we won the bid. And the program is ongoing it hasn't launched yet. Hi, everybody. So, was wondering if you could give a little bit of guide on CapEx, where is it going even directionally in '23? And I'm curious if operating cash flow can keep pace with growth in operating profit or does that kind of lag as well, given some of the expenses? Yes, so we expect CapEx to be similar to the investment in 2022. Our new campus is planned to be completed during the second quarter and additional investments for completion is about $60 million. The remaining CapEx investments relates to storage, datacenters and computer equipment and such. Thanks, Anat. And just a follow-up, could you help quantify the shifted engineering expenses that shifted from 4Q into 2023, either in margin or dollar terms? And the same, I guess if you could, if it's possible to quantify the pull forward of volume ahead of the price increase, but mainly the engineering expense is something I would hope you could just help quantify for bridging purposes? Thanks, Anat. One four, 14 yes to be clear from this year to next year it's mostly about the NRE expenses. But it's not a very significant number out of the total OpEx mix in 2023. Yes hi. Thanks for taking my questions. I guess, for the first one, I was just wondering if you can talk about what you're seeing on the enhanced ADAS solutions, particularly in terms of being able to upsell customers when it comes to sort of basic ADAS and nearing REM. On that, how much of, you talked about the ASP increase expecting for 2023, but how much of that is going to be driven by being able to sort of sell enhanced ADAS solution or it the basic ADAS and how are you seeing OEMs adopted at this point? Is it really more of a high-end sort of adoption or they looked a little bit more down market, and I have a quick follow-up. Thank you. Beyond Volkswagen that launched a year ago with a 12 versus 2.5, we have now two additional OEMs with big programs with cloud enhanced ADAS, and it's ramping-up. I believe at the end of the day, every carmaker with a front-facing camera would include also as an option maybe higher trim option and enhanced ADAS, because it doesn't add any hardware to the mix, it's just a software update and it makes a lot of sense. But by increasing significantly increasing the ADAS capability by having the data from the cloud, about where the landmarks are, the drivable path location of the traffic lights, association of traffic light, drivable path, all of this creates new opportunities for enhancing driving assist at quite a reasonable cost of few tens of dollars for car per year, something like that. Okay and for the follow-up. We get a lot of questions about sort of how to think about performance in the recession and if the backdrop was to get worse. I know you talked about sort of tapering some of the OEM demand that you're seeing in terms of volumes. But how are you sort of thinking about the likelihood of pushouts, particularly a program, the plan towards the end of the year, pushing out timelines in terms of launches or adoption of certain programs. And also how would you sort of flex your OpEx in this scenario that macro does being a bit worse? Thank you. Yes so, I mean - this is Dan. Obviously, we're susceptible to swings in global production a bit by, as you've seen in the past years we're growing so much faster than overall production, that is not as big of an impact to us as probably to others. We acknowledge kind of the risks around production and that's why we set our forecast to basically flat to 1% global production growth, even though - and set our volume forecast below the orders and commitments we've gotten from our customers. We're definitely not hearing about any kind of like push-out of programs or anything like that and also we have the driver of adoption growth that wouldn't impact us too much as well, but not hearing, just to be clear, not hearing anything about that. So overall like, we've done well in all kinds of environments over the last 10 years. And yes, that's so that's - and in terms of flexing operating expenses, I don't think we would. I think that our business is built for the long-term to drive content per vehicle growth to drive new solutions for the next 10 years plus. So, I don't think we would pull-back on operating expenses. Good morning. Thanks for taking the questions. First, wanted to ask so we've talked about SuperVision quite a bit, cloud-enhanced ADAS as well, I'm wondering about EyeQ Kit if we could discuss the evolution of those conversations with customers. How that's developed over the past six-plus months, let's say. And could it or has it been intersecting with SuperVision at all with these customers? Yes, indeed. All the advanced system Chauffeur and SuperVision, EyeQ Kit comes as a critical component, especially when you talk about the Chauffeur, some of the SuperVision programs include also EyeQ Kit some do not. But EyeQ Kit is becoming a major component in our discussions of advanced system. So advanced system is something beyond the SuperVision and beyond. Thank you for that. And for my follow-up, I just wanted to ask a question on near-term expectations. So in light of the component issue that you said with SuperVision, which sounds like it's, just timing and the timing of expenses, are there any additional guardrails we should be keeping in mind when it comes to near-term especially first quarter expectations? Thank you. Yes, sorry about that. So the question is in terms of the first quarter, on the financial side of things, so clearly want to be looking at timing around SuperVision and component availability expense timing as well around R&D. Just wondering if there's, any additional guardrails or things that would be specific to the first quarter we should be keeping in mind beyond just the revenue waiting first half versus second half, let's say? Thank you. Yes I mean, I think we covered that. We think Q1 revenue will be below Q4. We're not going to get more specific than that, and kind of talked about the reasons I mean, every year we have more revenue in the back half versus the first-half we do think it's going to be a little bit more pronounced this year, because of the constraints on SuperVision supply in the first-half as well as. We do think that there was some additional buying of EyeQ before the price increase, which I think is natural, we don't think it was major, but that's our read of why Q1 is a little bit below Q4, I hopefully that gives you enough information. Thanks, Luke. Yes, thank you and congratulations on great results. A question on the ASPs you mentioned that third of your revenue growth last year came from higher ASP growth, and this appears to be a very strong kind of investment thesis of your ASPs kind of move higher. How do we think about the balance between kind of unit growth versus ASP growth as you kind of ramp-up more of the SuperVision products? So and that - there is a big difference between ASP of EyeQ and SuperVision therefore when you're going with the volume of SuperVision, you don't need to grow a lot in order to produce these - or generate this high revenue. So there's a big difference there and we think that as we go further, with a higher SuperVision in the mix, you will see this ASP continue to grow. Exactly I mean, I think we have a lot of visibility on content per vehicle growth the design-wins that we achieved in 2022 came in at $105 per unit. On a blended basis, right, that's a mix of base EyeQ, cloud-enhanced ADAS, SuperVision. SuperVision was definitely the biggest contributor to the year-over-year growth in ASP that we saw in Q4. Even though it was 0.5% of the volume and like we said in the prepared remarks. We see a trajectory to the low 60s in the back half of 2023, still with really one customer, plus an additional Geely brand in the back half. So a very powerful driver and the fact that Chauffeur is becoming a bigger part of the discussions with OEMs, brings even more potential upside in the future. It takes time to play out like everything in this business, but we're feeling really good about the content per vehicle trajectory. Appreciate that. And for my follow-up, a lot of the questions we receive from investors is, trying to analyze the evolving competitive landscape with very large semiconductor suppliers, as well as some niche competitors that are developing certain types of computer vision application? So I'm wondering as you are increasing the content per vehicle as you're adding and kind of upgrading and upselling your customers to higher levels of autonomy, how do you currently see the competition and how do you foresee it evolving as OEMs going to adopt higher levels of autonomy? Thank you. I think when you go to those, high level of complexity of systems, the semiconductor is really a small part of the mix. You have so much on top of the semiconductor. You have the perception software, the driving policy software, the control of the car software, the mapping, the integration of all of them together it is way, way beyond a semiconductor business even when you talk about the basic ADAS, which is a front-facing camera with a chip behind it. The optimization and the economy of scales over the last decade of this particular product, makes it very, very unlikely to a newcomer to gain market share. It's highly optimized the validation as it's very, very expensive, requires hundreds of petabytes of data to properly validate. And if you don't have any disrupting new idea there, being able to take market share in that particular highly optimized business is very, very unlikely and less incumbent for some reason stops to deliver and I don't see us stopping to deliver. So really the game in terms of market share is on the complex systems, SuperVision and beyond. I think there Mobileye is clearly at a very, very leading position a SuperVision type of a product, I don't see anything outside of the Tesla FSD that even comes close to it. And we are having a very strong traction for it, more and more carmakers more brands. Chauffeur is another step-up. So this is where the competitive game is going to be not on the low end ADAS. And there it's way beyond a semiconductor business. Hi, guys just two quick ones. First, if you could just discuss exactly what on with the January price hike, so we can understand why folks may have pre-bought in front of that, just to understand how big that is? And then the second one, Amnon, as you're making this progress with SuperVision as far as book business and discussions, are the customers just kind of throwing up their hands and saying, listen, we just can't do this ourselves or these other partners. So we're just kind of handing the keys and becoming exclusive with you or are they sort of parallel processing other systems and what - how is that developing? I don't think the story is so dramatic as to handling the key, all right? OEMs do what makes the most sense. They want to deliver a product, they want to deliver a competitive product, they need to compete with other OEMs, they need to provide value to the customers and they see what Mobileye is doing. I think the launch of the ZEEKR SuperVision created a kind of a significant moment. Because it's one thing to show a development system and other thing is to show production system doing something very impressive. So it's not that OEMs decided to throw in the towel, it's simply a natural evolution of a competitive landscape. You need to be able to deliver brands with the best technology and use the suppliers for it. The EyeQ Kit allows the carmaker - I think, the EyeQ Kit was a very important moment here. It allows the carmakers not to completely tweak our system at the black-box, but to add to it their own software and to create further differentiation, but trying to replicate what Mobileye has been doing, personally I don't think it makes sense, really, because, I know the amount of investments that's being done. And this kind of investments cannot be done just through money. There is a time factor forward - a significant time factor forward. So I think that the ZEEKR launch created kind of a reality check in many of our OEM partners. Hi, good morning and thanks for squeezing me in. Two questions if I could, first of all on at CES the conversation around your radar innovations were pretty interesting. I was wondering beyond just the technology roadmap. What else is going to drive your ability to start disrupting in that product space? I guess you're talking about going to market in 2024 to trying to win new business. And then secondly, as you it's sort of right-sized for the volumes needed under SuperVision by the end of this year with your manufacturing partner is that when we should start thinking about gross margins and SuperVision, improving or do we need more volumes beyond like end of calendar '23 to start seeing that improvement? Thank you. Okay, I'll start with the second half of your question the gross margin in terms of the cost of production is not volume-dependent. We simply did another spin-off the - off the hardware. Was a highly - was better, optimize the component, so that would reduce our cost. Another part of the increasing our gross margin of SuperVision is higher bundled. Once the bundles, once software bundles will include beyond highway that - increase our gross margin, was it first half. The radar it's important to mention that our motivations for building those radars is not just to enter into a new market place was to create a very streamlined, eyes-off a system where you don't need a 360 degree awareness from ladders and because that is expensive. We want to limit the ladder, only for front-facing and the remaining 360 to be handled by imaging radars and those imaging radars that we're developing really cutting-edge in terms of. Now 48-by-48 channels, 100 DB of sensitivity and they can create an end-to-end autonomous driving experience as another layer of redundancy. And that would considerably reduced the cost - of and eyes-off a system. I'm talking about an eyes-off with the full capability, full ODD. Thank you. Thanks, Steven. Thanks everyone for joining our first earnings call as a public company and we will see you next quarter. Thank you again.
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Greetings, and welcome to the Inotiv, Inc.'s Fourth Quarter and Full Year Fiscal 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Devin Sullivan, Managing Director for The Equity Group. Thank you, Devin. You may begin. Thank you, Paul. Good afternoon, everyone, and thank you for joining us for Inotiv's fiscal 2022 fourth quarter and full year financial results call. Before we begin, I'd like to remind everyone that some of the statements that management will make on this call are considered forward-looking statements, including statements about the company's future operating and financial results and plans. Such statements are subject to risks and uncertainties that could cause actual performance or achievements to be materially different from those projected. Any such statements represent management's expectations as of today's date. You should not place undue reliance on these forward-looking statements and the company does not undertake any obligation to update or revise forward-looking statements whether as a result of new information, future events or otherwise. Please refer to the company's SEC filings for further guidance on this matter. Management will also discuss certain non-GAAP financial measures in an effort to provide additional information for investors. A definition of these non-GAAP measures and reconciliation to the most comparable GAAP measures are included in the company's earnings release, which will be posted on the Investors section of the company's website at inotivco.com and is also available in the Form 8-K filed with the Securities and Exchange Commission today. Joining us from the company this afternoon are Bob Leasure, President and Chief Executive Officer; Beth Taylor, Chief Financial Officer; and John Sagartz, the company's Chief Strategy Officer. Bob will begin with some opening remarks, after which Beth will present a summary of the company's financial results. Then, we will open the call for questions from our analysts. It is now my pleasure to turn the call over to Bob Leasure, President and CEO of Inotiv. Bob, please go ahead. All right. Thank you, Devin, and good afternoon, everyone. We appreciate you taking time to join us today and appreciate your patience with respect to the delay in announcing of our results for the fourth quarter and full year. Following a very strong third quarter, total revenue for the fourth quarter of fiscal 2022 rose fivefold to $150.5 million from $30.1 million in last year's fourth quarter. For the full year 2022, revenues improved to $547.7 million from $89.6 million last year, with the increase across our DSA and RMS business segments reflecting approximately 31% organic growth plus the contribution from acquisitions. Adjusted EBITDA for fiscal Q4 improved to $18.3 million or 12.1% of total revenues from $4.3 million or 14.4% of total revenues in last year's fourth quarter. For the full year, adjusted EBITDA grew from -- grew to $90.5 million or 16.5% of total revenues from $9.3 million or 10.4% last year. This was a very solid year of continued growth and was reflective of our ongoing evolution into a comprehensive provider of non-clinical CRO services and research products to the global pharmaceutical and biotech industries. During 2022, we consummated several acquisitions that enhanced both our geographic footprint and portfolio of service offerings. We began the integration and optimization of our acquired operations and created a path to what we believe will be sustainable growth in sales and expansion of margins. We're pleased with the progress we made in fiscal year 2022 and have entered '23 with specific plans to continue to improve our overall business model while addressing what we estimate will be a temporary disruption in our NHP business, which I'll discuss in greater detail shortly. During the fourth quarter, we did experience unexpectedly higher operating costs related to company-wide recruiting and the validation of new DSA services, as well as certain non-recurring costs related to restructuring charges, legal fees for closures of facilities, and consolidation expenses to move operations from Dublin, Virginia to other facilities; we also began the preparation for moves from Haslett and Boyertown; we had acquisitions integration costs, including expenses from terminated M&A deals, which we will not close, and financing transactions and the discontinuation of a capital project. Overall, our DSA business had an exceptional year, generating revenue of $165.3 million, an 84.5% increase from 2021. Organic DSA revenue growth in 2022 was $49.6 million, representing incremental growth of approximately 66%, supported by $26.1 million of incremental revenue from strategic acquisitions. For 2023, we've already added new capabilities and capacity in Rockville, Maryland to conduct Good Laboratory Practices, or GLP, studies for in vitro, cytogenetics and bacterial mutation assays as components of the standard battery of genetic toxicology studies required to support first-in-human evaluations of novel therapeutics. We continue developing our suite of genetic toxicology services and look forward to seeing continued growth in Rockville as we also complete the facility buildout and launch our biotherapeutics business. We are completing other projects to build out the capacity and capabilities across our existing enterprises, specifically completing a project in Boulder, Colorado. This expansion was initiated in early fiscal 2022 and will be coming online during fiscal '23. We are expanding operations as well in Fort Collins, Colorado, but we'll be narrowing the plan which was scheduled for 2023. Once completed, these expansions will increase our DSA facility capacity by 30% and our DSA revenue capacity by an estimated $50 million. These expansions will also improve the overall quality and efficiency of our service offerings, while reducing our reliance on third-party outsourcing for certain services. We are reprioritizing some of our capital plans that we believe can generate quick returns and overall reducing our spend in fiscal '23. Conversely, we will delay our previously-announced expansion activities at our ILS facility in North Carolina, which we acquired in January 2022. The slowdown of our expansion does not impact our near-term growth prospects and we will evaluate these needs and investments in the future. Our RMS segment contributed $382.4 million of revenue in the year, reflecting strong incremental revenue well above the run rate when we entered the RMS market with our Envigo acquisition in November 2021. Organic revenue growth in 2022 was $91.3 million, representing incremental revenue growth of approximately 24%. This was our first year in the RMS business. We've had a chance to gain further knowledge of this business, have taken significant actions to improve the operations and enhance future margins through site optimization plans, enhanced pricing across the product portfolio and other significant operational changes. We have also made significant progress in our comprehensive site optimization master plan. In June, we announced the closure of two RMS facilities in Virginia. The closure of Cumberland, Virginia facility was completed by the end of fiscal 2022. Cumberland revenue was less than 1% of our total revenue and did not contribute to adjusted EBITDA. The operations at our Dublin facility in Virginia ceased in November of 2022, and the customers were transferred and are now being served from other locations. Since the closings, the Dublin property has been sold and the Cumberland facility is in the process of being sold. The previously-announced facility closures in Haslett, Michigan and Boyertown, Pennsylvania are now in process and should be completed by March of 2022 -- or March of 2023. We recently announced the closure of two facilities in Indianapolis. The activity of these Indianapolis facilities will be relocated to other existing facilities and should be completed by June of 2023. We also introduced the proposed consolidation plans of Gannat, France and Blackthorn, U.K. into existing facilities, which if approved, we hope to complete in 2023 and 2024, respectively. Now, I want to move to give a little bit more detail on our non-human primate business. As stated on our November 16, 2022 release, out of an abundance of caution, we have not initiated any shipments or imports of NHPs from Cambodia, although we do continue to sell and import NHPs from other countries. Cambodia is a critical supplier of NHPs to the U.S. In absence of imports from China, Cambodia represented over 60% of the NHP imports, according to CDC statistics. We continue to work with external and internal resources to review our current NHP inventory from Cambodia and we'll begin shipments of these NHPs only after such time that we can reasonably determine the NHPs in our possession are purpose-bred and not wild caught. While we are not currently aware of any outside constraints on importing NHPs from Cambodia, Inotiv will not import from Cambodia until we can complete satisfactory on-site audits of our suppliers. We are in communication with our Cambodian suppliers and we expect that we will be able to be on-site in Cambodia to complete these audits during this quarter. We do understand Cambodian officials have stated that they will be shipping NHPs. Even in a significantly-constrained market, we believe the DSA business will have -- our DSA business will have ample access to NHPs to meet our clients' needs. Having access to the supply, along with our desire and ability to have a positive impact on this industry, was a critical factor in the decision to purchase Envigo and Orient BioResource. We believe the current situation shows the need to implement changes within our industry, and we look forward to working with others in our industry and with the government to continue to lead changes to this industry. With respect to broader market conditions and commentary, during the fourth quarter 2022, an increased level of quoting activity translated into a higher backlog at year-end. As a reminder, when we report new awards, they are net of cancellations. Despite the growth in backlog, we also continued to experience a high level of cancellations, due primarily to molecules not being ready as expected for projects that were awarded 12 to 18 months ago and the abandoning of projects which were seen as risky. We have seen some market commentary that the industry is seeing a downturn in the biotech funding and spending. We have experienced a few occasions recently where this has been the case with our clients. We continue to monitor market conditions closely. The operational investments we made in 2022 in areas such as recruiting, internal processes, facilities, technology, personnel have been significant. We have allowed -- and it has allowed us to further integrate our acquisitions and begin to achieve synergies. We invested over $36.3 million in internal projects during 2022. We believe these investments will allow us to broaden our service offerings, improve margins, enhance our overall level of customer service and maintain a high level of animal welfare. Within our RMS business, specifically, the investments will allow us to implement our comprehensive site optimization plan, which currently includes closing nine of the 24 sites we acquired with the RMS business. In addition to the operational investments in 2022, we've also had an opportunity to review our cost and pricing. As a result, we have been able to amend customer contracts and pricing. Many of the pricing changes began to go into effect in January of 2023. These will help offset inflationary cost increases, which we experienced in 2022 and during Q1 of fiscal 2023. During the 12 months ended December 31, 2022, we hired approximately 860 people, which is over 35% of our current workforce. This was a significant investment and was needed to support our growth and improvements last year. We've seen our retention rate increase and we're able to successfully reduce our turnover rate. At present, critical operational leadership positions are all filled. Overall, in 2023, expect employment to stay consistent with our current levels, and we expect a growth -- to support our growth in 2023 from efficiency gains. As a result of market conditions and what we have been able to achieve over the last four years, in 2023, we expect to be less focused on acquisitions. As stated earlier, we have also delayed and reduced certain expansion activities we had previously announced related to our DSA business. We believe that this course of action is prudent given the current state of capital markets and our desire to focus on integrating and optimizing the businesses we acquired and have built over the past two years. We believe our strong organic growth for fiscal 2022 has exceeded the industry average of low double digit growth for Discovery Services and mid to high single digit growth for Safety Assessment, which speaks to our ability to increase market share. As per guidance for 2023, for fiscal year end -- year ending September 30, 2023, we are providing guidance of at least $580 million of revenue and at least $75 million of adjusted EBITDA. Due to the recent disruption of our NHP supply chain, the guidance of $580 million of revenue includes a range for Q1 fiscal 2023 revenue from $118 million to $122 million, and approximately $460 million of revenue during the nine-month period of Q2 through Q4 of 2023. The guidance of $75 million of adjusted EBITDA includes an expected negative adjusted EBITDA margin in Q1, and adjusted EBITDA margins of approximately 17% during Q2 through Q4. We will continue to focus on organic growth and market share gains with our expanding service offerings in the DSA business. With the strong backlog growth through 2022, we have good visibility on DSA revenue heading into 2023. We look for efficiency improvements to leverage our fixed cost structure on increasing sales to enhance DSA margin. Our RMS business will benefit from the price increases implemented in January of 2023 and the expected market share gains, while further margin expansion will be driven by our site optimization plans. We also continue to invest in enhancing our animal welfare programs. Our guidance does assume a reduction in the number of NHP sales from last year. Although we've experienced a short-term disruption, we are not aware of any importation ban from Cambodia and NHP sales could increase throughout the year from our guidance level if we are able to resume full importation levels. We hope to get further knowledge and comfort on 2023 importation levels based on additional supply audits that are expected to take place during this quarter. Even if the total volume of NHPs is lower than 2023 -- '22, we expect to benefit from price increases for NHPs, which could range between 65% to over 100% throughout this year in this highly supply-constrained environment. Although we were impacted by the NHP supply issue in Q1, we believe the business is well positioned to achieve above market revenue growth rates and expansion in margins. As stated previously, for 2023, we are focused on optimizing organic revenue growth and improving margins, and less focus on acquisition opportunities. We continue to guide long-term revenue growth of high single to low double digits and long-term EBITDA margins of 18% to 22%. With that, I'll turn it over to our Chief Financial Officer, Beth Taylor. Beth, please go ahead with the financial overview. Total revenue for the fourth quarter of fiscal 2022 rose to $150.5 million from $30.1 million in last year's fourth quarter, driven primarily by significant incremental revenue from our RMS segment and higher revenue in our DSA segment. DSA segment revenues grew 46.8% in the fiscal 2022 fourth quarter to $44.2 million, up from $30.1 million in the fiscal 2021 fourth quarter, and that was driven by $2.1 million of incremental revenue from acquisitions over the same period last year and an incremental increase in revenue from internal growth of $12 million during the quarter. The fiscal 2022 fourth quarter revenue was lower than fiscal 2022 third quarter revenue due to higher benefits in the third quarter from cancellation fees and the fourth quarter revenue being impacted from less canines being available for studies. However, the canine shortage issue is improving and we expect to see the benefit of this starting in the second quarter of fiscal 2023. Our RMS segment revenue in the fiscal 2022 fourth quarter was $106.3 million. We did not have any revenue for our RMS segment in the last year's fourth quarter. RMS segment revenue was lower in fiscal 2022 fourth quarter compared to the 2022 third quarter due to shipping less units of NHPs during the quarter. Our total gross profit increased to $42.2 million or 28% of revenue, up from total gross profit of $10.3 million or 34.2% of revenue in last year's fourth quarter. Gross profit for our DSA segment improved to $13 million or 29.4% of segment revenue from $10.3 million or 34.2% of segment revenue in last year's fourth quarter. The percentage decline in gross profit was primarily driven by laboratory capacity investments and cost associated with the recruitment of additional scientists to support new capacities and services. The work currently being conducted includes development of assays, validation of equipment, and establishment of good laboratory practices that will be coming up during the last half of fiscal 2023. RMS segment gross profit in the fourth quarter of fiscal 2022 was $29.2 million or 27.5% of RMS revenue. RMS gross profit in the fourth quarter included approximately $200,000 of non-cash inventory step-up amortization, which negatively impacted gross profit percentage by approximately 0.8%. We did not have any RMS gross profit in last year's fourth quarter. Our operating loss for the fourth quarter was $242.5 million, reflecting an increase in operating expenses to $271 million from $13.7 million in last year's fourth quarter. As we noted in our press release, higher operating expenses were driven primarily by a non-cash goodwill impairment charge of $236 million related to our RMS segment. And as part of our impairment assessment, we determined that the carrying amount of goodwill attributed to our RMS segment was in excess of its fair value, primarily driven by the sustained decrease in our share price as compared to our share price at the time of the Envigo acquisition. The remaining increase in operating expenses reflected restructuring charges and legal fees related to the previously-announced closures of our facilities in Cumberland and Dublin, Virginia, acquisition and integration costs, which included M&A due diligence for opportunities we explore during the quarter, a one-time charge for the write-off of deferred legal and accounting fees for our S-1 registration statement that was withdrawn and a non-cash charge for amortization of inventory step-up. Adjusted corporate unallocated G&A totaled $14.5 million or 9.6% of revenue in the fourth quarter of fiscal 2022 compared to $3.2 million or 10.5% of revenue in the fourth quarter of fiscal 2021. The 900 basis point decrease was due to the advantage of scale as revenue has gone up. We continue to maintain a long-term objective for adjusted unallocated corporate G&A to be between 6% to 8% of revenue. Interest expense increased to $8.9 million from $0.5 million in last year's fourth quarter, reflecting our higher debt balance for borrowings obtained for the acquisitions and an increase in interest rates. Consolidated net loss attributable to common shareholders in the fourth quarter of fiscal 2022 totaled $244.2 million or a negative $9.54 per share, and included the $236 million non-cash impairment charge for the RMS segment. This compared to consolidated net income attributable to common shareholders of $9.4 million or $0.59 per basic share and $0.06 per diluted share in the fourth quarter of 2021. Adjusted EBITDA increased to $18.3 million or 12.1% of total revenue from $4.3 million or 14.4% of total revenue in Q4 fiscal 2021. Our book-to-bill ratio for our DSA segment in the fourth quarter of fiscal 2022 was 1.03x, down from 1.19x in the immediately preceding third quarter of fiscal 2022. For the year, our book-to-bill was 1.33x. In the fourth quarter of fiscal 2022, we experienced another record quarter of post-issued. However, the sequential quarterly decline in the book-to-bill was a result of an increase in project cancellations, as Bob referenced earlier, which was higher than what we saw in Q3 of fiscal 2022. As Bob noted, the majority of the cancellations reflected the unavailability of molecules for projects that had been booked up to a year-and-a-half in advance and clients abandoning projects which are seen as risky, and more recently a number of projects being put on hold due to lack of funding or pending -- or pending funding. DSA backlog improved to $147.2 million at September 30, 2022, up from $143.2 million at June 30, 2022, and that was compared to $81.4 million at September 30, 2021. Net cash used in operations for the 2022 fiscal year was $5.2 million compared to cash provided by operations of $10.7 million last year. The use of cash during the year reflected our increase in net working capital for our NHP business due to the timing between deposits made to our suppliers and when the shipments are received and then when the cash is collected from our customers. CapEx in the fourth quarter totaled $5 million or 3.3% of revenue, with total 2022 CapEx totaling $36.2 million or 6.6% of revenue. CapEx for the year reflected investments in facility improvements, site expansions, enhancements to laboratory technology and system enhancements to improve the client experience. We expect our fiscal 2023 CapEx to be approximately 3% to 4% of projected revenue, which we believe will be less than $25 million. The CapEx investments will focus on completions of DSA capacity expansions in Boulder and Rockville, and initiation of an expansion project in Fort Collins, completion of RMS deferred maintenance projects, and continued animal welfare enhancement projects. Our balance sheet as of September 30, 2022 included $18.5 million in cash and cash equivalents and $15 million balance on a $15 million revolving credit facility and a $0 balance on a $35 million delayed draw term loan. In October, we drew down the entirety of the $35 million delayed draw term loan and a portion of the proceeds were used to repay the $15 million balance on the revolving credit facility. Total debt, net of debt issuance cost, as of September 30, 2022 was $353.7 million, including the balance on the revolving credit facility. We were in compliance with our debt covenants as of September 30, 2022. We currently have $15 million of availability on our revolving credit facility. And based on our financial guidance, we anticipate that we will be in compliance with our financial covenants for fiscal 2023. While 2022 did present some challenges, we made significant progress to improve our services, build capacity, integrate and optimize our acquired operations and implement plans to enhance margins. We remain pleased with our financial performance and the foundation that we have built to continue to grow and capture a significant portion of the opportunities in our market. All right. In closing, I'd like to take a moment to thank our 2,200-plus employees who work tirelessly every day to provide unique Inotiv experience for all of our customers. The reason -- they are the reason our customers want to grow with us and I truly appreciate all they do. Thank you. [Operator Instructions] Thank you. Our first question is from Frank Takkinen with Lake Street Capital Markets. Please proceed with your question. Hey, thanks for taking my questions. I wanted to start with a couple on the NHP dynamic. First clarifying question. I think I heard you correctly, Bob, that you stated Cambodia is still exporting NHPs. But if I understand correctly, you guys have elected kind of interesting conservatism to not take importation from Cambodia. The first clarifying there. And then, two, kind of walk through the process of the audit that you plan to go through with your on-site visit? And how would it look in Q2 and forward as you can return to shipping NHP, how quickly that can occur again? Well, okay, first, let's -- hi, Frank. I think as far as Cambodia, the Cambodia government officials have said that they will be exporting. So, I'll leave it at that. As far as our -- this is our internal decision that we will not bring in imports until we have had a chance to be on site to audit the facilities in Cambodia. This is something that's really not been allowed since COVID. I think the last time people on-site were in January of 2020. Of course, we did not own the business back then. But due to COVID, nobody's been allowed on-site. We've recently been notified that we will be allowed on-site, and we're looking forward to people going over there shortly in order to be able to audit those facilities. So, we'll wait and see how those audit turnout before we make the decisions to import, but that will be the next critical path. As far as what the audit will tell, no, we will not talk about what audits we're doing internally or externally with the NHPs at this point. Okay. That's helpful. And then, maybe on the cancellation theme, it sounds like you're not alone in that dynamic, but maybe just kind of think -- speak to how you're thinking about the cancellation trend as you move into 2023? And what you kind of baked into your guidance on that front in the DSA business? Yes, I know. I think that's definitely a headwind that we face. We have seen and we're going to have to continue to see our quoting increase to overcome the cancellations that are out there. It's something that we started preparing for probably nine months ago as we saw this and it's turned out to be true. We've been increasing our sales and marketing efforts and budgets, while we've also been adding additional salespeople. So, I expect that we continue that strategy and continue investing our sales and marketing dollars, and how we can be more intelligent with how we're investing and how we're selling. But that's something we'll do hopefully daily in order to get smarter and better to get more shots on goal, if you will, and more opportunities, and then what can we do to be more effective in closing. Okay, great. And then, maybe one last one for me, a bigger picture question. Prior to all the NHP disruption, the big picture growth commentary and business model profile was a high single, low double digit, in aggregate, with DSA outpacing that and eventually reaching 18% to 22% EBITDA margin profile. But once we cross over some of these NHP disturbances, has your thought process around that business model, that business profile changed at all? Or do you feel it's still fully achievable once we reach a time of more predictable NHP supply? I think it is fully achievable. I think that we -- as we indicated that -- I think that the first quarter -- the fourth quarter and the first quarter, we had some inflationary pressures on our business, specifically our RMS business. But I think with the price increases that we implemented this January and the price increases we implemented with the NHP business -- remember, we still do sell NHPs. They're not all from Cambodia. And along with the new services that we're adding and I think the site consolidations that we're doing, I think we -- those -- still optimistic those are very achievable targets. Good afternoon. Thanks for taking the questions. Maybe first up on the flip side of the cancellations, are you seeing a more normalization in the bookings, meaning you're not getting customers coming in a year or 18 months early to book? As you built out capacity, are you feeling like you're getting back to a more normalized bookings timeline? Matt, I think there may be a little bit of that, but I would tell you that we do have some projects that are booked out into 2024 already. So, as I look at our 2023 backlog for the rest of this year, we probably have 65% of our business already in the backlog, which is I think probably more normal. And I think that we are booking things into 2024. And I think as people get more concerned again about access to NHPs -- because if the trend continues, there will be less available this year. I think that will have people booking further out again. Got it. And then, I guess, on the NHP side, how much of a headwind to EBITDA margins does that represent over the near-term while you're basically holding those the Cambodian NHPs until you determine whether or not it's safe to give those to your customers? What kind of a margin hit does that represent? And how much of a benefit it will be when you're able to finally kind of get those out the door? Well, when and if we get them out the door, when we do, it will be a positive. But in the meantime, we're still selling NHPs, and margins will remain very good with the ones we have, because the demand is very high, and there are fewer available. But I can tell you with the pivot that we did -- and you can tell we pivoted the business a little bit in the last three months since we probably talked. And we're less focused on acquisitions. We don't need to go out and hire 860 people. More focused on efficiencies, a little less capital expenditures. Basically, that's allowed us to look at our expenses in our workforce. We did have a small reduction in workforce take place in December. We are reducing some expenses, the hiring and recruiting expenses. We're starting to see synergies still that we had not gotten to before. And we're starting to see some of the benefits for the site optimization plans. So, I'm pretty optimistic that we have made some significant changes in the business that have not been seen yet by our results and not been seen in market, because of the changes that we have -- that we had started a year ago with the site consolidation plans. But we're now starting to finish -- and then some of the investments that we needed to make initially, there's a lot of travel, for example, in introducing the sites to one another. Our IT programs, at one point, I think, given the examples, we had 220 software programs. We consolidated down to 120. There are many examples like that where we get synergies and those take a year to run off. So, as we start to see those things take place and come to fruition -- and again hiring and recruiting 860 is not a -- 35% of the workforce is -- this is pretty substantial feat for any company if you're growing that fast. And so, I think those sort of things that we're going to be much more efficient about next year and why we're going to see some improved margins, not just -- it's just not about how many NHPs can we sell. Got it. And then, maybe one last one and it touches on that a little bit as far as the site optimization. You have been building out some capacity, particularly in some newer markets. How quickly -- I mean, what does the pipeline for those services look like? How quickly do you think you can ramp up on the sales side to kind of offset some of the upfront costs that you've borne getting those services ready to go? Well, that's a good question. And I would like it to be a lot faster than that it is, but I'm probably -- I'm not very realistic. So -- but I would tell you, in Rockville, we've only brought it probably 25% -- probably 20% right now. The capacity is available in what we've built in Rockville. But what I've seen grow over the last three months during the quarter we just finished in December 31, very optimistic about the level of quoting activity, the backlog we built, and how we're ramping up those revenues. Now, again, it's only 20% of the facility and the capabilities available. But seeing that ramp up has been very encouraging. But I don't think -- that's something that I think that facility should eventually do $25 million to $30 million. That's not going to happen overnight. That will take a couple of years to build that up, I believe two or three years realistically. But I'm very pleased with what I've seen to date in the first 90 days that was open. And as we bring -- we'll bring on more capacity by March and, again, by June, and so far, the response to what we're building is very positive. And that doesn't only impact just Rockville, but some of the things we're doing in Rockville impacts our other facilities, because it's -- when we acquire company, remember, we pick up those sales and benefits from many other locations. And we're already seeing what we're picking up in Rockville benefiting other locations that we have. So, I'll remain optimistic at this point and I think that will be good investment for us. Okay. Hi, good afternoon. Thanks for taking my question. My first question is what percentage of 2022 -- fiscal 2022 revenue was represented by your NHPs, and maybe more specifically the Cambodia NHPs? David, I think in our last press release in November, I believe we indicated that maybe the Cambodian NHPs were $140 million of our revenue. Now, it's not top of my head, but I believe that's what we said in the November. Beth, is that correct? Beth, are you on the phone? Okay. And then, as I think about your guidance and the progression, you, obviously, are guiding toward a lower level of activity in the first quarter. As we sit here today, I mean, you may not have the books closed, but the first quarter is done. What drives the sequential improvement -- what's the difference between the factors impacting 1Q versus what you're going to get in 2Q and beyond? And maybe you could provide a little more detail as to whether 2Q, 3Q, 4Q looks similar, or do you expect a kind of a progression -- an improving progression through the balance of the year? You're breaking up through some of that call, David. So, I think you're asking if -- where we're going to see Q2 versus Q1, where would some of the sales increases come from? Yes. I apologize if I'm breaking up. So, just trying to get at the differences in 1Q, which is already now done versus your step-up in both revenue and profit margin 2Q and beyond. Yes. I think that we will see some benefits from price increases. So, the price increases in the NHP business are going to be somewhere around 65% to over 100%, depending on where they came from. And those didn't go in effect until January. So, I think those will be substantial, because we are still selling NHPs. In addition, I think, we'll start seeing some of the additional services come on board from the DSA business. And then, the price increases we took on the RMS business range and the other models other than NHPs were somewhere between 5% and 25%. So, I think we will see some increase in sales from those. Between now and the end of the year, I do expect that we will see increasing sales from NHPs. Okay. So, then maybe my question on DSA would be, in terms of the cadence of impact, you said you're still putting out record levels of quotes, but those are being dampened or diluted by cancellations. And normally, cancellations have a nearer-term impact and the quotes have maybe an out-quarter impact. Is that the right way to think about the new business -- the net new business that is coming in? It is. It puts additional pressure on the short-term operation to be flexible to move things around as things open up, or to go back out to the market and see if somebody else has a need for the capacity that just opened up. And -- so, it does require a little bit more flexibility in how we handle the operations. Okay. Then my last question on the debt front. You described a number of -- you and Beth, both, the movements in your delayed draw on your revolver and the covenants or the limitations disclosed in the press release tonight. From a practical standpoint, do you see those limitations through March of '24 as preventing you from doing what you want to do in the business? No, I don't. Those -- the changes we -- the pivots we made in the business were done before those amendments just came in place obviously in the last week or two. And I don't -- and I think with the relationship we have with our senior lenders, I believe that if we felt a need to change again for an opportunity that we have the kind of relationship that they would be open to listening to and we could work through those things. But at this point, for us, I think we have a lot we can do to become much more efficient and get to the synergies and finish the site optimization plans that are going to enhance our margins, and that's why I'd like to make sure we're doing in the short term. If we get through all those sooner than later and opportunities come up, we'll get -- we can go back and talk to them, but right now that is not our [indiscernible]. Thank you. There are no further questions at this time. I'd like to turn the call back to Bob Leasure for any closing remarks. No, again, I'd just like to thank everybody. We had the opportunities to look internally to figure out what we can do smarter and better. This had us refocus and ask a lot of questions about our business and what we should do different. And that was a great opportunity for us to pivot. And I think that, as a result, we'll be a much better company for this and much better position in the future. So, again, I want to thank all the people that worked with us over the last six or eight weeks. I apologize for the delay, but we'll look forward to moving forward into 2023 and what we can deliver. So, thank you very much.
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EarningCall_1282
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Good day, everyone, and welcome to the Boot Barn Holdings Third Quarter 2023 Earnings Call. As a reminder, this call is being recorded. Now I'd like to turn the conference over to your host, Mr. Mark Dedovesh, Vice President of Financial Planning. Please go ahead, sir. Thank you. Good afternoon, everyone. Thank you for joining us today to discuss Boot Barn's third quarter fiscal 2023 earnings results. With me on today's call are Jim Conroy, President and Chief Executive Officer; Greg Hackman, Executive Vice President and Chief Operating Officer; and Jim Watkins, Chief Financial Officer. A copy of today's press release along with a supplemental financial presentation is available on the Investor Relations section of Boot Barn website at bootbarn.com. Shortly after we end this call, a recording of the call will be available as a replay for 30 days on the Investor Relations section of the company's website. I would like to remind you that certain statements we will make in this presentation are forward looking. These forward-looking statements reflect Boot Barn's judgment and analysis only as of today, and actual results may differ materially from current expectations based on a number of factors affecting Boot Barn's business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made during this conference call and webcast, we refer you to the disclaimer regarding forward-looking statements that is included in our third quarter fiscal 2023 earnings release as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. On this call, I'll review our third quarter fiscal '23 results, discuss the progress we have made across each of our four strategic initiatives and provide an update on current business. Following my remarks, Jim Watkins will review our financial performance in more detail, and then we will open the call up for questions. I'm extremely proud of the entire Boot Barn team for their tremendous execution in the third quarter as we delivered total sales at the high end of our guidance. Total net sales grew 5.9% on top of 60.7% growth in the prior year period, driven primarily by strong sales from new stores opened over the past 12 months. On a three year basis, total sales have grown [technical difficulty] compared to the third quarter of fiscal 2020, just prior to the start of the pandemic. We are very encouraged that this three year growth has been driven primarily by an increase in the number of transactions as we have added a significant number of new customers to the brand while legacy shoppers seem to be purchasing more frequently. From a margin perspective, during the third quarter, merchandise margin declined 190 basis points, driven by a 180 basis point headwind from higher freight expense. We maintained our full price selling posture in what we believe was a highly promotional holiday season across retail. As a result, we were able to achieve a merchandise margin rate nearly in line with last year's record-setting performance after normalizing for the transitory freight headwinds. Once again, this demonstrates the strength of the Boot Barn brand and our ability to drive the business forward without resorting to unnecessary sales or promotions. I will now spend some time highlighting the recent progress we have made across each of our four strategic initiatives. Let's begin with expanding our store base. We continue to be pleased by our ability to grow new units each year. While historically, we targeted 10% new unit growth with each store generating approximately $1.7 million annually, we have recently been overdelivering on both metrics. We expect to open approximately 43 stores in the current fiscal year or more than 14% growth. Even more encouraging is our new store model is now $3.5 million and more than double our original target. At this level of sales, our new stores are paying back in just over one year with nearly 100% cash-on-cash returns. The pipeline for new store openings remains strong as we continue to broaden our retail footprint across the United States. During the third quarter, we opened 12 new stores, including our first store opening in the state of Connecticut, further expanding our Northeast presence. The success of our new stores in new and existing markets, coupled with less sales cannibalization than we originally anticipated, gives us further confidence in our ability to expand to more than 900 stores of the country or nearly triple our current store count. Moving to our second initiative, driving same-store sales growth. We are pleased with our same-store sales performance in the third quarter with consolidated same-store sales down 3.6% while cycling 54.2% same-store sales growth in the prior year period. We are particularly encouraged by the performance of our retail store sales, which declined a modest 0.8% while cycling a 55.7% growth in the year ago period. During the third quarter, our strongest growth categories were work apparel and men's Western apparel. While sales of men's and ladies western boots, ladies apparel and has declined, it is important to note that each of these businesses was up against incredibly strong double-digit or triple-digit growth in the prior year period. From a geographic standpoint, we saw growth in our East and North regions, a slight decline in our South region and a mid-single-digit decline in our West region, which is perennially our strongest region. Given the outsized growth we saw in all regions of more than 50% in our prior year period, we are again pleased with the performance across the country. From a marketing perspective, the team continues to expand our customer reach by modernizing the brand and carefully tailoring our communication to each customer segment. We use a combination of media formats to target our legacy Western and work customers in addition to our more recently added country lifestyle and fashion customers. We believe the content of our marketing not only showcases the Boot Barn brand within the industry but has also garnered the attention of a much broader customer base for mainstream retail. From an operational perspective, I am proud of our field organization across the country for another very successful holiday season. The team has not only risen to the challenge of the higher average store sales volume but has continued to expand the brand's footprint through new stores, including 12 additional store openings in the third quarter. The store team's ability to deliver world-class customer service, manage the inventory levels needed to sustain the elevated store sales and allocate store labor hours to the many omnichannel offerings we now have in place is a testament to the dedication of our team and the hardworking nature of all of our store partners. Moving to our third initiative, strengthening our omnichannel leadership. We continue to focus on our omnichannel capabilities by integrating our stores and digital channels. Approximately 60% of online orders involve a store associate underscores the importance of our brick-and-mortar presence. We've always believed that the most successful and profitable way to service an e-commerce customer is by seamlessly integrating the store and digital channel. As an example, we added in-store fulfillment to our omnichannel offering. Now when a customer places an order online, they have access not only to inventory that is in our distribution center, but they also can select merchandise for more than 300 stores across the country. This enabled us to enhance the in-store experience while also providing digital customers with a much broader selection of merchandise. In-store fulfillment has resulted in shorter delivery times and a pronounced expansion of exclusive brand sales online, which further contributes to the profitability of the business. In the third quarter, our e-commerce sales -- same-store sales declined 15.2%, which was in line with our expectations. As we discussed on our prior earnings call, we believe the recent decline in our e-commerce channel is a result of competitors having a stronger in-stock position compared to last year. We believe this trend will continue for the next two quarters until we cycle the softer business that emerged in July last year. It is important to note that this headwind impacts our digital business, but not the strength of our stores business for a couple of reasons. First, our e-commerce customer has historically been a less loyal customer. Secondly, we are very prudent with our online spending for new customer acquisition. As a result, our pay-per-click spending over the past several years has been pared back to a level that focuses more on bottom line profitability than top line sales growth, which could erode our earnings. Our focus on the long-term health of our e-commerce business has enabled us to grow digital sales by more than 45% over the past three years with an even greater growth in earnings. Now to our fourth strategic initiative, exclusive brands. During the third quarter, our exclusive brand penetration grew to 34.1%, more than 570 basis points of growth over the prior year period. On a trailing 12-month basis, our exclusive brand volume has exceeded $500 million and now makes up 32.2% of sales. Our exclusive brand team continues to design excellent merchandise on both a price and quality perspective. Consistent with prior quarters, three of the top five selling brands in the third quarter were Cody James, Cheyenne and Idyllwind. We expect to drive continued growth in this area of the business with the 10 brands that currently comprise the portfolio. These brands not only provide us with competitive differentiation, both in stores and online, but they are also accretive to the business by approximately 1,000 basis points of margin. The success of exclusive brands once again exceeded our original expectations. At the beginning of the year, we had anticipated expanding our exclusive brands by 300 basis points. We now are focusing -- we now are forecasting exclusive brands to grow to 33.4% of sales or approximately 500 basis points of penetration growth versus last year. I do want to express my appreciation to the entire exclusive brands team for continuing to provide product innovation and for the outsized growth in our exclusive brands business. We believe that the combination of our exclusive brands, along with the strength of our third-party vendor partners, provides for an exciting and diverse merchandise assortment, both in-store and online. Turning to current business. Through the first four weeks of our fourth fiscal quarter, our preliminary consolidated same-store sales have declined 1.5% compared to the prior year period, driven by a 16% decrease in e-commerce sales partially offset by growth in retail store same-store sales of 1.2%. Please note that our retail store same-store sales growth for this short four week period is artificially suppressed as it incorporates one day of zero sales given that our quarter began on Christmas Day this year. Importantly, when looking at our January business on an annualized basis, we continued to maintain an average unit sales volume of approximately $4.2 million per store. This elevated store sales volume began in April 2021 and now sustained itself for 22 consecutive months. For reference, our average store sales volume historically had been $2.7 million annually and is now more than 55% higher than that. In an effort to better understand the reasons for this AUV growth and its sustainability, we conducted a survey of approximately 3,000 of our customers, both legacy and new to Boot Barn. Among the many questions that the survey asked, we were particularly curious to learn where the new customers came from, what made them shop Boot Barn and whether they would continue to shop with us going forward. On the first question, the survey feedback indicated that we gained new customers throughout the pandemic, not only from within the Western industry, but we captured an even greater number of shoppers from mainstream retail channels. It was also quite encouraging to learn that these new customers were attracted to Boot Barn stores by a combination of our upgraded marketing and our expanded product assortment. Finally, when we ask customers how likely they are to shop at Boot Barn in this calendar year, 96% of them said they are very likely or extremely likely to shop with us again. To summarize, we believe that we have reached a new level of average store sales when we consider both the qualitative feedback from the customer research and the ongoing consistency of the monthly sales volumes. In the third quarter, net sales increased 6% to $515 million. Sales growth was driven by sales from new stores added during the past 12 months, partially offset by the decline in same-store sales. Higher average unit retail prices, driven in part by inflation, further contributed to the increase in net sales. Gross profit decreased 2% to $188 million or 36.5% of sales compared to gross profit of $192 million or 39.4% of sales in the prior year period. The 290 basis point decrease in gross profit rate resulted from a 190 basis point decrease in merchandise margin rate and 100 basis points of deleverage in buying, occupancy and distribution center costs. The decline in merchandise margin rate was driven primarily by a 180 basis point headwind from higher freight expense. Selling, general and administrative expenses for the quarter were $115 million or 22.4% of sales compared to $99 million or 20.5% of sales in the prior year period. SG&A expense as a percentage of net sales increased primarily as a result of higher store-related expenses and store payroll. Income from operations was $72 million or 14.1% of sales in the quarter compared to $92 million or 19% of sales in the prior year period. Net income was $53 million or $1.74 per diluted share compared to $69 million or $2.27 per diluted share in the prior year period and $1 per diluted share two years ago. Turning to the balance sheet. On a consolidated basis, inventory increased 54% over the prior year period to $592 million. This increase was primarily driven by added inventory in our distribution centers in order to support new store openings and our exclusive brand growth. Average comp store inventory increased approximately 20% over the prior year period -- over the prior year in order to support the elevated level of average unit sales volume per store. On a 3-year stack basis, our retail store same-store sales growth of 57% has outpaced our 3-year stack average comp store inventory growth of 33%. The final portion of the increase in total inventory during the third quarter can be attributed to new stores, both the [44] new stores opened over the past 12 months as well as the inventory for stores that will open over the next couple of quarters. We continue to be pleased with our current inventory levels and that our forward weeks of supply are in line with our historical average. We finished the quarter with $50 million in cash on hand and $59 million drawn on our $250 million revolving line of credit. Turning to our outlook for fiscal '23. We have updated our guidance for the fiscal year and now expect total sales to be between $1.67 billion and $1.68 billion, representing growth of 12.2% to 12.9% over the prior year. We expect same-store sales growth of 0.5% to 1% with a retail store same-store sales increase of 2.5% to 3% and e-commerce same-store sales decline of 10.5% to 9.5%. We expect the gross profit to be between $611 million and $615 million or approximately 36.6% of sales. Gross profit includes an estimated 140 basis point decline from freight expense partially offset by 40 basis points of product margin expansion. Our income from operations is expected to be between $228 million and $232 million or 13.7% to 13.8% of sales. We expect net income for fiscal '23 to be between $167 million and $170 million and earnings per diluted share to be between $5.51 and $5.60. We also expect our interest expense to be $6 million and capital expenditures to be between $90 million and $95 million. For the balance of the year, we expect our effective tax rate to be 25.1%. We now expect to open 43 new stores during the year, including the 33 stores we have opened through the end of the third quarter. The 10 stores we plan to open in the fourth quarter will be the sixth quarter in a row of opening at least 10 new stores. Please refer to the supplemental financial presentation we released today for further information on our revised fiscal '23 guidance. As we look to the fourth quarter, we expect total sales to be between $438 million and $448 million. We expect the same-store sales decline of 3% to 1.5%, with retail stores same-store sales of flat to growth of 2% and e-commerce same-store sales declines of 20% to 16%. We expect the gross profit to be between $156 million and $160 million or approximately 35.7% of sales. Gross profit includes 250 basis points of merchandise margin pressure, including an estimated 290 basis point decline from freight expense partially offset by 40 basis points of product margin expansion. Our income from operations is expected to be between $59 million and $63 million or 13.5% to 14% of sales. We expect earnings per diluted share to be between $1.42 and $1.51. As a reminder, the fourth quarter includes an extra week of business compared to the prior year period, which we estimate will generate approximately $34 million of sales and $0.19 of earnings per share. The primary driver of the revision in our guidance relates to freight expense. Our end of year inventory is now projected to be lower than what we expected, and freight charges are declining faster and to lower rates than what we anticipated three months ago. While both these developments are great news, it also means that from an accounting standpoint, we will no longer carry as much capitalized freight on our balance sheet. We now expect that more freight expense will be recorded in the fourth quarter and will be 290 basis points higher than last year. While this freight expense negatively impacts the fourth quarter, it is overall very positive as our current inventory purchases are being burdened with lower freight charges which will benefit merchandise margin more than we expected as we move into next fiscal year. While we are not yet providing guidance for fiscal year '24, we would expect freight expense to be a benefit to next year's merchandise margin of approximately 100 basis points. To summarize our changes in guidance, the high end of the guidance range provided at the end of our second quarter was $5.90 per share, and we're reducing it by $0.30 to 5.60 per share. The $0.30 reduction is driven by third quarter results that were $0.09 below the high end of our range and freight headwinds in the fourth quarter that are expected to add an additional $0.21 per share of freight expense compared to what we had previously guided. With an improved retail store sales trend, combined with an anticipated 100 basis points of improvement in freight, exclusive brand penetration growth and the continued opening of new stores, we are headed into fiscal '24 with multiple opportunities to fuel earnings growth. We are very pleased with our third quarter business and believe our runway for future growth is extremely promising. We've nearly doubled the size of the business in just three years and achieved store productivity levels that far exceed pre-pandemic levels. As we head into fiscal '24, we have multiple levers of earnings growth from same-store sales and new store openings to margin accretion from exclusive brands and lower freight charges. I'm very proud of the team across the country and want to thank you all for your dedication to Boot Barn and your strong execution. Great, thanks. So maybe, Jim, on current trends, could you speak to the progression that you've seen post-holiday, maybe by category, if you could break down Western versus functional strength. And then just with the continued positive comps at stores, maybe if you can touch on performance that you're seeing from your newer store builds and just the opportunity that you see - or is there a ceiling on the potential to accelerate unit growth as we think about next year and beyond? Okay sure. On the first part of your question, particular if I focus on stores business, as we turned the calendar into January, we've seen some nice sequential acceleration in the business and feel like we're on pretty solid ground. We had a positive retail store same-store sales growth in January after making up for the first day of Christmas Day, which was obviously zero sales and minus 100%. As we look at it by category, most categories have gotten sequentially better from the third quarter into January where we really love to see some of the very functional, more basic businesses performing positively. So some of the things that have really been strong in Q3 and gotten stronger into January are things like work boots, men's cowboy boots, work apparel had a nice third quarter. So we're really quite pleased that sort of the more staple, basic parts of the business that drive tremendous volumes are improving. We're also seeing less, decline in some of the businesses that had been under pressure. For example, ladies cowboy boots was up against ridiculously strong numbers last year, as was ladies apparel. And they've both gotten sequentially better into January, ladies western apparel actually slightly positive as we got into January. So it's been a nice progression in categories. We've seen a nice progression in some of our softer regional businesses. Our western region has gotten better. We've seen a nice sequential progression in the transaction count. So in the third quarter, our transactions were down mid-single digit, and now they're sequentially getting better than that. They're still slightly down. But that's been nice to see. So it's a short and low volume month of January, but it certainly looks like things are, at a bare minimum, sustaining, if not improving. From a new store perspective, we continue to just be thrilled with the new store performance, the stores - the number of stores that we're opening there, immediate volumes, their ability to sell Western product in Eastern parts of the United States, et cetera. So we are well set up to exceed our original 40 stores for this year. Our pipeline is very strong going into next year. We have the good fortune that our new stores are performing at much better than the original algorithm for sure and even better than what we're modeling them now. And that is in new markets and existing markets. So maybe harkening back a little bit to what we said at ICR, if we did nothing but continue to open stores for the next six or seven years, we doubled the size of the company even if we didn't grow comps. So while we'll continue to try to look for growth in every part of the business, the new store engine is really quite compelling. Great. And then maybe just a follow-up on gross margin given a couple of the moving parts here I guess, maybe, Jim, could you help lay out the components of the gross margin in the fourth quarter, maybe between merchandise margin and freight? And then as we look to next year, it sounds like you gave the freight expectation, but help us to think about merchandise margin between full price selling and private label expansion - any changes to the historical structural model in your view? Sure, so on the fourth quarter, the product - the guide for the product margin - and you know, I'll refer you to the deck on Slide 15. Product margin expansion, we're expecting 40 basis points of product margin expansion, excluding freight. The freight headwind in Q4, we've modeled at 290 basis points. And so that works out to a merchandise margin decline of 250 basis points for the fourth quarter. As we look to next year, again, we're not - you know as we're not providing guidance at this time for fiscal '24, but I think particularly in the merchandise margin discussion here, what we said just a few moments ago is with the freight coming in so heavy from an expense standpoint in Q4, it's really removing a lot of the capitalized freight balances or the freight that we purchased at more expensive rates off of the balance sheet in this fiscal year. And as we move into next year, we expect that will be a tailwind of 100 basis points just right out of the gate from a freight standpoint. And so again, that assumes that we've got freight rates and charges coming in similar to what we're seeing in the more recent weeks and months. So that's a tailwind there. And then we've talked about exclusive brand penetration growth over the years, and we started a model of growing that, 250 to 300 basis points a year. So right out of the gate between those two items, we've got some really nice tailwinds as we look into next year. Hi thanks, good afternoon, everyone. Maybe Jim again it just a follow-up on the freight question so it was a change from three months ago, I think, an extra 40 basis points. So am I understanding it correctly that your sales a little bit better? And so that's pulling forward some of the excess freight costs out of fiscal Q1 now into fiscal Q4. Is that the key reason for this increased gross margin pressure? It is - it's not necessarily the sales component of it. And just going back to the numbers, we had originally expected - again, going back to three months ago, 90 basis points of freight headwind in Q4, and that's now 290 basis points of freight headwind. And so there are two real components that are moving that. Again, this is great news with regards to the health of the business. Freight's costing us less money. We purchased our containers on spot rates. And so, we're able to take advantage of - the costs have down quite quickly. And the other piece of that is that we're managing our inventory down faster than we had expected. So as we look to our end of the year balances for fourth quarter around inventory that helps us. So the accounting rules dictate that we match the freight paid to the inventory when it's sold through and so, between those two things, the projected inventory balance coming down during the last three months for that year ended balance. And then also the freight rates on the inventory purchased during the last three months have come down more than anticipated, and that allows us to - to your point, Peter, expense more in the fourth quarter than what we had anticipated. And that does come from next year's freight expense moving it up to this year. Okay. And then just on that is - so will freight remain a bit of a headwind in fiscal Q1, fiscal Q2 or is it going to pretty quickly reverse as a tailwind? It should quickly reverse a tailwind. And again, as evidenced by the last 12 months, I mean, we guided the year at 100 basis points of freight headwind, it looks like it's going to come in closer to 140 basis points. We've talked about the complication of guiding freight and what goes into that. But assuming that the rates kind of stay where they are today and -- we would expect that to reverse pretty quickly into Q1 and then also through the rest of the year. Okay that's great. And then for Jim Conroy, I just want to pivot to a separate topic. So the subject of stretch denim has actually hit my radar for Boot Barn in the Western and work areas. I'm wondering that you do have some stretched denim products and some kind of basic looks. Is the stretched denim trend starting to hit your customer? And I guess what are you seeing there? It seems like there could be like a meaningful refresh cycle, if that's starting to take hold? Sure, it's a great question. If I break it down by men's and ladies, on the ladies side, the vast majority of denim sales are stretched already, and they've - we've been in that business for several years. And for us, as you know, most of our denim sales on both sides men's and ladies, are pretty functional in nature. So I think we'll continue to have a pretty standard replacement cycle. I'd love to say and promise we're going to get even more sales in denim because there's been a new trend or something different. But for us, it's something that we've been in quite a bit, particularly on the ladies side. On the men's side, it's probably two-third of our sales are stretched with the balance being sort of more rigid denim. And there's been a little bit of an uptick there, but nothing meaningfully that will -- I don't think will change our trend going forward. So I think we're well positioned to take care of that customer. It is a little bit more than it has been in the past, but it's not such a big number that it's been a sales driver and nor do I think we can promise it's going to be a replenishment cycle sales driver going forward. Good afternoon. Thanks for taking my question. Wanted to ask on the regional outlook in more detail for the fourth quarter, just given some of the weakness you've seen in the West. Is there something specific happening there? Or is it just a function of tough comparisons? And then as we think about this quarter, Texas rodeo season, Jim, what's your expectation for performance this year versus last year? Just remind us how you performed last year. Sure. On the first part on the West, I would sort of say this for the entire business. Our business was so incredibly strong last year, the way we view it internally. The fact that we're not down 15% in our third quarter is a victory. The West business, in particular, was a little bit less strong or down relative to last year, but that's on top of multiple years of growth and just phenomenal execution. As I look forward for the Western region, one of the things that could help them grow from this new elevated base, yes, it gave part of it back in the third quarter, but the base is so much higher than it had been historically, is with the persistent lean that we've seen in California. Oftentimes, we call out the short-term benefit of that in our business, but there's been so much rain that could have a positive impact on the ag markets that were part of the reasons that the Western region declined in the quarter was difficulty in agricultural markets in the Central Valley. And that's where we have a tremendous amount of sales volume. In terms of what we're looking at for our fourth quarter rodeo season in Houston, we had a pretty solid fourth quarter last year. But if you look at all of the quarters from a comparison standpoint, there was nothing notably stronger about our Q4. The Houston concert lineup looks pretty good. And I think we'll be well positioned to take on that business. So we'll see. But I don't think there's anything particularly high or ominous from a year-over-year comparison standpoint other than what we've been cycling for the last several quarters. Great. That's helpful. The follow-up question I had is just commentary about the pricing and promotional environment. I think the expectation was promotions will remain confined to the holiday quarter. Is that still the plan as we look forward through calendar '23? Sure. I can take it. The -- we're -- we run the business with very few promotions 12 months out of the year. When we get into holiday, we have a couple of sales on different things. And our promotional posture this year was very similar to prior years, maybe slightly more than last year when everything was essentially full prices. We were short on goods and comping up 55%, but very similar to two years ago. As we get into the other 11 months, there's even fewer sales promotions that happen throughout the year. January tends to be a month where everybody, including us, clear some of our inventory. We're doing that as we -- sort of normal course of business, that's actually -- has not put any undue pressure on our margin rate from a year-over-year perspective, which is why we're calling out accretion for this fourth quarter. So we don't expect any change in our promotional posture, very little impact from competitors changing their price or promotion or clearance strategy. And while there has been some noise there, we just don't react to it anyway. So I wouldn't expect anything differently than full-price selling and occasional clearance all to move through the small amount of clearance products they have and sort of standard course of business for the balance of the quarter. Great, thanks a lot. And congrats on a solid quarter. So your active customer counts continue to grow at a pretty impressive rate. I think you're at 6.8 million now. Can you just provide some color on customer behavior, whether there's a way to stratify them by spend or what segment of them has shopped in the past year? And then how should we think about growing loyalty members versus small declines in traffic? So on the first piece, our average customer shops with us approximately twice a year. One of the things that's been very encouraging is, as we've grown our customer count and expanded the definition of the Boot Barn brand to bring in customers from other retailers, and in many cases, mainstream retailers, those new customers are also shopping with us twice a year and have proven to be repeat or to use a different expression sort of sticky customers, which is great. They continue to shop. They continue to shop the same frequency sort of legacy shoppers, and their spending per trip and per basket is continuing to be in line with legacy customers, which is at -- and all of that triangulates back to our average unit store volume remaining at $4.2 million up from $2.7 million. I know you know these numbers, Max. In terms of reconciling the additional customers and transactions being down, if you look at it over a long period of time, customer account's up dramatically and average transaction's per store up meaningfully. If you look at it over a shorter period of time, we continue to add customers in total because we're adding new stores, even if our average transactions per store on an average basis comes down slightly. So that's how you can reconcile the math. But bigger picture, we're just thrilled that we've been able to grow the customer database, invite so many new customers into a Boot Barn store and hold on to them. And I think as we get past some of these 55% LY comparisons, we'll settle back into sort of more normalized growth. But I've been in retail for a long time. And just the mere fact that we grew 55-plus percent and haven't given it all back is just -- makes us incredibly pleased. That's very helpful, Jim. And then what do you attribute all the strength in exclusive brand penetration growth to this year? Is it some of the omnichannel initiatives? I think the new stores in the East have a little bit higher mix. Or is there anything else to call out? And then just how are you thinking about longer term, whether it could be a little bit higher than the historic algo that you've spoken to? Sure. A portion of it is maybe compositioning higher in new stores in the East. But I think just arithmetically, that would only give you a slight growth. I think the bigger piece is maybe two different things. The first, last year, we -- our business was so strong that we were outstripping many of our third-party branded partners' ability to show us. And the single vendor, if you will, vendor that was able to ship within full was our exclusive brands. And I think that really introduced the six legacy brands and then the four additional brands to customers that perhaps had never tried them before. And now that they've tried Cody James, Cheyenne or Idyllwind or Moonshine, maybe long-term lifetime customers. So I think there that free trial that we had last year when we were in stock in many of our branded partners were working their butts off to try to get us in stock, but we're falling a little bit short. We had the product available and had the trial. The second piece is we've added the four brands. We've expanded the original brands into new categories. And I think when you put all of that together, we just wind up getting outsized growth. Going forward, we haven't guided next year. We've got some work to do before we lay out our guidance for next year. My intuition is we'll probably say we'll grow 2.5 to 3 points of penetration next year. And we really do want to see some nice continued growth from our strong branded vendor partners as well. Thanks for taking my questions. I want to ask, like usual, about the inventory. But you said the inventory is going to be lower than expected. So where do you anticipate the inventory being at the end of the year? Can you give us a number, like the range of what you anticipate? Sam, it's Greg. I don't think we can give you a good prediction on the balance sheet. What I would tell you is the number is lower than we thought as our merchants work really hard to cancel orders where appropriate, et cetera, et cetera. So we brought the inventory down, as Jim described, and that's relevant from the cap freight perspective, but it will also put us in a better position. You saw that at the end of Q2, our inventory was up about 83%, and now it's 54%. And that is a combination of our merchants doing a really good job of managing their receipts based on sales and their inventory position coming in, if you will, to the quarter. So -- but I can't quantify a number for you. Well, let me just -- let me -- one more try here. You were $641 million at the end of Q2. You're at $592 million at the end of Q3. Can we look at another $40 million drop? Is that a reasonable number? Or I mean is it sort of working its way down? Because it sort of worked -- it bounced way up. It went up $55 billion and another $35 million, almost $100 million and then another 50 that from -- it kept going up sequentially. So can we expect the inventory to be -- now start to come sequentially down sort of the way it looked like in from Q2? Let me just continue and then Jim can chime in. I mean if you think about the drivers of the growth that Jim outlined on the call and we've talked about before, it's to support the exclusive brand product, right? That's the growth in the DCs. That was about half of our overall growth year-over-year. So half of that is DC inventory that primarily is driving or supporting the exclusive brand penetration growth. And then the remaining roughly 50% is split pretty evenly between comp store inventory levels and in terms of new stores. When you think about the comp stores, we're really happy about how that inventory is positioned. The weeks of supply at the end of Q3 is in line with non-COVID historical weeks of forward supply. So could that come down a little bit? Perhaps. But we're pretty happy with kind of that normal 27 weeks of supply. And then if you think about that remaining quarter, it's new stores, and we're going to continue to grow new stores. So maybe it comes down a bit, but I would tell you, overall, we're pretty pleased with the level of inventory. Are we a little bit heavy in men's work boots still? Yes, we are. Are we concerned about that from a markdown liability? Absolutely not. The only thing I was going to add, Sam, to try to help you, if you look back historically, the inventory at the end of Q3 is depleted a little bit, just coming out of holiday, we typically have a build into the end of the year of inventory. And so I would think of it as more of the build coming out of holiday is going to be less than what we had originally expected and less than what we've seen historically, particularly last year where we had a very sizable build as we're chasing inventory to have enough for the sales. Okay. And then I just missed this. Can you just -- I know the West was the weakest, but can you just give me that North, South, East, West, how the sales performed in the quarter? And of course, Jim is quoting same-store sales. One of the things that we are trying to continue to focus investors on is if we were to quote those numbers in total sales, you might get a slightly different answer. And investors should be virtually indifferent between sales growth from new stores and sales growth from comp stores. I often joke that, we're going to threaten to stop reporting comps. I'm only kidding. We won't do that. No one has spiked my cappuccino. But I do think we want people to be really focused on new store sales and total sales growth going forward because they're almost as accretive as same-store sales growth to earnings. In all due respect, you're opening a new store that's opening -- I mean I think you originally -- I think you said at ICR, you're planning to open new stores you're originally planning to open at 1.7, they're opening much higher than that. Now they're leveling off at 4.2 versus a much lower number. Well, the same-store sales tell us if you're actually getting to that 4.2. The new stores are accretive. They're opening better than they were, but unfortunately, Wall Street standards go up as your standards go up. Your stores are averaging -- your stores are topping off around 4.2 on average, which is way above where you originally thought they would be. And you mentioned at ICR that you opened -- you had four stores in Phoenix that you went to eight and all the business went up. Your stores in Delaware and probably in Connecticut are opening well above their pro forma. But I mean when you start talking about that, everybody's expectations go up and then you sort of need the comp to make sure that those stores that opened two years ago are getting to that same place. I mean do we all want to know that? That's why I mean it's... But total sales growth is what's going to drive earnings. And also it's part of why our inventory continues to grow, right? We're continually asked about our inventory levels. And yes, I can tell you, and this might disappoint you, Sam, but I'm not sure our goal is to massively ratchet down our inventory. It seems that running with the inventory levels that we've had over the past few years have enabled us to grow our business to the extent that we've been able to grow our business. And in each of the last five years, we've had margin accretion. So that's also something -- just to set your expectation, something we're really setting out to achieve is to spin our inventory much faster than we presently are. Well, I was asking more about the sales and the same-store sales. I wish you all the best and continued success. Thank you. Thanks. So I was going to ask about store growth. You've exceeded expectations in an environment where a lot of other retailers had to reduce their unit growth guidance. As we look ahead beyond FY '23, do you see kind of that continuation of 13%, 14%? It almost feels like you're stepping on the gas a little bit more. Any color you might be able to share at this point in time? I'm sure that you have a lot of leases signed already for FY '24. But any additional color you might be able to share on that at this point. Sure. Well, I think you're alluding to a lot of companies are calling out supply chain challenges, permitting challenges, et cetera. And the honest answer is we are feeling many of those same challenges. The real estate team has done a really nice job of just casting a wider net, so we can continue to have a very healthy new store pipeline. So while we don't have intentions of guiding next year, we've been opening up double-digit stores in terms of store count every quarter now for several quarters in a row. We thought we would get 40 stores this year. We'll get more than that. So next year, I think it would be surprising if we didn't guide 40 or 45 or 50 stores for fiscal '24. And we'll face into some of those challenges that the whole retail industry is facing, at least those that are growing stores. But we've, I think, very strategically and carefully made sure that there's enough stores in the pipeline that we can continue the pace that we're going. So I think it's a momentum that will continue as we look forward for at least the next few years. Okay. And then I'm going to avoid gross margin inventory questions and switch gears to SG&A. So I just wanted to understand. As we look back, as you point out, total sales growth since pre-COVID December quarter. As I look at your SG&A rate, 22.4% in the quarter, it was 21.9% back three years ago with a much lower sales base. Just wanted to get a sense for -- I might think that given that massive amount of total sales growth that you'd see a little bit of leverage. But can you help us talk through and think through the puts and takes on that 50 basis points of deleverage over that 3-year period? Sure. I think as we've level set the business and we've -- yes, I think as we move forward and we get to the fiscal '24 guidance and lay that out, I think we can probably build a little bit better bridge on what this new level of business and a normalized year looks like going forward, Jeremy. I think there are some variable costs in there that will continue to rise with sales, and that's marketing and store labor. And so we'll continue to have those. And then there's some other things that we've done. We've had one hurdle this year is just around the inflation around the supply that we have at the stores. And so getting that through the system. Hopefully, those costs come down over time. But we have had some inflationary pressures. We haven't called those out specifically in much detail, but that is putting some pressure on us this year in Q3. And so the other thing is the wage pressure. I mean the wage rates in the tight labor market is something that we've been working through also. And so while nothing we call out on a regular basis, that's something that we're dealing with. And I think as we get into next year, we continue to open new stores, and we'll be able to kind of work those through the system a little bit more evenly than what we saw this last year and even the year before, as we've called out. I think last year, in the first half of the year, we saw tremendous leverage when it came to wage rate and marketing because we weren't able to keep up enough to support the sales that were in there. So it's a great question. It's something that we're very focused on, expense control and keeping the SG&A rate down as much as possible, and we're going to continue to focus on that. But there are some inflationary and wage pressures that are operating this year. Would you be able to elaborate? Can you give us a sense for where hourly wage rates are up on a year-over-year basis and then again versus three years ago, pre-COVID? Yes, thanks for taking my questions. Let's start with Jim Watkins. Looking at the gross margin guide for Q4, I think you said 35.7%. So that's down, I think, 310 bps year-over-year. But if I compare that to pre-COVID Q4 '19, it's up like 280 bps. And if I ex out the freight, it's up like something like 570 bps over that four-year period? I was hoping you could maybe just sort of parse out that increase by kind of the main components. I mean how much of that is just leveraging the occupancy versus what you've picked up in exclusive brands versus anything else? I'm just trying to better understand like how structural that, gross margin gain over the four-year period? Yes, I think the big piece of that is the merchandise margin, particularly if you exclude freight. And I'd refer you back to the ICR deck where we kind of - have a depiction of what that merchandise margin rate looked like over the last several years. Over five years, it's up 400 basis points and 640 basis points if you exclude the freight. And so that's driving a lot of that gross margin expansion that you're talking about there. And how structural do you feel that merch margin improvement is? Can you maybe speak to some of the strategies that have driven that increase? Yes - great question. We think it's very structural, with the exception of the freight, which is going to go away, which will help our merch margin going forward. Again, Jim alluded to it earlier in his remarks that from a promotional standpoint. And you know us well Mitch, that we're not a promotion driven business. We have some promotions throughout the year, but it's more of a handful of styles that are on promotion. And we'll continue to find ways to increase our merchandise margin via exclusive brand penetration growth. And Jim talked about some of the product and the expansion we've seen earlier and the team that is working on developing the product as a first rate team. We'll continue to roll out product that's compelling to our customers. And so that will help us from a merchandise margin standpoint. We talked about - Jim in his prepared remarks talked about the in-store fulfillment and the benefit that, that is to us. And one of those benefits is ability to clear any product that we have that needs to be marked down and moved out of the store. We're able to do that more quickly as customers can find that online versus just going into that one store and us hoping that somebody in that size and with that style preference purchases that product. So, we've got lots of ideas to continue to grow that merchandise margin and not to sustain it at the level that it's currently at. Okay. And then maybe just one for Jim Conroy Jim, when I look at your store comp, your store comp has held up well, particularly on a multiyear basis. And correct me if I'm wrong, but I believe your e-comm of late has maybe been negatively impacted by competitors being better inventory than they were a year ago. But I would guess that your store competition could probably make the same claim? And I know you talked about your store customer - a little bit more loyal. Could you just kind of talk to the strength of your stores, just from a retention standpoint? I know that - slide that you presented at ICR kind of spoke to that in terms of where you pulled customers and - their intent to repurchase. But why is it that store customer is behaving so well, especially maybe relative to the e-comm customer? Sure, it's a great question, Mitch. Thank you for asking it. As you know, we have always been a stores' first brand. And we really invest in the in-store experience through inventory assortment, where we've remodeled a number of stores. We've got a new store prototype. We've brought digital capabilities into the store and so on and so forth. That coupled with the brand has continued to build strength and momentum over the last several years. We've completely changed our creative five or six years ago. We've changed our marketing and media mix to really make the brand more top of mind for customers. And when you look at our core customer, they are extremely loyal to us, where the authoritative source for our types of product, our lifestyle products. Most of our customers that shop with us join our loyalty programs. So the vast majority of our sales go through our loyalty program. So we can reach out to them again. They are continually pleased when they come in and they find the product that they need in their size and so on and so forth. So that customer has just demonstrated time-and-time again that they are extremely loyal to us, rarely will shop other competitors, and shockingly, rarely shop online. They shop our stores, and the overlap even between our stores customer and our bootbarn.com customer is very low. So it's a phenomenon that works for us, where 85-plus percent of our business continues to go through our store, and we expect that to maintain. We would like to see our e-commerce business start to get back to growth once we cycle the software business in July, and we expect that to happen. But if we continue to sustain the levels within our stores and hopefully grow from this new floor, that just bodes well for the future. Great, thanks guys. When you look at these new stores just doing the volumes, Jim, at $4 million, has it changed any of the strategy of how you go to market, where you place those stores to more tenant improvements? Anything that you could point to that the, success of these stores are changing how you look at where the next 10 are going to go? I'd say yes and no that the underlying model is virtually the same. The size of the box is virtually the same. I think the things that have changed a little bit is, historically, and this goes back five or 10 years, we were really looking for a destination location that somebody who was squarely in the Western and perhaps work customer segment would drive to us to shop. Then when we tried to take the brand and broaden its definition to attract more customers and we expanded the merchandise assortment that was outside of just Western product and run in some more casual country products and changed our marketing and branding and media mix to also reach out to customers outside of the Western industry, our new store locations followed suit. So we are now in more traditional power centers that might be next to a Costco or a Home Depot or a Walmart or Dick's Sporting Goods, et cetera, where in the past, we were sometimes sort of by ourselves in maybe a third rate center, but now we really are trying to attract a broader customer base. So all of those pieces have come together nicely and as we mainstreamed the brand, we've also looked for slightly more mainstream retail locations, which for us came relatively easy because there was a lot of available real estate. There are no further questions in the queue. I'd like to hand the call back over to Jim Conroy for closing remarks. Well, thank you, everyone, for joining the call today, and we look forward to speaking with you on our fourth quarter earnings call. Take care. 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.
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EarningCall_1283
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Good day, and welcome to the Polaris Fourth Quarter and Fiscal Year 2022 Earnings Call and Webcast. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to J.C. Weigelt, Vice President, Investor Relations. Please go ahead. Thank you, Betsy, and good morning or afternoon, everyone. I'm J.C. Weigelt, Vice President of Investor Relations at Polaris. Thank you for joining us for our 2022 fourth quarter and full year earnings call. We will reference a slide presentation today, which is accessible on our website at ir.polaris.com. Joining me on the call today are Mike Speetzen, our Chief Executive Officer; and Bob Mack, our Chief Financial Officer. Both have prepared remarks summarizing the quarter and year as well as our initial expectations for 2023. Then we'll take your questions. During the call, we will be discussing various topics, which should be considered forward-looking for the purpose of the Securities Litigation Reform Act of 1995. Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2021 10-K for additional details regarding risks and uncertainties. All references to fourth quarter and full year 2022 actual results and 2023 guidance are for our continuing operations and are reported on an adjusted non-GAAP basis, unless otherwise noted. Please refer to our Reg G reconciliation schedules at the end of the presentation for the GAAP to non-GAAP adjustments. Thanks, J.C. Good morning, everyone, and thank you for joining us today. We delivered another record year for both sales and earnings from continuing operations despite a difficult supply chain environment and lower retail versus our original expectations. We also improved our cash position in 2022 and executed over $500 million of share repurchases. I want to thank the entire Polaris team through your relentless effort in a challenging environment, we delivered record results once again proving this is the best team in powersports. During the year, we made progress on our 5-year strategy with a renewed focus on powersports. And while we intentionally delayed several product launches in 2022 as the team focused on navigating the supply chain challenges and delivering orders to dealers and customers, we didn't stop investing in innovation. With more than $365 million invested in R&D in 2022, we continue to make our mark on the industry within the wide open side-by-side category with RZR Pro R and Turbo R. And through the introduction of the industry's first connected technology with RIDE COMMAND+. With a focus on extending our industry leadership, we divested TAP and redirected our resources, time and focus on our core powersports customer. A decision that has had a positive impact on our EBITDA margin and returns. While innovation is the foundation of everything we do, our #1 priority will always be the safety of our riders. We are making investments in product safety while standing behind our vehicles and acting if needed. Our investments in safety and quality over the years have supported what I believe to be one of the broadest post-market surveillance programs in the industry, which is enabling us to aggressively monitor for and identify issues. We recognize these recalls are frustrating for dealers and customers, but we are committed to correcting these identified issues. This approach to monitoring our products even after they leave our factory floors, combined with our ongoing investments in engineering testing, supplier quality and manufacturing processes, bolsters our focus on providing our customers with safe, high-quality vehicles. Last point I'll make is that we benchmarked our recalls per 1,000 vehicles produced from 2016 through 2022 against automotive, On-Road motorcycles and powersports. Polaris was in the top quartile in terms of the fewest number of vehicles impacted per 1,000 produced. We have and will continue to invest in and drive improved quality for safety of our riders. As we look at the fourth quarter specifically, sales grew 21% to $2.4 billion. Excluding marine, North American retail was down approximately 6% year-over-year with modest growth in Off-Road utility and Indian Motorcycle, offset by a slowing Off-Road recreational market. These trends are similar to what we saw in the third quarter and are expected to continue into 2023. While fourth quarter market share was down approximately 1.5 points year-over-year, it was our best market share performing quarter of the year, and we saw 2 consecutive quarters of sequential share growth in On-Road and ORV. Pontoon retail declined overall with share loss concentrated in the low end of the market, and we gained share in the high end of the market. Both adjusted gross profit and EBITDA margins expanded nicely to drive year-over-year adjusted EPS. EPS growth of 57%, despite increased headwinds from warranty costs, interest expense and foreign exchange. I'm proud of our record performance, especially considering the environment and the unanticipated headwinds that the team worked relentlessly to overcome. Now let me talk about the demand environment. The demand story remains mixed. Polaris ORV Q4 retail was down 4% year-over-year and down 1% sequentially, mainly driven by softness in the REC space. Our ATV and RANGER products were up low to mid-single digits sequentially and year-over-year. Remember, the utility space represents approximately 60% of our Off-Road business, including sales to commercial customers, which do not factor into our retail metrics. We continue to see and expect stable demand here as these customers use their vehicles for work applications on a ranch, farm, job site or multi care homes. I'd also add that weaker recreation of retail in Q4 was partially driven by many RZRs being on a recall-related stop sale in December. As anticipated, the backlog of free sales declined in the quarter as shipments improved. We continue to see sales growth in our premium models such as RZR Pro R, Turbo R and RANGER Northstar as they remain favorites with customers due to their competitive features and capabilities. A few other points on demand include PG&A attachment rates are at or near record levels, indicating that customers are upgrading their vehicles with higher-margin accessories. We continue to see a steady mix of customers new to Polaris which is consistent with historical trends, while both short and long-term repurchase rates remain elevated or within the historic range. Interestingly, 5-year repurchase rates were at all-time highs and we're seeing these customers return and upgrade their vehicles to RZR Pro R, RANGER Northstar and even vehicles with RIDE COMMAND+. And on financing, the metrics we're seeing continue to point to a consumer in a healthy financial position. FICO scores and improved and approval rates are consistent with last year. Also, credit availability has not meaningfully changed. There continues to be strong consumer interest in the space, measured by online activity versus pre-pandemic metrics with Off-Road organic online searches, up approximately 30% versus 2019. Indian Motorcycles also saw strong web traffic leading to a record number of leads. So by segment, let me wrap up our thoughts on demand. In Off-Road, there remains a delineation between utility and recreation. Demand indicators are stable in utility, while recreation is soft with more pronounced moderation as you move through models with less content. We expect these trends to continue for the foreseeable future. In On-Road, we had a strong Q4 with the second quarter in a row of market share gains for India motorcycle. With a strong product line up for 2023, we are optimistic that On-Road can continue seeing share gains in retail growth. The marine demand at premium levels continues to be healthy. Inventory is the healthiest it has been in a long time. So we're seeing customers shop around a bit longer. Boat Show season has kicked off and thus far, dealers are optimistic as we enter their busiest season the year. Turning to North American dealer inventory. We continue to move closer to a more normal operating environment with seasonality even more present within our business versus recent history. For ORV specifically, we look at data from 2016 through 2019 to get a sense of the average seasonality with North American dealer inventory and retail before the disruption that occurred over the past couple of years. The data shows we typically see our highest dealer inventory levels and lowest retail levels in Q1, which makes sense as customers typically come in looking for units before the spring and summer writing season. We think this is an important context to know as we enter a more normal seasonal operating environment and to better understand the inventory build ahead of the heavier retail season in the summer. As for the current dealer inventory, we continue to make progress towards our new optimal level. In fact, most of our products are close to these optimal levels, except for our RANGER side-by-side portfolio especially the high-end Northstar additions, where we continue to see strong demand. Total company dealer inventory was up 116% from 2021 to 2022, but remains well below 2019 levels. We currently see the value of refilling dealer inventory at approximately $150 million, which is below the $400 million we discussed on the October call due to progress we made with its shipments in the fourth quarter. We expect to reach this optimal level in inventory sometime in the first half of 2023. So today, given a return to more normal operating environment and traditional seasonality, our operations are focused on building inventory into the channel where needed to ensure a strong retail season allowing dealers to sell products and not worry about availability. In summary, our say-do ratio in 2022 was high, with revenue coming in at the high end of our guidance and EPS exceeding guidance by $0.10 despite headwinds and in the supply chain and increased pressure from interest rates and foreign exchange. I'll now turn it over to Bob, who will summarize our fourth quarter and full year performance as well as 2023 guidance and expectations. Bob? Thanks, Mike, and good morning or afternoon to everyone on the call today. Q4 was another record quarter for us with contributions from volume, price and a mix up to higher priced vehicles. International sales grew 7% year-over-year, overcoming a 9 percentage point drag from currency. Adjusted EBITDA margin expanded 272 basis points, overcoming increased warranty, marketing and G&A expenses. Below operating profit, interest expense continued to tick up given higher rates. In Q4, we executed $400 million in 3-year floating to fixed swaps at an all-in rate of approximately 5%, starting in February 2023. This will allow us to maintain our fixed to floating debt ratio near our 50-50 target for 2023. Additionally, we were opportunistic share buybacks, repurchasing 1.2 million shares in the quarter. Adjusted EPS from continuing operations was $3.46, up 57%, marking a new quarterly record for Polaris. For the full year, I want to call out a few things. First, we did what we said we would do and grew both sales and EPS by 15%. Price and favorable mix to higher content vehicles helped drive these results. We were also opportunistic with share repurchases by repurchasing over $500 million in shares. The year was not without its challenges, and I am incredibly proud of our team who delivered these results despite ongoing supply chain challenges, rising inflation and additional warranty costs. Turning to our segment results for Q4. Let's start with Off-Road. Sales rose 19% relative to last year to $1.9 billion. Whole goods increased 22% and PG&A was up 8%. Adjusted gross profit margins were up an impressive 503 basis points. Similar to Q3, sales growth and margin expansion were driven by price and mix, which more than offset higher warranty expenses commodity costs. Looking at retail performance, ORV was down about 4% in North America with declines in recreation, somewhat offset by growth in utility. Within Utility, there is better performance in RANGER versus ATVs. We believe the industry was down low single digits, thus pointing to modest share loss in the quarter. Some of our share loss was due to holds on recall products, and we would expect to gain back that share as we work through the recall and the sales hold lifts which should occur in the first quarter. Sequentially, we were able to gain share with higher shipments and healthier dealer inventory. Q4 also marked our highest quarterly ORV share performance in 2022. We continue to see positive trends in our utility segment as well as robust double-digit growth in our commercial, government and defense business. Snow was negatively impacted by rework associated with 2 recalls where fixes have now been communicated to dealers. With healthier inventory across our Off-Road portfolio as well as new innovations, we look to gain market share in 2023. Switching to On-Road now. Sales of $302 million were up 29% versus last year, with whole goods up 35%, while PG&A was flat. Remember that our On-Road segment includes the Aixam and Goupil businesses in France, along with our most global business, Indian motorcycles, thus, you see a strong mix of international revenue, which saw meaningful pressure from FX. On-Road shipments in the quarter were the second highest of all year as we are settling into a more normal supply chain environment. This helped Indian motorcycle gain share for the second quarter in a row. Gross profit margin was up 358 basis points to 17.1% as the team continues to execute well on its path to profitability. Driving this expansion in the quarter was volume and mix towards heavyweight motorcycles and price. Moving to our Marine segment. Sales of $245 million were up 36%, driven by price and mix. Inventory is the healthiest it has been all year across all 3 brands. We still have some work to do in entry and high-end models but a healthier supply chain has given us a path to quickly make progress as we work hard to set up dealers for a successful boat show season. North American pontoon retail was down low 30s as we continue to prioritize high-end boats. With recent improvements in dealer inventory, we expect to return to a more normal mix of entry, mid and high-end boats in 2023, which should lead to share gains. Gross profit margin was up 209 basis points based on mix and price, along with improving supply chain stability. Reviewing the full year segment data, actual results were in line with our expectations with a little outperformance in margin from the On-Road Group. The performance last year sets us up for a strong 2023, highlighted by expected share gains and an abundance of new innovative new products and technologies being launched. Moving to our financial position. We continue to benefit from a healthy balance sheet with our leverage ratio at 1.6% -- 1.6x and a strong cash position. Free cash flow was up over 800% year-over-year all of the growth coming in the second half of the year. The cash momentum is expected to continue with further growth anticipated in 2023. As a dividend aristocrat, we concluded our 27th straight year of increasing our dividend. We executed on our commitment to investing in our simplified portfolio with over $300 million spent on CapEx and 4% of sales spent on R&D in 2022. We believe we are set up well for a variety of scenarios in the broader market with our balance sheet and cash generation capabilities in 2023. Now let us talk about our initial guidance for 2023. We expect sales to be flat to up 5% relative to 2022. Drivers for performance include the following in order of expected impact, favorable mix from new products, higher content vehicles and more PG&A. It is important to note that the majority of our new products are expected to launch in the second half of the year and be priced above like products currently in our portfolio. Second is volume. We expect retail to modestly outperform the industry in Off-Road. Our commercial business is also expected to have a strong year, but those units do not count towards our retail share performance. On-Road is expected to have a strong year with a very competitive lineup of bikes. We believe Marine will be in a stronger competitive position with healthy inventory across its entire lineup as well as some new boats across all 3 brands. Price is expected to offset increased promotions with price being a stronger contributor in the first half of the year due to the carryover from 2022. We view FX and finance interest as headwinds and to sales growth in the magnitude of over 160 basis points. These expectations contemplate flattish industry retail for the year. Therefore, any deviation in the industry could positively or negatively impact results. Another swing factor could be the timing of new products, which are expected to launch in the second half of the year. By segment, we expect Off-Road sales to be up low to mid-single digits and On-Road sales to grow low single digits, driven by retail and share gains. With new products and healthier dealer inventory, Marine is expected to be relatively flat to last year, with share gains from new products and healthier dealer inventory, offset somewhat by a weaker industry. For margins, we expect modest margin expansion at the adjusted gross profit and EBITDA line. Drivers include volume and mix, along with reduced cost premiums associated with inflation and a healthier supply chain. Some headwinds to acknowledge include increased financing interest and FX. We are currently forecasting an FX headwind of approximately 60 basis points to EBITDA, mainly due to recent movements in the Canadian dollar. We are also carefully watching the euro. Adjusted EPS from continuing operations is expected to be down 3% to up 3% with most of the drop-through for margin expansion being consumed by higher interest rate expense. In fact, combining the headwind from FX and a higher interest rate expense in 2023, we estimate the impact to be a drag of approximately $1.50 to adjusted EPS, helping offset some of this headwind as a benefit in our share count given the work we did to repurchase shares in 2022. A few other items to note before I turn it back over to Mike. Operating expenses are expected to tick up as a percentage of sales with the bulk of that being attributed to sales and marketing. This increase is driven by a return to more normal advertising levels and in-person dealer events. We encourage you to model shares flat to Q4, so roughly $58.5 million. Financial services income is expected to be up 40% with higher interest rates and increased dealer inventory, driving more income from receivables. Operating and free cash flow are expected to be up significantly versus 2022 as investment in working capital is not expected to be a drag. Lastly, we are planning a meaningful investment in back shop capacity in Mexico to bring outsourced fabrication and injection molding activities back to historical levels. That activity, along with capacity expansion investment at several other facilities is going to drive CapEx higher year-over-year. Mike will touch on this briefly, but we are excited about the opportunity to invest in growth while also taking more control of our supply chain. Our capital deployment priorities in 2023 are as follows: we intend to continue to invest in the business, and our intention is to have our 28th straight year of increasing our dividend. After that, we look at balancing share repurchases and debt pay down with likely a bit of both this year. At a minimum, we look to offset dilution from our stock-based compensation program. If you recall, part of our 5-year strategy is to reduce our base share count by at least 10%. And with the repurchase activity concluded last year, I can say we are ahead of our initial plans. Therefore, we expect to be opportunistic with share repurchases while also balancing debt pay down and making these decisions based off what we think is the best for the company given return metrics and what we deem as a healthy financial position. Lastly, as we think about the first quarter, there are some moving parts worth mentioning. We do expect retail ex Marine to be flat to modestly up year-over-year. Remember, promotions are netted out of revenue, and with those increasing, there will be a headwind to both revenue and gross profit margin. And then we expect year-over-year pressure from foreign exchange and interest expense. Some items working in our favor are price and an expected reduction in cost premiums. On EPS, we have looked back at pre-pandemic years regarding the cadence of earnings, and we expect 2023 to have a more normal cadence of earnings with 16% to 17% of our full year EPS being realized in the first quarter when we typically see a seasonally soft retail quarter. Overall, we believe we are set up for a strong year, including share gains across our segments, margin expansion and strong cash generation. Although headwinds exist, our team is focused on delivering these results as we continue to march towards our 5-year targets. Thanks, Bob. We made a lot of progress on our long-term strategy in 2022 and are well aligned on what needs to get done this year to meet our 5-year goals. Starting with the strategy we laid out at Investor Day last February, nothing has changed. This team is focused on executing the strategy. We consistently review progress to our strategic objectives as a team as well as with our Board. We believe the 6 pillars of our strategy will drive growth, improve margins and drive strong financial returns for investors. Rider driven innovation and best customer experience will be on full display in 2023 and as we have a very exciting year for new product introductions across all segments. Consistent with the success we saw in 2022 with the RZR Pro R and Turbo R, I think you will be impressed with our Off-Road launches in 2023. Polaris Off Road will not only raise the bar for our industry, but will redefine product categories. Both dealers and customers should be excited to see and experience what's to come. Indian motorcycle has much -- had much to be proud of in 2022 with the launch of the new FTR Sport and Indian Challenger Elite. And 2023 is set up to be an even better year with new bikes and accessories consistent with the innovation riders have come to expect from America's first motorcycle company. And our Marine business is gearing up to ship new products across all 3 brands from Godfrey Mighty G to the Hurricane Sundeck 2600 and plus more to be announced in 2023. Boat show season is upon us, and I saw firsthand the level of excitement and energy around these already released products. Our strategy isn't just about innovation. Last year, we invested significant money back into the company to ensure we have agile and efficient operations as well as capacity to support the innovation. In 2022, we expanded our PG&A distribution center in Ohio -- added capacity at our Monterrey, Mexico facility to support new Off-Road products coming out in 2023, and added capacity in Elkhart, Indiana for our marine business to support the growth in our large boat cat segment. As we look forward, we see a need for additional capacity in our Off-Road business to support planned growth. Starting in 2023, we're investing in vertical integration as well as capacity expansion in a new location in Monterrey, Mexico. The investments in construction are scheduled to start this year with the benefits being realized in early 2024, certainly an important step to support our 5-year strategy and align with our agile and efficient operations pillar. Lastly, we're well on our way and on trajectory to achieve our 5-year financial objectives. 2022 saw us drive growth, expand margins, improve returns and execute on our capital deployment plans. While 2023 is bound to have some challenges, I expect another solid year of progress against our objectives. Let me wrap up. We did what we said we would do in 2022. We expect demand signals to be mixed in 2023 as they have been for the past couple of quarters. We're closely watching a number of demand indicators and our plan is to remain agile in managing our manufacturing and shipment plans so that we can swiftly respond to positive or negative trends. We expect overall powersports retail to be relatively flat this year, plus or minus a point or 2 as we settle into a more normal operating environment. For Polaris, it's expected to be an exciting year for product launches and new services as we accelerate rider-driven innovation and the best customer experience. There are meaningful headwinds to our financial results given recent foreign exchange moves and higher interest rates. We have done our best to help you model them given the information we know today, but realize both of these have been volatile as of late. This environment requires us to remain agile to changing conditions, and we are well poised to do just that. As I have said before and it remains true today, we know that winning in a competitive environment requires our entire organization to be focused on delivering. With the best team in power sports, I'm confident we will deliver on our commitment of being the global leader in powersports. We're excited for 2023 and what it offers us, our dealers, our customers and our shareholders. We believe the decisions and investments we are making today will not only set Polaris up to deliver a strong year, but also generate strong growth and returns over the long term. I wanted to ask about the flattish retail forecast that is embedded in your guidance. To me, that suggests you hold or maybe gain a little share in an economy that does not enter a recession. I'm just curious if you considered scenarios with a deeper economic downturn or pressure on your market share and what those downside scenarios might look like? Okay. Thanks, Craig, and I appreciate the question. Yes, we've modeled a number of different scenarios and the result on operations. I think the element to keep in mind is it's not predicated on a substantially better economy. If you think about the areas where we lost share in 2022 is predominantly concentrated around the RANGER product line, the utility space. And when we look at the inventory levels for that business, they are still well below even the optimal levels, and those optimal levels are well below where we were in 2019. And given that we see that market holding up, it's an opportunity for us as delivery improves to get back in and pull that share back. And we essentially have seen that playing out over the last 2 quarters. So we know when we've got the availability that we're going to pull the share back. And we're happy with the performance we had in REC last year, the Pro R, Turbo R put us in a share gain position, which is great given some of the challenges we've had over the past. And really, it came down to availability within our RANGER product line. And we've seen that steadily improving, and we anticipate that will continue through 2023. So being able to get caught up on both the dealer inventory as well as just the continued solid demand that we have in that category is important. The other element is we do have new products coming out that serve new segments. And I think that's really important to think through because there will be a little bit of cannibalization that comes from these products, but we do think that they're going to appeal to a different subset of the industry, and we think that's going to put us into a really good spot. The last thing I would point to is, we've managed this business through some pretty volatile and uncertain environments just in the past several years. And the team has got a really strong track record of being able to react and move the business in the right direction. And we know what our guideposts are relative to dealer inventory. We're going to let that plus the demand data that's coming in from the dealers really be a guidepost for us. The other point I'd make is dealer inventory obviously was up strong versus last year, '22 versus '21. But the thing to consider and similar to the dynamic we saw in the third quarter, a lot of that inventory went into the channel very late in the quarter. We were still dealing with some manufacturing disruption from suppliers as well as even some of the recalls and when you think about that dealer inventory number one, a lot of that is clearing out in January as we were able to get into the hands of dealers and they're getting through the setup and delivering the customer demand. But also, we're clearing recall holds over the course of January and February. And we know that those vehicles are in demand because we've had consumers at least put initial deposits on them that has shown up in the presold numbers. So we're watching January closely right now, retail is outpacing anything we would be shipping into the channel. So we feel good about the dealer inventory levels. I just wanted to -- if we think about the retail commentary you just gave and then look at the actual reported sales guidance, what sort of gets you to the low end versus the high end of the sales? Is it just sort of how long or sticky that price and mix benefit is? Or is it retail? What is sort of driving that? I mean there's going to be an element of it that's the retail. We've factored in the level of promo that we think is appropriate given the industry conditions. And a lot of that promo is really geared around interest rate buy downs -- just knowing that the kind of the low to mid-end of the markets are pretty sensitive to the interest rates. They typically finance. And so we've built that in to allow us. So I don't know that we're necessarily anticipating any substantial price moves. I think a lot of it's really going to be, as we talked about earlier, we're going to let demand and dealer inventory kind of guide where we ship to the business. And if we see pockets as we look through the scenarios. And frankly, it's why we widened the guidance range relative to what we normally do is to just recognize that there's a fair amount of uncertainty. And when we talk about flattish retail, as I mentioned in my prepared remarks, we're kind of running scenarios where we're down a couple of points or up a couple of points and using that to help guide where we need to go and then factoring in the fact that we do have new products coming in that serve new segments. And we've got a -- we anticipate strong demand for those, but also making sure that we've got plenty of inventory in the channel for the dealers. Makes sense. And then just on that new product introduction, you gave us the earnings cadence 16% to 17% in the first quarter, but also just the timing of these products. It sounds like in the back half of the year, should we be looking to historical cadence for the quarters? Should it be more back half weighted because of these products? How do you sort of want us to think about that? Yes. So it will be -- I think looking back at historical cadence is the right direction to go. Probably a little bit more to the back half than historic just because of the new products and the timing of those. The other thing I think folks need to keep in mind around growth for next year is the commercial business. We have a very large business selling rangers to commercial accounts folks like United Rentals, Herc Rentals, things like that. And that business, one doesn't run through the dealers. It's sold direct. It doesn't show up in retail. It doesn't count as ROVA retail. But it's a business that is really strong right now given the infrastructure bill and the chip fab bill. So those markets are really strong. We do really well in them. And that business is up significantly for 2023 with relatively low risk in terms of it happening, regardless of sort of what happens in the general economy because those projects are funded. So that gives us a little bit more stability and confidence in the growth on RANGER as we go into '23. And Fred, the last point I'd make is from a sales standpoint because, again, it doesn't show up in the retail is our PG&A business typically as the market starts to slow, if people aren't buying new vehicles, they certainly are repairing and upgrading their vehicles. So we know that, that PG&A business is going to resilient in offsetting. So I think in the past, we've talked about the retail-driven portion of our revenue is probably in the 40% to 50%. So there's a number of other factors that play out in terms of PG&A, the commercial, the government as well as international growth and revenue performance that are going to influence those numbers just outside of North American retail. I guess first question on margins. What's the margin drag that you guys are assuming from increased promo activity in '23. Does pricing offset that dollar for dollar? Or is it margin neutral? So in -- if you look at '23 versus '22, the pricing -- the carryover pricing from '22 into '23 really carries through the first half, and that will largely offset the increased promo for the year. The other -- but the other piece of that drag is dealer finance with floor plans with dealer inventory being up, floor plan rates being up, the floor plan finance cost for us is a drag. So -- but promo itself is mostly offset by the carryover of the price. And Joe, just keep in mind that when we talk about the finance promo, the way Bob has got this structure with our financial partners, we end up pulling back some of that income below the line. So some of that GP margin headwind gets offset much lower in the financial statements. Okay. And then, I guess, second, sort of big picture, could you tell us what the industry was down in '22? And maybe why that would get better in a tougher economy in '23? Well, you have to remember, we're such a large portion of the industry. And when you have a combination of us on a -- especially as we get towards the end of the year, pretty substantial stop sale for our REC business. And then struggling to get the product out for the utility business, that puts a fair amount of pressure on the industry. And as we look into 2023. And as I mentioned earlier, you get a combination of us getting back on pace with Ranger, knowing that the utility segment, at least for the past couple of quarters, has shown resilient demand and we anticipate that to continue for the factors that we outlined earlier and the new products that are going to come into the market, those are going to be enough, at least from a Polaris perspective to obviously drive retail that, as we said, could be flat to up, and that should create more stability in the industry. What I'll tell you is, even with that expectation around retail, we're still down below where we were in 2019, both Polaris as well as the industry. So it's -- I would characterize it more as a stabilization coming off of 2020 when we saw outsized demand and then really continued challenges in '21 and '22 as an industry, we were struggling. And obviously, we were disproportionately impacted by the supply chain challenges, and we see that stabilizing as we get into to 2023. And even with a choppy macro, we think the opportunity is specific to Polaris relative to the utility segment, RANGER inventory levels as well as the new products coming on seen that gives us the opportunity for some growth. A couple of little clarifications. You mentioned retail in January, you said sort of outpacing what you're shipping. Can you kind of put that into roughly like a retail year-over-year, how January is pacing so far? No, I don't know that, that would provide a whole lot. But I think the point is similar to what we experienced, if you remember the call back in October, we talked about the fact that dealer inventory had moved quite a bit coming off the third quarter. But we were watching, specifically at that time, it was RANGER and ATV retail sales, and they were 2x overstripping what was sitting in the channel as well as what we were able to ship in. And so similar to that dynamic, maybe a little bit different in the fact that we did have late shipments given some of the challenges we had on the utility side specific to RANGER . But coupling that with the recall holds that we had on our RZR business, given some of the fuel system supplier-driven quality issues that we're working to have resolved here in January and February. That puts us in a position that retail is going to outstrip, which just means that dealer inventory is going to come down a bit and calibrating what we saw at the end of 2022. Okay. And can you quantify roughly what percent of retail in Q4 was presold? I think you've been giving out that number in prior quarters. So just wondering where that ended for Q4. Yes. I'm not going to give a specific number, Robin, but it's kind of been down quarter-over-quarter. We did see strong presold, though. And some of that happens because of a model year change too. As the model year change comes in, people stop preordering because they want to wait and get the new model. And for a period of time, we don't take preorders on new model years. So that dynamic ends up in Q4. But while it was down, we are seeing strong -- which we would have expected as dealer inventory refills. So it's not like people aren't buying, it's just that they're -- they can buy at the dealer. But on the products that are in high demand and some of the products that were on hold with the recalls, we had seen strong presold as consumers get in line to get those products. So it's still well above where it would have been historically. It's just not in the levels it was during the pandemic. Yes. And Robin, one of the dynamics we watched it play out in India. As we got more stock on the floor. We would see cancellations in the presold, but all of those were moving to folks buying bikes off the floor rather than waiting for a bike to show up in a month or 2. And we've essentially seen that dynamic playing out. And as Bob indicated, now it's becoming a little bit better indicator around the demand where we don't have dealer inventory levels at the adequate level or we have product that's on hold and we've seen that playing out specifically around the high-end RZR as well as RANGER products right now. Okay. Great. No, that makes sense. Just 1 quick final clarification, if I could. In your market share numbers, I guess dealers have been talking about some OEMs imports from China growing share. And I think initially, those were not in sort of the included in the market share data that you gave. Are those other brands now in your market share numbers or not yet. It's still kind of just a legacy competitor brands? No. I mean when we give market share data, Robin, we can only really give it for the folks that participate in ROVA and some of the Chinese manufacturers don't participate in the trade organization. So we don't get their reported data. But the other thing to keep in mind is that as you look at some of these -- the Chinese entrants, we certainly -- we don't dismiss any competitor ever. But the bulk of the products they have been selling, especially during the pandemic has been lower end products in a range that we don't participate in, in a meaningful way. So to some degree, it's probably grown the market more than it's changed the share dynamics. Yes. And Robin, I mean, I'll reiterate what Bob said, we will not be dismissive of a competitor. But we do know -- I mean we spend a lot of time out meeting with dealers, Bob, Steven, Edo and I and -- the consistent dialogue from the dealers is the majority of the folks buying those are not necessarily customers for businesses like ours or higher-end competitors. And we've also seen that the dynamic has changed quite a bit. The issue was when none of us had availability and they were able to get product in, they were able to move it. Now they're at a point where they're at a surplus and the dealers are really pushing back hard on how much inventory is being pushed in the channel. So it's kind of -- it's come back in to parity. And I think as the availability of our products as well as the rest of what I'll call the legacy higher-end industry improves, I think you'll see that dynamic at least coming back in a parity. That said, we're taking a hard look at it to understand how we -- how -- if we and how we potentially compete against that particular end of the market, and obviously, don't want to necessarily take Polaris down into a super cheap value play, but we're going to continue to look at that and monitor it and react accordingly. Just a question on PG&A. You noted attachment rates are healthy. with reduced dealer whole goods inventory targets in 2023, does that extend the PG&A or do you lean more aggressively into attachment sales with higher dealer in stocks? Certainly, there -- they operate PG&A on an RFM model, similar to we do whole goods. So obviously, that will tamp down any of the, call it, in-store traffic. But -- that said, if you're seeing fewer whole goods move, typically, people are buying oil kits, maintaining the vehicles because we know people are still writing the same rates that they have historically as well as if they're going to hold on to a vehicle for another year or 2, they're likely to buy some accessories. And so there'll be some of that. The attachment, the factory install, we call it, in terms of shipping a whole good with the accessories on it, we've seen that steadily increasing. And so I anticipate that, that will continue. And even with a more muted whole good growth rate, you're still going to see PG&A attachment rates inching up. probably not at the same leaps and bounds that it had over the last 5 years. But there's still a lot of accessories. We've got new products that are coming out this year, and there's more accessories available on those products than we've ever had historically on a new product launch. So the team's really gotten to a good cadence recognizing that it's a great way for the customer to be able to customize the vehicle, but it's also a great margin opportunity for both Polaris and the dealer. Got it. Got it. And then second question on motorcycles. This is a category where, I guess, you've had some margin challenges over the years, but you made a lot of progress in 2022 on motorcycle gross margins. So just talk about the drivers of the margin improvement other than the mix, which you referenced in your prepared remarks, but the games seem to be holding well here. So how should we think about the potential upside from here? And what have we assumed in your 2023 guidance with sales up low single digits on raw material cost relief? Yes. I mean we've talked a lot about the fact that the team is driving a path to profitability plan. And we're really happy with what we've seen, the adherence to it without compromising the quality and the innovation. I mean there's a lot of different factors. I mean, one is the scale of the business, as you grow it, you're obviously leveraging your overhead. So there's a lot to be said there. I would talk about things like the price and promo environment stabilizing. One of our largest competitors was doing some pretty challenging things a few years back. And with new leadership that has certainly stabilized and created an environment where I think we're able to ensure that we get full pricing on our vehicles plus we were dealing with an environment where scarcity was also driving a bit of a premium. On top of that, we're leveraging into our engineering spend. We had to essentially build up bikes from scratch, all categories. And with the introduction of the chief this past year, that really filled out the platforms that we needed as a company. And so as we move forward, we'll still be spending good money on engineering, just not at the levels that we did when we were effectively creating a new business. PG&A has been a huge focus for us is an opportunity. If you look at us relative to some of our competitors, we're still below where we should be. But I'm really happy with the progress the team has made over the past couple of years to drive that performance. And then international has become a huge growth catalyst for us. About 40% of our revenue growth for Indian is coming out of markets outside of the U.S. And so that gives you a really good opportunity into those markets. You're able to hold price and really get paid the premium that the bikes deserve. So happy with what we've seen. The teams are working pretty much every opportunity they have and we expect that trajectory to continue. Yes. The only thing I would add is we've also continued to pursue localization in that business. It is Unfortunately, they're most impacted by FX given how global it is, but we've continued to increase the level of bikes. We assemble in . And as you know, we started to assembly in Vietnam earlier this year, so -- or earlier in '22. So that starts to benefit as we move forward, and we'll continue those efforts to make sure we're producing the Indian motorcycles where they're being sold. I'm hoping you guys can elaborate a little bit more on Marine, mostly the trajectory of the improvement you're hoping to achieve. I'm wondering if mostly a remedy that stems from correcting the correction of the supply chain. So it's sort of a smooth improvement going forward. versus the recent declines at retail? And then is there any way to think about what the impact of the switch coming on to the market might have had on the lower price point end of the market or demand, sorry? Yes. So I'll take the last first. We know that it's had an impact. I mean when you come on with a new product, it certainly does. When we look at the Pontoon market, the true Pontoon market, which in theory, the switch doesn't necessarily qualify just given some of the stimulations the legacy brands held up quite well. And so we're obviously tracking their performance, and we spent time talking to some potential customers at the Minneapolis Boat Show and I think for the most part, we feel like it's not necessarily pulling pontoon customers away. It's probably pulling PWC customers up into a larger version of the product. But we're going to continue to keep an eye on that. When we look at the improvement that we're expecting in Marine, I guess I'd characterize it, it's a tale of 2 sets of businesses. One is -- when we look at Godfrey and Hurricane, there's been a lot of work over the past several years to turn those businesses around. And the boats are absolutely gorgeous. They've done a spectacular job of improving profitability I mentioned it in my prepared remarks, everything from the Mighty G, which we're seeing tremendous pickup on the electric version of that boat, that's tapping into a whole new segment, both electric as well as consumers who are looking for a smaller, more maneuverable Pontoon all the way up to the Hurricane 2600, which is an absolutely stunning fiberglass boat. Those are obviously going to drive significant market share performance. We saw market share gains in both those businesses in 2022, and we expect that to continue. Where we really struggled was Bennington with Ben moving into the leadership role of the entire Marine segment. he's really going to bring a lot of that same philosophy and approach to Bennington that was brought to pull Hurricane and Godfrey back up to market share gains. And we're pretty confident given what we've seen in terms of product plans, go-to-market strategies that will put Bennington back in a really positive spot from a market share perspective. Part of the challenge we had this past year was just being able to get boats into the channel. We added capacity -- there's some automation moves that are being put in place, and that should improve our ability to deliver and put us back in a share gain position for that brand. Yes. I think the thing people maybe miss on the boat business, when we bought it in 2018, Bennington, obviously, the crown jewel and continues to be. But Bennington is also the bulk of the earnings and Godfrey Hurricane really in addition to kind of having dated boats, had what I would call dated financials. And so they weren't really big contributors to marine profitability. And now we have months in '22 where Godfrey and Hurricane made more money in a month than they made bought them in 2018. So Ben and the team have done a great job driving profitability improvements, along with quality and design improvements in those businesses. And as Mike said, now Ben is bringing that -- some of that same focus, particularly on the design side over to Bennington and we'll see good results there as well. But marine profitability has improved quite a bit since we acquired the business, and we've got more activities underway to continue to drive that. So it's been a really good story. Okay. And then can I just clarify, I think you guys had said in the prepared remarks that you were going to start capitalizing on the expansion in Monterrey in 2024. But should we assume that the sort of elevated CapEx goes beyond 2023 for maybe another year before normalizing to pay for that expansion? Yes. I mean the reason that we made the statements we've made is that it's obviously a new location. The first wave of this, just given the current backdrop from a broader economic standpoint is really focused around in-sourcing. We're trying to bring some of the activities that we outsourced during the height of the frenzy to be able to get product out. We're trying to bring some of that back in to bring it back into more parity. It's also a pretty substantial cost play. And that's why we'll be able to start to realize benefits sooner. And then there'll be additional investments as we start building up the capability to produce new whole goods to serve both that market as well as the broader North America market. Yes. So you should -- the exact timing of the CapEx will depend on when we decide to start the investments as we look at just what the market does over the next year or so. But I think CapEx will be elevated over historic levels. It was in '22. It will be in '23. I think Mike and I have been really clear with everybody that we feel like the business was under invested in historically, is part of the reason we went back to a more focused portfolio, and we're putting our money into high-return operational investments that either improve quality, improve the product and drive better costs. And you'll see us continue that. I wanted to dig into the inventory replenishment dynamics, continual conversation we've had the last couple of quarters. What was the full year replacement benefit for 2022? Is it easier to just take the $750 million that you gave us a couple of quarters and subtract the $150 million that you gave us this time around and I guess if so, doesn't that suggest a pretty sizable headwind this year as we lap that even with the $150 million left over. Yes. I mean I think the basic math has that as part of the equation. I think the more challenging aspect is, yes, $150 million is what's mathematically left after you look at the end of the year. But as I pointed out earlier, we're already clearing through some of that dealer inventory. So you have to consider the fact that we had a fair number of our RZR on hold coming out of the end of the year and even into January and part of February. And then a lot of RANGER that got delivered in the last week or 2. And as you know, between transportation time and setup time, those things aren't retailing until January even into February. And so it's difficult because it kind of moves around. I would suggest that $150 million is probably understated because you cleared through in January and February, the recall holds as well as the backlog of consumer deposits for some of the higher-end ranges. But it's in that ballpark. But as we look forward, one, we still have opportunity to refill with Ranger and that demand is holding up. So that $150 million we said first half, and it's really going to depend on how that demand profile plays out because we're still going to be planning, I expect a catch-up. But we then have in the second half, we have some new products coming on the scene that we feel pretty confident given the redefining of the segments, new areas of opportunity and growth, coupled with all the factors I talked about before outside of just North American retail that drive growth in this business. That's why we're pretty confident that we'll see revenue growth as well as lapping of pricing and some of the other dynamics that we have. The other piece of that, too, is with the commercial business, keep in mind that the growth in the commercial business, which will be very strong in '23 and has been -- was in '22 as well. That business doesn't impact dealer inventory because it goes straight from the factory to the customer. And so you won't see that show up in dealer inventory, but it does obviously show in revenue. Just to clarify, I shouldn't be sort of taking -- it sort of seems like the first half sets up really favorably because you've still got that $150 million that should sort of be an add-on to your sales but then the back half of the year kind of feels like a $600 million headwind you're telling me I shouldn't think about it that way. No, I wouldn't. To Mike's point, I think that the timing of refilling the $150 million is going to depend on retail, and it's all really RANGER at this point, so -- or mostly RANGER. So as we continue to have strong shipments in Ranger, we think we'll drive better share, which will make it harder to refill that inventory. So some of that or much of that could push to the second half some of the chunk of the commercial business is second half diluted again, we feel really good about that. And then we've got all the new product in the second half. So I don't -- I wouldn't view it as that headwind is all in the second half. Yes. And I think, James, when you're trying to do that math, you also have to consider we had retail declining in Q3, Q4 of last year. And if you assume retail is flattish. That obviously needs to focus into your calculus. Got it. One more quickie for me. Pricing and mix, it sounds like from your anecdotal commentary that you still think there's a tailwind there. I guess how do we think about wholesale units versus wholesale dollars within the context of your guide? Are you getting a meaningful sort of ASP benefit as you sort of bridge those numbers? So there's not -- I mean, we expect pricing to be relatively flat. There's been a fair amount of price taken in the industry over the last few years. So we're not going into the year with expectations of ongoing price increases. So we think that will be relatively flat. A lot of the benefit really comes from mix and what we're seeing, and I think this is really across the industry, the industry really has changed. The mix has moved much more towards multi-passenger and premium units. And that continued in '22. We expect it to continue in '23. That's where the customer is going. I think you kind of got to look at this a bit like the SUV and truck market where consumers have -- nobody buys a -- really a 2-door truck anymore, right, everybody buys a crew and be buying fully optioned out. And that's the same thing we see across the product lines is that move to premium and multipath,and that drives a lot of the ASP benefit. Two questions here. First, just to clarify on what happened in fourth quarter. You expected fourth quarter retail to be positive. So in or down 6%, I guess. I guess where does that come from? Is that all the recall? What else left retail like short of your expectation? It was really -- it was a combination of the recall holds which were obviously on a substantial number of RZR. And then really, it was the timing around the shipments of the utility vehicles into the channel. We had a couple of specific supplier issues that pushed our shipments much later in the fourth quarter than we would have liked. The good news is those products are moving in January. So customers are not happy about it being late, but at least they're getting their vehicles now. And just from a unit standpoint, a little less impact from margins, but same issue with snow. We had a couple of calls in the quarter. And we're very conservative in terms of how we look at shipment side revenue, so we don't recognize revenue. But some of the -- a lot of those units, the dealers can't retail them. We had the fix out. It was pretty simple fix, but the dealers can't retail them until they can prove that fix is done. So that pushed some snow units that would have retailed '22 into early '23. Okay. Got it. And a second question here to you, Bob. Maybe give us a bridge to the financial service percent flat retail and more cash buyers, how do we get up 40%? Yes. So even on flat retail, we're seeing 2 things. As promos, we're seeing continuing higher pen rates because as promo comes back in the market, a lot of our promo is focused on interest rate buy downs. So that makes the percentage of the units that we sell a higher percentage to get financed by our partners, which helps drive that income. And then the other piece is our floor plan financing higher floor plans, higher rates. Our share of that with our JV partner goes up as well. Okay. When you buy down and offer promos, does that go against your financial services income? Or is that against gross margin? I wanted to ask a little bit more about retail sales. I was just wondering, is there anything we should think about in terms of cadence within the flat for the year? Is 1H plus 2H different? Anything to think about maybe on a quarterly basis? Any color would be helpful. No. I mean, we expect to return to more normal seasonality. So I think we've said a couple of times, we think that in general, as inventory improves, consumers' behavior will return back towards buying in time for the riding season. So spring into summer will be better, and then they'll -- you'll especially for motorcycles. I think that will be close to normal. Boats is trending back towards its normal seasonality. We had a couple of years where people were buying late in even Q4 in the cold season to make sure that they had their boats for the spring season. And I think as things return to normal, people are kind of moving back towards the put a deposit on it and retail happens really in the spring when they pick the boat up. So I think you'll see that dynamic. And then I think on the share side, it's -- we're continuing to make progress, ship and RANGER. And so you'll see that build through the year as we look to take share back in that market where we lost share, primarily due to under-shipping what our historic share levels have been. Okay. Got it. And then maybe just 1 quick 1 on pricing. It sounds like maybe not so much of a benefit this coming year, but still holding. But at the same time, it sounds like are ASPs obviously higher than 2019. I know there's some mix in there, but I guess are you seeing any pushback on pricing? It sounds like no, it sounds like the consumer continues to accept your pricing increase? Is that fair? Or are you seeing any kind of -- anything on the affordability equation? Yes. I mean there's certainly higher promo in '23 versus '22 and some of that is designed to counterbalance particular units where we feel like we got maybe a little ahead of the curve on the price ratio relative to the competition, but that's all factored into our guidance and how we built the plan for the year. It really is ASP driven, and I think folks underestimate this change in mix, both on and the mix to crew and then the -- because it's a kind of a double benefit, right? It's a mix to crew, which are larger, more expensive vehicles and then a mix to the premium end of the multi-passenger vehicles. and our increase in like factory install and things where we get much higher PG&A capture. So that's really the bulk of the driver in the ASPs. Just 1 for me. PG&A. You guys are talking about how this would most likely be the most resilient part of your business in '23. But can you break out how much of that business is, I guess, not attachment based and how much is brake fix and more sustainable in a tougher economic environment? Yes. We don't -- we haven't historically given out those breakdowns on the business. But what we have historically seen, and we saw it through the course of the pandemic, but people couldn't get units, they were fixing their old units, riding levels are staying high. So we've seen continued good sales of kind of more of the maintenance parts. And the other dynamic that happens when people can't get new units, whether it's availability or in the event of a downturn, the their interest and willingness to pay for to buy a new unit, we see them come back and accessorize their older units. So we don't expect or know any reason why that trend would change, but we don't really break out of how the G&A business falls between to and [indiscernible] upgrade.
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EarningCall_1284
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All right. Good afternoon, everyone. I'm Matt Sykes, the Life Sciences Tools and Diagnostics analyst at Goldman Sachs. And today, we have the pleasure of kicking off the new year with Agilent, Mike McMullen, CEO; and Bob McMahon, CFO. Mike, Bob, thanks for joining us today. Thanks, Matt. Happy New Year to you and to your clients and I must say it's great to be here in a face-to-face environment again. Certainly is. It certainly is. Maybe we'll start off just kind of â I'll let you guys set the stage a little bit and talk about the most recent quarter you had, your fiscal fourth quarter and some of the trends you're seeing across your businesses, particularly how you ended the year just given the way your fiscal year shapes up would be, I think, interesting know and kind of how you see 2023 shaping up? Yes. No, the timing of how this conversation is just great coming off a great close to 2022. And if you look at our performance, 2021 was a great year for the company, and then we topped it off with even stronger year, the following year with double-digit growth, 12% core, margins up 160 basis points earnings per share of 20%. I'd like to say that because there's momentum in the business and we felt really good about the â how the team has continued to deliver for our shareholders and our customers, and we've probably exited the year with good momentum. Obviously, there's question marks about the long-term outlook for the economy in 2023, but we felt like we had a reasonable look, particularly at the first half of 2023 because of the strength of our backlog. And you may recall some of our conversations, Matt, where we're really kind of really keeping an eye on how would the order picture look like for the rest of the calendar year because we mentioned later we've got this October 31 fiscal, but we're also keeping an eye on how we finish the calendar year business and is as expected. So that gave us a real sense of confidence that we had kind of a good bead on what was happening in the marketplace. Great. Maybe we dig into the guide a little bit. I mean, if we look at what your kind of guide implies for the full year relative to what you guided for Q1, it seems very front-end loaded guide for the year so implying a slowdown in the back half of the year. Clearly, there's a lot of unknowns about the back half of the year. Would love to kind of get your view as to the level of Agilent prudence in the back half versus things that you're actually seeing in the market based on conversation... So Bob and I are a tag team on this and I think there's a high level of prudence in the guide because of the uncertainty. Not many things that we know, but what we know is that the â we've got the strength in â of business we can expect from the backlog, we've got the on-target year-end orders, we've got a very resilient services business, we've got some reservoir things, great things happen in our NASD business. So we have a lot of confidence about the first couple of quarters. There's just a lot of uncertainty about the back half of the year. I think what you're thinking, Bob, is we... Yes, absolutely. We came into this year as Mike, you just mentioned, with strong momentum. Actually, Q4 was our strongest quarter within the fiscal year, we ended with elevated backlog. So we have really good visibility into the first half of the year, and we'll see how things play out in the second half of the year. We're going to go up against tough â tougher comps, which plays into that, but I think it is an element of that prudence. And we'll know more in a few quarters. Yes. And I think under the guide that we will know more, I think we've got indications from our large customers that they are planning to have increases in their budgets. We just don't know what they have actually settled out to and it probably will be a couple of months before we know for sure. Got it. Maybe there's been a lot of discussion around instrument growth over the past year. 2022 and 2021 were exceptional years for instruments. So if I look at your commentary on the Q4 call about your backlog and then your guidance for mid-single digits for instruments growth for the full year, that again, implies a high visibility and strong first half with an uncertain back half. But maybe talk a little bit about things that you're seeing within the instrument market, maybe break it down. I know we talked before about small mall versus large mall and kind of what you're seeing in the instrument market to kind of give people a little bit more clarity as to how to think about the full year? Sure. Sure, Matt. And when we talk about uncertainty, really, it was uncertainty around CapEx purchases, right, instrument purchases. And when you look at the two largest markets for Agilent Pharma and our chemical and advanced materials market, what we're looking at is how long can this accelerated replacement cycle for liquid chromatography in small molecule pharma continue. So listen, we've enjoyed the growth rates of â 20% to 30% growth rates in liquid chromatography over the last two years. I just don't think there's been a structural change in the market. So we think we're kind of in, if you will, baseball terminologies, or maybe weâre talking about football during the fourth quarter here going down for the two-minute drive. So, we would expect a moderation of growth in small molecule replacement. It's hard to say when that's going to happen. But we're kind of assuming, if you will, in our guide that some of it will be in the second half of next year. At the same point in time, there is also other positive puts that we haven't seen actually in my career. You are seeing new secular drivers in the Advanced Materials space, which as you may know is roughly a third of our CAM space, about 30%, 35% of our business. We think that's growing 10% double digit growth rates, onshoring of critical components, investments in semicon and then whole revolution that's going on in automobile industry with battery technology for electric cars. So we think there's some â and then the other one we've been talking a lot about today, Bob, has been the PFAS market. So while there are some kind of maybe a potential of slowing of demand in liquid chromatography in the small molecule, we will see continued strength in biopharma side of that market. But we're also seeing new drivers of growth in chromatography both LC and GC in these other areas. Yes. And I think it's important to add on the small molecule side, our view is that it's going to revert to the mean. So it's still growing. As we think about how we were building the guide for FYâ23, we still expect very solid growth in our pharma end market which represents about a little over a third of the business, 35% of our overall, two-thirds of that or 40% of that's large molecule, which we expect to grow high single digit to double digit growth. And the 60%, which is the small molecule element, still expecting to see mid-single-digit growth there. So, still very good growth but not at that 20% level. Yes. And our commentary shouldn't be interpreted of any concerns on the competitive nature relative to our portfolio. In fact, we know via the objective inventory stats, we've been continuing to gain market share in core liquid chromatography. So it's more about, based on what we've seen historically in these markets, they will be virtually mean over time. Got it. And maybe one more on instruments. We often get the question of sort of replacement versus sort of Greenfield demand. And I think some of that has to do with the end markets. Because you think about some of the areas in advanced materials within CAM, there is actually some of the greenfield opportunities, whether it's PFAS or lithium batteries, et cetera. But maybe kind of help us understand maybe the split over the past few years in terms of replacement versus greenfield and where you could see that over the course of 2023 changing, if at all? I think Bob may be we want to think about this as we kind of take it by end mark. If you go let's say let's go pharma first. I'd say it's probably 60-40 kind of reflective of the mix between small molecule and large molecule. So the 60% being more of a replacement side of the market and about 40% is new demand. And even in small molecule China is expanding their territory. It's more of commentary around U.S. and Europe. But some of these new secular areas such as reshoring and some of these newer technologies such as the research behind lithium batteries, the semiconductor, that's all greenfield. And so what we're seeing is I would expect to see more greenfield in 2023 and 2024 than what we actually saw in 2022. And I actually think that that's a positive because there will continue to be a refresh of the existing business. But in both of those categories, it's not replacing existing capacity, it's adding to the overall capacity. And I think in those areas we gain more than our fair share of the existing market share. Yes. Bob is making a very important distinction here, which was historically, I think, people have thought or that space as almost all replacement business, and it's not the case at all anymore. And like I said, there's some nice new growth drivers for us on the secular side. Got it. Weâll get into that in a little bit. Maybe just shifting a little bit, Bob, just on operating margin expansion, we read our strategy reports, some or the strategy reports, which are basically going for a challenging year overall for the market for margin expansion. How are you viewing your margin expansion opportunities in 2023? And how important is continued high growth in instruments that margin expansion strategy? Certainly, growth cures all. But I think we've demonstrated both in very high growth as well as moderate growth or even low growth, we've been able to expand margins. And so it is important, but we're not reliant on instrument growth to drive our overall business. And if you look at what we did just in 2022 as an example, a lot of our operating margin leverage was actually an operating expense, which goes across. And so the investments we've been making in the digital applications, how we go to customer and how we support customers, I think, will continue to be a lever for us. In the instrument side this last year, we were dealing with higher input costs with chips and other raw materials and so forth. And we were being able to offset some of that, recovering that through cost but you look at our overall gross margin, it didn't change that much. And so I think next year, I would expect it to be in similar kind of fashion. I do think that gross margin, if you look at it, X mix, will probably be a little better this year than it was next year just because of some of the reduction in some of the pricing or cost pressures. Now, as our business in ACG grows faster, that pushes down that mix. But if you look at it on a group by group, I think you'll actually see some improvement there. But I still think that our ability to leverage the one adjuvant kind of culture that we have and the digital efforts will drive the majority of it in the operating expense. Got it. In related to this, can we talk a little bit about price? I mean, last year was a pretty exceptional year across the sector. In terms of price, when you did about 400 basis points last year, you're looking for another 300 basis points this year. Talk about sort of the customer environment today to price increases and then obviously, it's impossible to model, but the impact of lower levels of inflation moving through the year with the level of price that you expect this year and what that impact could actually have on margins going forward. While it's never an easy conversation to have with customers about, we need to move on, on price, they've been understanding the support of the changes. They understand what's been happening relative to supply chain costs, labor costs and such. I think as inflation starts to moderate, which hopefully is what we're some of the additional data we're seeing actually holds, I think they're going to be less accepting to have multiple increases in a particular year. So in fact, we're not assuming that in our guide now, that also assumes that there is a moderation of inflation. So I think right now the environment is still supportive, but I think you're not going to be able to play out at least from my view, 2023 like you played out 2022. That's correct. Yes. I mean, in 2022 we had to take in order to cover some of the increased costs that we saw, which were higher than at the beginning of the year, we had, we took multiple price increases. What we're seeing right now is a plan to have our annual price increase, just the one, and as you say, we still have in our order backlog, the pricing increases. And so we still see some of that kind of anniversary itself into 2023. And we've seen as you know, we talked a bit about, Bob mentioned ACG in terms of which is our service business in terms of how it has a different structural model in terms of gross margin. But overall, healthy profitability. This is also our customers understand that in a very labor intensive market, they understand because they're dealing with our own labor force. So they understand and they're accepting of change there. You just have to be viewed as doing what's reasonable. And we've gone out, as Bob mentioned earlier, his comments, we didn't try to recover all of our costs. Yeah. So and I think we believe that's going to serve us well in terms of our long-term relationships with customers because we never wanted to be viewed as taking advantage of the situation, particularly in a period of time when there everybody was desperate to get product and such, we didn't want to play that game. Yes. I think there's sometimes in confusion is that price X should lead to operating leverage, but if you're simply covering your costs, it flatterers the top line but doesn't help the operating. Doesn't really give you the operating leverage. However, if inflation were to come down meaningfully over the course of this year, then the operating leverage kicks in. I don't think that's something that you would bake in because it's based on inflation forecast, it's highly uncertain. But that still could be an upside for margins by the end of this year, depending on that. I'm a big fan of the business. I still think it's a significantly underestimated part of the business and what you guys do. Just leveraging your large installed base, developing deep relationships with customers and actually getting competitive intelligence within the market. So youâve had really durable growth margin expansion. Could you maybe talk a little bit about what some of the drivers are over the next few â over the longer-term to continue that growth over time and that margin expansion for ACG? Yes. So that was a â and I appreciate the support, Matt. I mean, that was a big strategic bet we made back in 2015 to go after a big time the services marketplace. And where we redefined in our own minds what was the addressable market and why we were doing, why we wanted to be at this business because as it historically have been sort of all about the box. And if you look from a customer experience standpoint, that service experience was crucial to them. And we thought that we could really do a good job in there. And we also are anticipating this really gets to the root of your question of why we think this is durable is the market continues to expand. So this is not simply me trying to take a service share gain from somebody else. We are growing share in an expanding market. So whatâs going on here? So first of all, starting with pharma, and I think youâll start to see it in other end markets as well is they really want to make sure their teams are being as productive as possible, offloading to â they want to outsource to a company like Agilent, things that their technical teams were doing, like asset management, support help, all these kind of things. So the market itself is expanding and also the nature of what customers define as services is expanding as well. The whole area of digital service is now a new business for us. Our customers know a tremendous amount about the scientific data thatâs coming off their instrumentation. Sometimes the operational data is not always clear. And they did have it, it was kind of in a very fragmented way. So weâre now able through sort of digital services, be able to show the customers, hey, back to the competitive intelligence. Well, hereâs whatâs going on in the entirety of your lab and labs. Hereâs the instruments, the uptime, the main thing in history, the age of the equipment, a lot of operational data that was missing. So this is a whole new set of services as well. And then I think weâre doing really well on the share side as well. I think this market â this overall service business has lot of legs still in front of us. And weâve had a series of strategies where weâve been driving, what we call, connect rates. And I think weâre in a really unique position here to be the undisputed leader here because of the fact that we have the most instrumentation placed in the marketplace already. So if you go to the labs, everybodyâs got equipment from Agilent. And so we already had a relationship with customers, and now weâre just taking more of other operations under our leadership. So weâre really excited about the business. You saw, I think another double-digit growth from ACG in 2022. The business is durable. Itâs competitive intelligence. It also leads to ultimately more on the instrument side. So thereâs â I think thereâs lots of legs here. And Bob, Iâve been chatting about this all day. Iâm sure I left something out. No, no, no, I think youâre right. I mean, the only thing I would add is we firmly believe thereâs a lot more runway in this business. When we think about that attach rate, we just crossed over the 30% attach rate in Q4, a milestone, but weâre clearly not done yet. We think that we usually can get into the 40% and 50% â up to 50% depending on technology over time. And so this has been a strategy thatâs paying off and if you think about the number of instruments that weâve placed over the last two years, itâs been fantastic. Those are coming off of warranty and now itâs a big opportunity for us to increase that service attach. And I think is â Mike, the only thing I would add is we see this continuing because the instruments continue to be more sophisticated. The more sophisticated the instrument, the harder it is to self-maintain and you couple that with the drive to productivity for scientists and researchers. They donât want the researchers to be calibrating instruments. They want them to be running experiments. And so I see this as a continuation and really has the opportunity to go across all of our end markets over time. And as we were talking earlier today, Matt, in terms of the use of digital capabilities to provide support to your customers, pre-COVID, we were kind of pushing some of the concepts on to customers and now itâs been a pool. So to be able to support a customer remotely through digital because often sometimes, maybe as much as one-third of your service interaction on, what they call, no park calls, which are the customer is not sure exactly how â having some questions about how to operate the instrument, for example. So the fact that we can do things digitally, they love it because, A, uptime is a critical importance to the laboratory operation and even today, the customers really donât want a lot of people shapes and around the laboratory. So a, that gives advantage to Agilent. One is we can support them digitally but if we do need to go to the customer lab, we can take care of the entire lab. So you donât have multiple people coming either. Yes. I think maybe just one last thing on this because thatâs intangible, but I think extremely important because this is a strong competitive advantage for us. And so having a trusted adviser that â when you know when you call, letâs say, an instrument goes down and you can go and fix that instrument, thatâs a very sticky business. Think about â Iâd like to think about it as a mechanic or a plumber. If you have a plumber or a mechanic that you can â youâll take your car to each and every time something needs to be done, thatâs hard to displace and so the more instruments we have under contract, I think the better it is and the more sticky that customer is and actually it creates opportunities not only to improve our products but also get more competitive wins because you use them as benchmarks for the next customer and so forth. So I think itâs a real competitive advantage for us. Got it. You kind of addressed already some of my questions on the growth side. But on the margin side for ACG specifically, it did about 25.5% EBIT margins in fiscal 2022. Weâve always thought about this business as sort of a long-term potential like a 30% EBIT margin business. Maybe help us understand sort of the drivers behind further operating margin expansion as it relates to ACG. Is 30% a realistic target? And is it attach rates? Is it geographic expansion? Like what are some of the drivers of â for ACG margins specifically? Do you want to take that, Mike? Yes, yes. So I think â bottom line, I still think that 30% is achievable. And I think itâs a combination of a couple of things. The attach rate will really drive that. So you think about its attach rate and digital capabilities. And so if you think about attach rates, the more you have attach rates, whatâs the number one cost or the number one expense and unscheduled service call, somebody who has to go out to a system. But if you have predictive capabilities to understand or you are able to actually service more instruments with that service call, you get tremendous scale. And then I think â so the more instruments we have under contract, the more scale youâre going to have to be because you donât have to add more people. And then you couple that with the digital capabilities. Mike talked about this, the more you can actually solve without having somebody go out and get our customers comfortable with chatting with somebody online, one of the benefits that we saw in â during COVID was because you couldnât travel. Sometimes these folks are doing highly technical experiments that you have to get a specialist that may not be in the territory. So what they ended up doing post â pre-COVID was theyâd fly, take two days. Now you can put them on a Zoom call, instantaneous help supporting the customer. That helps, the customer increased it, but it also helps us from a cost perspective. So I think continuing to invest in these digital tools, WeChat is a great example of that in China. And then just building up the scale through the attach rate is going to help us drive that capability or that scale. Got it. Maybe pivoting to two kind of exciting areas of your business, ASD and cell analysis, theyâve been key growth drivers for you, and now theyâre getting some scale as well. Maybe talk a little bit about NASD first. When you think about sort of the move from preclinical to commercial and the boost in volumes, and you guys have been building capacity and thatâs been the only constraint. It hasnât initially been demand. But as you think about scale and the need to provide that scale at commercial â for commercial capabilities, how are you thinking about sort of your overall bioproduction, biopharma NASD type business when you think about sort of expanding outside of siRNA and other areas? And how can Agilent play a role and how important scale will be into that? Great questions. And just for the audience, when we use the word NASD, weâre talking about our GMP-grade oligonucleotide business. And right now, we are the leader in siRNA and all the oligo drugs on a market that used in siRNA are being supported by Agilent. So â and youâre right, itâs been mainly a capacity constraint. But as we continue to build out capacity, weâve got another production line coming online later this year. We can talk more about that. That business, I think, crossed over $300 million or so last year and weâre going to be bringing on another 150 or so of capacity. We donât see a lot in 2023. But we also have really special capabilities around GMP-grade guides for CRISPRs were really capacity constrained. So I think we think thereâs opportunities for us to not only continue to meet the increasing demand for siRNA, but to play more broadly across that space into antisense, into GMP-grade CRISPRs. And I think thereâs a real role here for Agilent play because of the reputation we have in the marketplace, which is how are we able to overtake and become number one in our space, which was not only that we have these great state of the art facilities, but we have a great technical team. And in the way this marketplace works from our perspective, itâs not simply the customer handing over a recipe to us say, go make this. Weâre actually intimately involved in their development activities. And weâve got a reputation in the marketplace of a company thatâs customer-oriented, easy to work with, highly technical and really there to ensure the customer success. So I think thatâs the kind of things that get us really excited about this space because â and then the market itself is just continuing to grow. And when we first started in this business a number of years ago, there was questions about would this science actually prove out to and weâre seeing really good indications from our pharma partners about therapeutic common market, theyâre going to service even broader population â patient populations. Yeah, I was going to say, I think that thatâs where we get really excited is when we look at the targeted disease states that are being developed right now, theyâre much larger targeted populations than the current products that are on market. And I think that helps us because people, you hear about oligos production and so forth, and many people make them, but they donât make them at scale. And so our ability to make these in kilogram scales, commercial volumes I think is best in the industry. And I think are continuing to push that envelope and invest gives us a big opportunity as the disease therapeutic areas continue to be larger and larger. And itâs one thing to do, all it goes for research, nothing to do for GMP. And you have to have the right systems and capabilities around regulatory. And as Bob has mentioned, one of our competitive advantages is be able to produce at scale at GMP side. So weâre feeling pretty good about our position in the marketplace and weâre also feeling increasingly confident about the uptake of Train B when it would come online for us. As you may know, we had some challenges relative to COVID where a lot of the skilled tradesmen were â we just couldnât get them, they just werenât available because they were ill, supply chain issues thatâs all behind us. So we still have work to do, but as Bob and I have been saying today, itâs under our control. And I know this question has been asked a lot this morning in other meetings, but just kind of remind us on at a $300 million run rate as you exited your fiscal year and youâre bringing on Train B $150 million, how should we think about the phasing in of that new capacity as it relates to the run rate for 2023? And then on the cost side, how should we think about the cost side? Yeah, thatâs a good question. So, our expectation is by the end of the fiscal year we will be at kind of the capacity run rate. But I think if you thought about that $150 million run rate created a third of that, thatâs probably a good number for FY2023 weâre assuming double digit growth happening and then obviously the full complement happening in 2024, so going on a $450-plus million book of business in 2024. We are going to expect to see startup costs probably into the tune of $10 million to $15 million in 2023. Thatâs built into it, itâs baked into our guide probably starts in 20 â in the second quarter as weâre training, bringing on folks for training on the floor and weâll have more of â the incrementals look very good, but youâve got a fixed cost of turning on the light, so to speak. And then going into 2024, then you would have that run rate being very accretive to the overall company. Got it. And then just on cell analysis business, a similar question. I mean, youâve built this business over a series of transactions or sort of last call is seven years built it into about a $375 million business growing around 25% plus. As you think about scaling that business as well and competing in that business, how do you think about Agilentâs position today versus where it could be? And how do you think about investments both organic and inorganic? Yeah. So thanks for that question, Matt. In fact, weâre all delighted. This is an example of our buy side of our growth strategy and through a series of really targeted acquisitions I think we build a nice business. And I think it first of all starts with the kind of view of our portfolio, right? So we have some of more traditional tools in the cell analysis, like plate readers, but we also have leading cutting edge where nobody else has these live cell analysis, for example, some of the imaging platforms. And so we think we have the scale to compete. And what weâre after and weâre going to be driving and why weâre going to continue to win is to be able to integrate these tools in common data formats to be able to have the integrated data analysis because what you would find as you go into these laboratories is they were using different equipment from different vendors, and weâre now going to have integrated workflows. That being said, this will be an area that we could see not only increased organic investments, but there are other things we can do inorganically here as well. So thatâs an area that weâll continue to look at for opportunities. And I think probably the same thing holds, we didnât â I didnât mentioned earlier when you were talking about the NASD business, there could be inorganic plays there as well. Got it. Just shifting a little bit to the risk side of the business, as we see them at least and would love to get your view on it, Europe is kind of still high on our list, given the energy situation over there. Youâve called it out over the last couple of quarters as being sort of on your watch list. You grew 14% in fiscal Q4 in Europe, so it hasnât shown up yet. But itâs something that youâve obviously talked about and is concern of â how do you see sort of in Europe the best of your ability playing out over the course of this year, particularly if we get a mild winter? Has there been some sort of subdued spending from some of the customers over there we could see return in the back half? How are you thinking about that? Yes. No, so great question. And I mentioned earlier that weâve now been able to see how the business finished through calendar year 2022 and havenât seen it yet. It would be the same statement around Europe. I think â but I think we still have to be cautious there because thereâs just so much macro noise around the economic impacts and the customerâs ability to invest when theyâre dealing with higher energy input costs. That being said, if things do continue in terms of moderate â more mild winter, if energy prices arenât at the escalated levels that people had anticipated, that could be that positive for us. Weâre not ready to call it but if that situation would develop with this thought as we set up the company, for 2023, what we knew was pointing to slowness in Europe. We havenât seen it yet, but those macro win headwinds that people were â have been concerned about havenât also dissipated either. Yes. Got it. In regards to China, obviously, some big policy changes there when it comes to COVID, which given the disruptions that you saw earlier this year, which â I have to say, you probably had the most significant disruption during calendar Q2, you still beat numbers, so it was very impressive. But â so weâre probably not going to see that from a government policy standpoint. However, there still probably will be disruptions because of COVID in China. How are you thinking about the opportunities in China under the sort of the new non-zero COVID policy? And what youâve learned this past year in terms of how to adapt to that environment? Yes, thank you, Matt. First of all, thanks for the recognition on how we handled 2022. I think sometimes we may get lost in a quarter-to-quarter variation was we did 18% of growth for the year in China. And then as you mentioned earlier, in our second quarter, we were pretty much for shut down in Shanghai for a large part of the quarter, all of April and a good part of March. And the team did find a way, the business was never lost, it was always deferred, et cetera. But in terms of learning, and Iâll get to the impacts of how we see the change in policy, in terms of learning what weâve done since then is really made sure we opened up multiple entry points into the country. So what we saw was if there was a lockdown, it would be in one particular area, but we over-indexed to Shanghai. different ports of entry. Weâve also put more â and you probably saw us a little bit in our working capital, we put a little bit more in terms of consumables and support parts in, what we call, forward stocking locations so that you werenât dependent on a support part coming in from the U.S. or Germany or someplace to get to our service engineers. So thatâs kind of things weâve done to sort of mitigate the risk. We relative to the change in policy, we were really delighted to see that because itâs now the situation is more under control, weâve actually already weathered one of those storms already without any impact. Weâve seen a lot of â we saw the wave kind of go through as a large percentage of the workforce was hit with COVID. Theyâre all back to work now. So fortunately, we havenât seen high degrees of real severity of illness. And weâve learned â back to learning, weâve actually learned to work remotely because a lot of people were still working remotely even ahead of COVID. So long story short, weâve already experienced some of the waves on our workforce in 2023. You wonât hear us talk about it in the quarterly call. So weâre feeling that itâs going to be more of a, if you will, normal cadence of business in China. And then hopefully, this also leads to improvements in the overall economic growth in the country, which I think is really part of the reasons behind some of the changes. And then weâre also hearing some indications that there may be some stimulus coming the way in 2023, still early days. So thereâs â Iâd say right now thereâs more net positives than net negatives relative to whatâs happening in China. Yes. Maybe address that stimulus because we were talking about it earlier about it could actually represent an upside for the back half of the year, particularly in the academic channel within China. Maybe talk about the dynamics of actually the stimulus money translating to spend in China relative than what people like you see in the U.S.? Yes, no, so, sometimes itâs a little opaque in terms of whatâs going on. But once the decision is made, it gets implemented very quickly. So weâre hearing indications that thereâs going to be money going into particularly life science research, academic research and we think once those plans get finalized, they get implemented really quickly. On the flip side is, the CHIPS Act in the U.S. was implemented with a lot of â was announced with a lot of fanfare. Itâs taken some time to actually get the point of the money being there. Now itâs the good news is weâre actually starting to have the conversation with customers about what this means for the new facility. So itâs starting to happen in the U.S., but Iâd say we think from announcement to implementation in China, we can expect that to happen more quickly. So perhaps thereâs a scenario that says, hey, after they come back from Lunar New Year, we know, get some more clarity and maybe itâs even as early as the second half of second half of 2023. We havenât assumed any of that. Got it. Moving to the newly renamed CAM segment. Itâs obviously had a great couple of years, and youâve talked a little bit about some of these secular drivers, semis, lithium battery material sciences, kind of how are you managing these end markets in terms of capacity, spend and focus? And do you feel that the overall CAM segment is significantly less cyclical than it has been in the past? And I do want to follow up this question with sort of overall commentary on resilience of Agilent and how the perception of Agilent is necessarily lined up with the reality of Agilent today when it comes to the resilience. And I think the CAM segment is actually a key part of understanding that. Yes. Iâm not looking at your question, but Iâm so glad you asked that question because that will be part of our â continue to be part of our storyboard, which is a much more resilient company. And the CAM segment is one â and we purposely changed the name because Iâve got a support contracts business, which is roughly 10% of all of Agilent. Iâve got an energy business which is less than 2% and thatâs what everybody always wants to talk about. Why are we talking about such a small piece of our business? By the way, we talked about this Chemical and Advanced Materials segment just to kind of frame it for the audience, about 35% of that is, what we call Advanced Materials, about 55% is Chemicals and about 10% is energy related. And 20% of the CAM â 20% of the total company; and then this Advanced Materials, we think there really is secular drivers behind it. So what are we talking about? What we're talking about is the revolution that's occurring in the automobile industry where we're moving to electric vehicles, which requires batteries and there's a lot of investments happening in terms of not only in production of batteries, but making them better. And a lot of that is centered in places like China. So â and that's also a concern from many people's perspective, nobody wants to have a concentration of key supply chain components anywhere in the world. So we're seeing both investments in China as well as in the U.S. and in particular, in this area. We talked a bit about this already. The on-shoring that's going relative to â initially it was about key ingredients for the pharmaceutical value chain, but now it's really focused on semiconductor chips. So we think there's new, if you will, secular drivers in the CAM space, which makes this market less cyclical. There's still a level of cyclicality there, but not like it was historic. And I think we're going to, Bob and I we are going to put in together some material to kind of show this to everybody. But... Yes. I think maybe just to put a couple of numbers to that. So the area that is probably the most cyclical is that energy set, 10%. Five years ago, that was about 30% of the overall market. So you can see in over this last period of five years, a dramatic shift. And then you couple that with more and more services being built into kind of the CAM market as well as part of ACG's expansion and so you get this more resilient business. And I think these investments in semiconductors, reshoring and then the lithium-ion batteries, that â those are things that I think are strategic countries and industries that are not going to change in the near term. I think that we see those as secular growth drivers that are going to be able to power through maybe some short-term kind of changes in the macro. And I think this is an unappreciated part of Agilent's business as well, which is having the strength in the applied markets is a net positive, right? Because I'm investing in core technology, say, for the pharmaceutical industry, but I can use those technologies in the same end markets as well. And we have a legacy of leadership in the space. Customers know us well. We're well established. So it's a nice leverage play for us as well. And then while it's not in the CAM space, we're also, as we were talking a bit today, the whole PFAS testing is a new â but PFAS testing is also a new secular driver for the business we haven't seen for some time. Yes. I mean, PFAS was funny when we initiated on the sector in 2020, we wrote about PFAS and no one wanted to talk about it. And so it was just crickets. But I think it's â you guys were probably the first one to really start talking about PFAS. And I think the technology has now come to the point where it's implementable and the problem, given some of the new regulations that are coming in and will be coming, I think the problem is being recognized. So maybe help us frame the size of the market today, the growth rate, what your share of that market is today? And how do you see this playing out over the next couple of years in terms of future regulatory EPA getting involved? How do you think about it? Yes, I think the audience is probably already quite familiar with the word PFAS, but again we're talking about the forever chemicals, and you may have seen some recent announcements of large companies getting out of the space because it's very clear that there are some issues relative to health consequences. There's thousands of these. We're seeing indications that thereâs going to be certain â certain chemicals will be regulated. And we think this is early days. I think perhaps the reason why weâre talking about it is weâre the leader in the space. So we sized the market of roughly $200 million, weâre probably half of that right now. We think that this has got multiple years of double-digit growth ahead of us because itâs going to be a regulatory-driven marketplace. The regs themselves are still evolving. A lot of it is now state-by-state here in the U.S. But you could see eventually perhaps something happening at the U.S. national level, the EPA I think youâll see regs happen in EU as well as China. So and I think thereâs going to be continued focus on the research because itâs still not clear exactly what â itâs everywhere. And how concerned should we be about all of them or is this a subset of them. So I think thereâs going to be money in the research. So weâve really started seeing kind of kickstart with the Infrastructure Act here in the U.S. And speaking of time, it took to get money from an act actually down to companies and states and so forth. And I think that thatâs where weâre starting to see that state-by-state regulation. But I think now what youâre seeing is potential for EPA to have standards across water testing in some areas. And I think that, that is â would be a real growth driver in terms of just the volume of screening that would be required. And as you said, the technology continues to advance and the science continues to advance in terms of understanding what these potentially could mean. And we think this is an expansionary play because to do this properly, you need to have the latest technologies. And we also know that our customers in environment labs, they donât have unused equipment to begin with. So itâs not a matter of just running another application on the existing equipment. So we see this as incremental growth. Yes. And our claim to fame here is not only to have the great instrumentations required, but the integrated workflow, including the sample prep to be able to, if you will, soup to nuts, be able to work with a customer and how to do the application. Okay. And minute left, weâre going to touch on capital deployment. Youâve already talked a little bit about it. But I think what would be interesting to folks is sort of the sense youâre getting from sellers has that â has sort of the bid-ask spread narrowed and how are you thinking about private versus public, bolt-on versus larger, just your view... Yes. So I think youâre talking about the M&A element of our capital deployment. Weâre also, as you know, are going to be investing on the CapEx side, as we talked earlier. But as Bob mentioned, I think, earlier today, it says weâre now in the same room. We werenât even in the same building before in terms of bid-ask spread. Iâd also say that weâve historically focused on the private sector, but there now are some interesting things that have us looking in the public space as well. There are some companies out there that have been kind of beaten down, but maybe unjustified so. I mean, theyâre still kind of â weâve got to be really careful because some companies we donât see viability of their businesses, but okay that might be interesting. So weâre more open to doing public deals and be, we would continue to do it on a friendly basis though. So we see the valuation as a net positive to this space. We also see HSR as real. So if youâre still â if youâre not â if there isnât any overlapping, itâs an easier path for you to win the deal in terms of approval standpoint. But I think you also do quality deals because money is no longer for you.
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Perfect. Hello, everyone. This is Rachel Vatnsdal from the Life Science Tools and Diagnostics team. Thank you so much for joining us today. So I'm joined with the Agilent team, Mike McMullen, CEO. Standard with the other sessions that you've been attending today, we'll kick it off with a 20-minute presentation by the company, and then we will shift to Q&A. During Q&A, if you're joining via webcast, you can feel free to submit a question via the Q&A function. And for those of us in person, feel free to raise your hand, and we have mic runners throughout the room that can hand a microphone off to you. Well, thank you, Rachel. I know I say, as I mentioned earlier, it's just great to be here and must be -- it's great to be back in a phased environment here at JPMorgan. So, thanks for joining today. There's three parts to my talk today. First of all, I'm going to talk to you an overview of Agilent, who we are, what we've been doing in terms of shareholder value creation. Then we're going to move forward and talk about where we're going to make sure that we can continue to perform at a high level in 2023 after the Agilent team delivered an excellent 2022. And then I'll close with what you can expect from Agilent in FY '23. But first, for your reading pleasure, our safe harbor statement. Okay. With that, I want to move on to who is Agilent. We're a $6.8 billion company with unsurpassed scale, a leading partner with unsurpassed capability to scale across the world's 265,000 laboratories. I would also say we've been working really hard to change the overall mix of the company's business. You noticed we've highlighted here the move to -- almost 59% of our revenues today come from high-growth pharma, these connected high-growth areas of pharma, clinical diagnostics and life sciences research. If you had a chance to listen to me talk last year in our virtual format, I talked to you about we had a winning strategy, this Agilent team. The Agilent team was performing at a very high level, and we're going to deliver, and that's exactly what we did in 2022. So, we grew 12% core in 2022 on top of 15% of the prior year. Margins, up 160 basis points in an inflationary environment that none of us have seen for a number of decades, and then our earnings per share growth continues to accelerate. We did 20% growth this year on top of 32% of the prior year. So, we're not at all satisfied. We continue to push ourselves. We're going to continue to drive shareholder value creation as we move forward. In fact, in terms of shareholder value creation, I want to remind you of what is our model here at Agilent. I stood in front of this group when I first became CEO back in the 2015, and I described our shareholder value creation model at the time, which was to drive above-market growth, which can tap a continued expansion of the operating margin and deploy capital in a balanced way. That's been our model that's been intact for -- since 2015. And what can you expect from that model? What we shared at our most recent Investor and Analyst Day back in, I guess, December 2020, right, Bob, above market growth, I think we'll do 5% to 7% core as a company, continue to expand operating margins. I'm sure we'll get into some of those details in Q&A, of 50 to 100 basis points per year, and continue to use the strong Agilent balance sheet to deploy capital in a balanced manner. Where does that all lead to? Double-digit EPS growth. And you can see by our results for the last 2 years, we're delivering on this commitment here. And as I show you the results for the last 5 years, you'll see that it's been a continuous story of delivering on this model. In fact, these aren't just some theoretical business model that we talk about with investors. This is what drives the Agilent team. And what I would say with you is that if you look at the growth rate of this company, pre-2015, which I call the creation of the new Agilent after the -- our spin-off of our Electronic Measurement business, and we come in a full focused company on life science diagnostics, our growth rate has accelerated. So not only had our growth rate doubled, but you'll see in the last few years, it actually has been accelerating with 15% core in '21, 12% core last year. I can remember being in front of a group like this 5 or 6 years ago talking about operating margin expansion. Could you ever get to 22% operating profit? Well, we've blown right through that. Margins are up 800 basis points since 2015. And last year, as I mentioned earlier, we delivered 160 points of improvement in an inflationary environment. Where does this all go to? Again, this idea of superior earnings growth, 17% CAGR through the last 5 years, now 32% in '21 and 20% in the past year, going from $1.74 to $5.22 in FY '22. So again, we've lined up our compensation systems. This is how we focus the entire company on this model. So, it's more than a theory. This is what we do at Agilent. I want to dig in a little bit deeper about the comments on the balanced capital deployment. So, what do I mean by that? So, we've got this great balance sheet. So how are we going to use it? So, the way we're going to use this balance sheet is to drive investments for growth as a top priority. So, let me start to the far right. So, this includes organic investments of CapEx. Up through 2015, we've invested about $1.3 billion in CapEx primarily to the first phase of growth for our NASD business but also to expand production capacity across other parts of the Agilent portfolio. Now I hope you had a chance to catch our press release that went out yesterday, where we announced another $725 million on top of this as we continue to expand our NASD business. And I'll be going to dig deeper about that, our plans there later on in my comments this morning. And then we've also deployed over $3 billion in capital for M&A. And we're really targeting great companies in fast-growing end markets, and we're really happy with our success to date. In fact, over 8% of Agilent's revenues today have come through acquired companies. And you hear me talk a lot about today, this build-and-buy growth strategy that Agilent has. The build -- our internal organic investments at NASD investment is one example of that. And then the buy, obviously, is what we've been doing with the M&A side of our activities. While returning capital to shareholders. So, during the last 5-plus years, we've paid out $1.6 billion in dividends. I think this is actually underappreciated aspect of Agilent's capital deployment approach, which is a growing cash dividend that we've been able to do every year since 2015. And then share repurchases, we have bought back $4.4 billion worth of shares since 2015, over $1.1 billion in '22. And you may have seen in a recent press release where we've been authorized by the Board for another $2 billion realization of our share repurchase for another $2 billion. So again, what you're hearing is consistency of execution of what we already called our balanced capital deployment. Okay. It's not just about the numbers at Agilent, although we're very proud of the results we're delivering for our shareholders. We also have a role to play in society. And I'd like to talk to you about our ESG initiatives but I'm going to focus in on sustainability, both in terms of what we're doing relative to our own operations but also how we're helping our customers. So, let's first of all talk about sustainability in our own operation at Agilent. So, we're committed to net-zero emissions by 2050. At Agilent, though, the real plan is to get there. This is not a slogan or some kind of statement. It's real at Agilent. So, we have multiyear plans to get us there. And in fact, since 2014, our car emissions are down 34%. But it's not about just what we can do with our own operations, how can we help our customers? So, you think about -- when you talk to our customers, they're really engaged in trying to meet their sustainability goals, and Agilent has a role here to play. Think about the engineering prowess we have in terms of how we design our instrumentation. It's much smaller and we use a lot less energy, and a lot less waste is generated. So, our engineering for sustainability is really a key part of what we do in terms of our NPI activities. We have an industry unique refurbished business unit, which is basically a certified Agilent pre-owned. So, instruments aren't getting disposed out somewhere in some dump site or actually being recycled and resold in the marketplace for other customers. And our efforts here have been actually recognized by the migraine lab, and we have eco-product labels. You also may know that energy consumption in a lab per square foot is right up there with what you see in hospitals and large commercial organizations. So, our customers are very concerned about the energy consumption that happens in their laboratories. And this is where our CrossLab Connect organization [indiscernible] go in, where we can go in and really offer them advice in terms of how they can reduce their energy consumption. So as proud as we are about the financial results we're delivering, we have a real role here to play in making the world a better place, and we're committed to doing that, both in terms of our own internal operations but also what we do for customers. And as you might imagine, there is a little bit of a commercial story on the right-hand side as well as we help our customers with their sustainability goals. Okay. Enough about the history in the past, let's look forward. The point I'm going to drive home today is Agilent is a diversified and resilient business with multiple growth drivers. So, what's behind that statement? Let me take you through that. So, I think, first of all, it starts with the market and, specifically, where do you want to focus your company's investments? So, a number of years ago, we decided that the priority investments we were going to invest at a higher proportion of our investment dollars into the fast-growing pharma and clinical diagnostic marketplace, while at the same point in time, taking advantage of secular growth drivers in applied markets. So, our model is we can develop core technology and applicate those across multiple end markets. And I think -- as I walk you through our storyboard in terms of our portfolio, you can see what we've got this more diversified, resilient new business. So, building a more resilient business, this doesn't happen overnight. It requires a focused set of efforts over the years. And what I wanted to talk to you today was how have we built resiliency at Agilent, how do we continue to build resiliency in terms of our revenue profile? First of all, it starts back when we spun off at that time a very highly cyclical Electronic Measurement business. That's when we formed the new Agilent. We then made a big bet on services and consumers, our CrossLab strategy. We entered the clinical market and diagnostics market. And as we'll hear later, we've been investing very heavily in biopharma APIs. This is our strategic intent around how to build resiliency. So how is it working out so far? So, if you go back to 2008, 2009, we were in a global recession. I think the global GDP was down 1.3%. Agilent, restated Agilent would have been down about 2%. If you look at what the pandemic caused in terms of 2020, global GDP was down 3.3%. Agilent actually grew 1%. So even in the face of a pandemic-induced global recession, Agilent has found ways to grow. And you can see it on the right-hand side here how significantly changed our revenue mix is from back in 2008, 16% was recurring revenue. Now almost 60% of our business is recurring revenue. So, these are real significant changes in terms of the portfolio of our business, but it came through a series of focused strategies the way it had started a number of years ago. Let's talk about one aspect of that resilience business. So, I mentioned earlier, we made a big bet on the services business back in 2015 with the formation of our Agilent CrossLab Group. The results speak for themselves in terms of how we've been delivering here. The business is now at $1.5 billion of business. I'd point out that 60% of those revenues actually come from annual or multiyear service agreements. So, a high level of predictability about the revenue recurring. We have built a best-in-class customer service organization second to none, and we also tied this very closely to our consumables business. You'll hear us talk a lot about connect rates, which is, of the Agilent installed base how much of their consumables and services are coming from Agilent. And we had a new milestone this last quarter, over 30%. We've think we've got a lot more headroom in front of us. But you can see how the growth rate has accelerated for the first few years from '15 to '20 about 8% over the last 3 years has accelerated to 11% in terms of our top-line growth. Now I'm arguably biased, but I think high growth, high margin, high driver of customer satisfaction. There's a lot to like here with the Agilent to our services business. I talked a little bit about the bets we make in terms of really investing in faster-growing segments of the market. So, a number of years ago, we said biopharma is a place we're going. And now through a series of focused investments and success in the marketplace, it now represents almost 39% of Agilent's total pharma business. And you can see how the business has grown. We were less than $100 million in 2015. We were knocking on the door of $1 billion. I think this chart is $1 billion. I think the actual number is $999 million, but I round it up for $1 billion for this presentation. But we've been driving a really straightforward strategy which is to leverage our positions across the biopharma value chain to expand our offering. So, we've been leading to -- providing leading analytic solutions in and out of the lab, building that kind of our strong instrument heritage here. We're a leader in biopharma services for therapy selection. This is where our whole companion diagnostics business comes in, market leadership in RNAi-based APIs and growing CRISPR position, we're going to dig into that a little bit deeper. And then also, we'll talk about our cell analysis business we built here. It's all about providing the capabilities across the whole value chain for our biopharma customers. So, the focused investments are paying off. And I would tell you we're not done yet. We think there's a lot of growth still in front of us in the biopharma space. So, I've been hitting that this already, but we have a leadership position today in the therapeutic oligonucleotide marketplace, particularly -- specifically siRNA. This is what we refer to as our NASD business. This is a large market, already $1 billion TAM, growing 20%. We become the market leader in this business. In 2022, delivered almost $300 million of revenue, high margin, growing 29%. Why are we winning? We have high-quality oligo API materials. I think it really kind of also -- the key point of the capabilities we have as a team, superior customer service. We are known in the industry as the company to work with. We have a solid and diversified client portfolio and I mentioned earlier there's this deep technical acumen, and we're willing to invest. Right now, we have what we call our Train B, which is the new production line that's targeted to come online in 2023. We're talking about that midyear of next year. In addition -- on top of that $300 million, that will add another $150 million of annual capacity of revenue. And again, we're looking -- we're pretty confident about how things would happen for us in '23 relative to Train B. And for the future, we're not done yet. If you ever have heard me talk before about this business, I've said, hey, there's more letters in the alphabet than A and B. In fact, we just announced yesterday in a press release that we're going to further expand that business, we're on the road to a $1 billion revenue business here as we invest $725 million in what we refer to internally as Train C and D, which is going to give us additional capacity at siRNA, but it also allows us antisense and more CRISPR guide RNAi material. So, we're very excited about this. This will actually double the revenues of NASD. And back to the sustainability story, our new design also incorporates a lot of sustainability capabilities to really limit the impact on water usage and waste production. So very exciting time for us, a great business for us and highly connected also to our genomics research business as well. So very excited about our ability to be on the road to $1 billion in revenue. We crossed over $300 million in '22, and we have more capacity coming on '23, and this will start coming online around '26 for us. So again, pointing to the future of strong growth in biopharma. The cell analysis side of our business, the title here is the buy side is working. Just as a reminder, what's driving this marketplace is things like, immunology, immuno-oncology, immunotherapy investments, cell and gene therapy, a really nice end markets through a series of acquisitions. We've built up a $400 million revenue business, growing 15% since FY '20 on an annual basis. This will be an area of continued priority of investment for us as we move forward. And again, I think it really shows the power of Agilent's business model, which is, we can both build internal investments, as I just shared with you, on NASD but also buy and build some really nice new businesses for our shareholders and customers. Remember, as I said, it's all about the market. And so, we've been really focusing on the higher-growth pharma markets and diagnostics markets. But I also talked to you about the secular trends that are going on in this space. There's 2 that I really like to highlight here, which is what's happening in advanced materials. This is a big market, $1.5 billion. We are the undisputed leader in this space of advanced materials. 2 secular trends I'd focus on here. I picked up a few headlines from the newspapers here. But as you know, there's a lot of onshoring going on relative to semiconductors. And as COVID-19 kind of highlights the world -- how concentrated the supply of chips was in particular parts of the world. You see massive investments, government-supported investments happening right now to build new fabs in the United States, Europe and other parts of the world. So, we're going to benefit by that secular driver that's happening right now. And I think we all know there's a revolution going on in the electronic vehicle side, electric vehicle side of the automobile industry. The demand for batteries is exploding right now. And this is where Agilent plays in the space already from the actual mining of the raw materials that actually goes into the production of batteries but also all through the value chain in terms of development, production and QA/QC. So again, this is a great example of our leveraging core technologies in markets that are growing rapidly. So, we will get the outsized level of growth here relative to our peers. We are the undisputed leader in this space. And then another secular driver I point to in the applied markets relates to the environmental testing area. You may be familiar with an emerging public health challenge, which is the so-called forever chemicals, which are everywhere, and they are forever. And I think there's a growing recognition that this has health consequences. You've seen a number of companies announce their discontinuance of production of forever chemicals. And why is that important for this conversation today? There is increasing levels of research and regulation happening in the space to monitor water test for water and other types of contaminants, if you will, out there. And this is where Agilent comes as leader in this space with our configured systems to allow our customers to work on PFAS. This initiative has really started initially in the United States. It's growing in Europe, and we expect China and Japan also to follow suit with more regulation, creating new opportunities for the company. So, going to just highlight the last three months just to show you about the secular drivers that happen in our applied markets business. So, in my opening comments, I said what can you expect from Agilent in 2023? Just a reminder of the guidance that we shared in our last earnings call, for the full year, we're expecting revenues of $6.9 billion to $7 billion. That would be core revenue growth of 5% to 6.5%, EPS of $5.61 to $5.69. And then for Q1, you actually see our core revenue growth is guided at a higher rate, $1.68 billion to $1.7 billion in terms of dollars for Q1 with core revenue of 6.8% to 8% and the EPS at $1.29 to $1.31. So, I went through the numbers pretty quickly. I want to get to Q&A, but I'm assuming you've got these already in your notes, but I just want to remind you what our guidance was in our last call. I'm going to close with a few key takeaways that I really hope came through in my conversation with you this morning. Agilent has a diversified and resilient business. We've got multiple growth drivers in fast-growing markets. And it's being driven by this Agilent team, which is focused on our customers. And I think you saw in the numbers, we have a proven track record of success and I would argue unmatched execution capabilities. What you're going to expect for us in the future is we will continue to prioritize investments for growth, expand our base of recurring revenue and anticipate and react quickly to changing conditions to deliver at a high level. So again, thank you for joining us today. And Rachel, I think we're going into Q&A. I think Bob is going to join us as well. So yes, we're shifting to the Q&A portion. As a reminder, if you do have a question, please raise your hand, and we'll have a mic runner hand you the microphone. So, thank you, guys, again for joining us. I figure just to kick it off, cyclical concerns, you highlighted some of the more nascent markets today like battery testing, PFAS, also some of the more semiconductor testing as well. But can you talk about how the portfolio has really shifted since 2008? And what is the resiliency of your portfolio today? So how much would you view as your portfolio tied to those true more cyclical end markets like energy? Yes, Rachel. It's great to have that first question because you hadn't seen my deck before you prepared those questions. But hopefully, what came through on a couple of key points I tried to make earlier, which is, first of all, the big mix of recurring revenue. So, we've gone from 16% to 58% of our business is now recurring revenue. We now have a very large services business. We have a diagnostics business. We have an API business, and these tend to be fairly insulated relative to global GDP pressures and then the big bet on pharma for us as well. Yes. And I think when you look at pharma, that business is now almost 40% of the total revenue back -- that's up from 10% to 15% probably back in 2015. So, you've got much more strong growth in more resilient end markets. And then coupled with that, even within the CAM and Advanced Materials area, that energy that you just talked about at one point in time, back in 2015, that was about 30% of that business, it's less than -- it's about 10% now and with the secular drivers that we talked about. And Bob, I think probably the energy segment is less than 2% of Agilent's total revenues. And that's why we actually changed the name of the segment to be Chemicals and Advanced Materials, more reflective of what's really going on there. Yes, perfect. Maybe as digging deeper into some of those more new markets like the batteries and semiconductors, can you just talk about what gives you confidence that these are going to be more resilient heading into a recession? We haven't really seen those markets be tested yet. So, what's your visibility into the growth there, longer term? Yes. So, you can imagine something like bringing on a fab is a multiyear investment, but the big difference is there's government funding and public support for these initiatives. So, it's now viewed as a matter of security and national security in terms of where we want to have chips manufactured. We haven't seen this level of government support in the private sector in the United States or Europe since I've been in this role. So, I think these -- I think you've got a level of funding that's coming from not only the private space but also the public sector space. And then on the electric vehicles, and Bob and I were talking about this, this morning, I mean all the major automobile manufacturers have major initiatives in this area. They're directly funding a lot of the research. We're also seeing money coming in from, again, government sources. So, I think it's this -- part of this play here is not just the private sector supporting these investments, but you're also with the government support. So, can you just talk about how much do you think is either an underlying market acceleration and instrument growth versus Agilent share gains? And then also, how are you thinking about this instrument replacement cycle and some of the growth being sustainable going forward? Do you think that we're going to have a reset given the tough comps? Or how are you thinking about instruments heading into '23? Yes, sure, Rachel. I think Bob and I will tag team on this. First of all, we're just delighted with the performance over the last 2 years of our LSAG business, which houses our analytic instrumentation business. And if you heard me talk before, I've quoted my Danish colleagues to say our market share results have been green, green is a Danish far. So, we've been actually picking up share across our core platforms. But I think part of the big story here is there's been a lot of demand. And I would submit that, in certain segments, there's been an accelerated replacement cycle going on. In particular, I've been on record talking about the small molecule segment of pharma, which really, in our -- from our assessment, delayed investments in 2018 and 2019 but sort of in a catch-up mode. So, we expect that to move towards the mean as we go into '23, and that's how we set up our guide. But we also think other parts of the instrumentation portfolio are driven by secular demand. Yes. Some of the ones that we just talked about, certainly in the Chemicals and Advanced Materials, we think, are secular drivers. And then I think within that pharma business, we still do believe that biopharma is a faster-growing end market than it was going into the company. And so, we still see expansionary opportunities there in the instrumentation. They are driven by the science. And we're seeing that with our customers. That's about 39% of the overall pharma business, as Mike just talked about, a combination of both instrumentation and services. And I think what's important here is it's really a workflow play. It's not just instrumentation. It's also the services and the applications. And that's one of the biggest areas of investment that we've been making in R&D, and we're seeing it in the results. Yes. And Rachel, I'd maybe drive -- draw connection here back to our ACG services business. So actually, we're going to get delayed gratification because we've placed so many instrumentation -- instruments over the last 2 years, and many of them start to come off warranty as we go into '23. So that will be another driver for us in terms of growth in services. And as Bob just mentioned here, back to this resiliency question. I forgot to mention this, but we've had this workflow strategy. So, as you sell a workflow around the instrumentation, you're often into a situation where, for the next 7 to 10 years, you have a recurring revenue stream, the consumables and services relative to that workflow. Helpful. And so then maybe just looking at your guidance for the fiscal year '23, you've mentioned how you have really strong visibility into the first half of the year. You guided to 5% to 6.5% core growth off of a stellar fiscal '22. So, can you talk about the implied guidance more towards the back half of the year? Is that more -- are you seeing some type of slowdown that could suggest that in the back half? Or is it really just out of an abundance of caution and conservatism given this point? And then what level of visibility would you need to see to be comfortable with lifting that guide throughout the year? Yes. So first of all, thanks for the characterization of 2022 a stellar. So, I'll take that on behalf of the Agilent team. The way we said at the guide was we have really good visibility in the next 3 to 6 months. So, we know what's in our order backlog and we know what's in our funnel. So -- and because I think that's really -- if you think -- look at Agilent's businesses, keep in mind that we're really talking about the CapEx instrument piece -- portion of the business. And we have really good visibility in the next 3 to 6 months of how that's going to shape out. As we said, the guide for second half -- for the full year, we said we really don't know what's going to happen. It's not a prediction. It's just a measure of, if you will, can I use the word prudent, in terms of our guide setup, which is we really don't know how the back half of the year is going to look like. What I can tell you is through calendar 2022, as we finished off our order book, orders came in as expected for the full calendar year. So, Bob... Yes, you characterized it well, Mike. I think as we look through Q1 and Q2, we'll have more visibility, obviously, into the funnel. And obviously, we're also going up against tougher comps in the back half of the year. So that does play into it. But I think it is kind of a wait and see. We're not seeing anything in the market that would suggest a slowdown in the back half, but we're a few weeks in into the calendar year here, a few months into our fiscal year, and we'll know a lot more in a couple of quarters. Yes, helpful. Then shifting over to China. So obviously, we've had some concerning headlines coming out of China with the recent outbreaks there. So, can you talk about what you guys are seeing in the conversations that you're having with your customers in that region? Also, Lunar New Year coming up. And then, finally, you flagged some potential stimulus in China. So, net-net, kind of walk us through what you're seeing in that market. And is there any upside or downside risk to that high single digits you've laid out in China for '23? Yes. So maybe just remind the audience how things worked out in the '22 for Agilent. So, there's a lot of variation by quarters as we were experiencing government mandate they had to shut down to certain parts of the country. But for the year, we actually delivered 18% growth for China. So, our business in China was very strong, and we have a great team there. I think we guided high singles for the year. We think that the recent change in the China government policy is a net positive for our business there because we will have -- in situations where our workforce may be effective with COVID and maybe it won't be able to work for a period of time. But we're not dealing with government-mandated restrictions, and so we think it's overall net positive. It's going to take a little while to kind of work through some initial disruptions as the well-publicized waves have been gone through different parts of China. We're experiencing that right now. And we find -- we've gotten pretty good about navigating our workforce and being able to work from home and avoid situations where people can't work all the time. The one variation, obviously, would be whether or not if customerâs labs have to be shut down for a period of time. Lunar New Year, I would just say, we're -- I was talking earlier this morning with one of our investors that said I'd love to not talk about Lunar New Year but it's always seem to be the case. So, for Agilent. This year, we actually lead to a condensed revenue cycle in China. So, we'll be fine for the first in Q1. So, don't be spooked by Q1 numbers is all assumed in our guide that will have less week or so less of revenue. Yes. I would say, Rachel, we're positive on China. And we think that, that business is going to be the fastest-growing region coming in to this year as of fast-growing last year. The stimulus that you talked about, I think we'll find its way much faster than stimulus finds its way in Europe, in the U.S. into key strategic industries which we support, whether that be semiconductor, bioprocessing and even the energy areas. I think that those are critical strategic areas that are part of their 5-year plan. Removing the uncertainty of the overhang around shutdowns and so forth and being able to manage that internally, I think, is a -- there will be disruption, I think, short term, perhaps, but it's much more manageable than, all of a sudden government-mandated shutdown that we can't go to the factory. And our capabilities are smack dab in terms of the priorities that the Chinese government has set for the country. So as Bob mentioned, we're very positive on China. Perfect. Shifting over to NASD then. So, Train C and D, great to hear about that announcement this week. So, you said that costs will be estimated $725 million set to open in 2026 and 2027. So, for starters, really, how should we think about the pacing of that investment over that time frame? And then on the demand side, can you talk through some of the levers there that gives you confidence that you're going to be able to warrant enough demand to really double the capacity there? Yes. As you can imagine, we've done a lot of work trying to quantify that and looking with our existing customers and looking at the clinical trial demand of not only our existing customers but also other opportunities and feel very confident. And one of the reasons that we feel confident is if you look at the therapeutic areas that are being targeted for oligonucleotide therapeutics or siRNA, they're a broader and broader patient population. So, more and more patients, and we're just seeing that with some of the products that we have on market in partnership with our partners. And so, we're looking at that. We feel very confident about that. We already have Train B, already orders in hand. And when we look into the future, not only looking at our existing customers, but the number of new therapeutic areas that are being focused on, we feel very confident that there will be enough demand out there to satisfy the capacity that we have. Yes. I wanted Bob to speak to it because it's not just me that shares excitement around this business. And Bob, maybe you can talk a little bit about the pacing of how the CapEx will be deployed. If you think about this pacing, we're -- as a reminder to what Mike just talked about, we're scheduled to have Train B, which is $150 million of revenue opportunity coming online mid this year. We expect that to be actually fully ramped up by the end of our fiscal year on an ongoing basis. So that will be a nice '23. We're expecting double-digit growth for that business and then going into '24 as well. And then from a CapEx perspective, that hasn't been built into the $300 million that we had built in. It's roughly $100 million to $150 million in addition this year and then more in '24. And then as we build the factory, because this will be a new shell in Frederick, then we'll start bringing that online in '26. And as I mentioned in my presentation, we have a large and diversified customer base. So, we have good line of sight to demand even out to '26 and '27. So, it's not like we're trying to build something and go look for the business. So, we know the business is going to be there. Perfect. Helpful. Then during your comments earlier, you mentioned some of the small molecule and the robust growth there. It grew 21% in fiscal 4Q, really strong numbers for small molecule. We haven't seen that in a long time. So, can you walk through what's really driving some of that acceleration in small molecule? You mentioned some of the replacement cycle. But just dig deeper into that. How resilient is this growth? And at what point do we kind of see a reset here? Yes. We're assuming it's going to reset in '23. And we're just delighted with the growth that we've seen over the last several quarters in small molecule. For the most part, this is a more mature market in U.S. and Europe. And our thesis is that there was a delayed reinvestment in this area in 2018, 2019. You may recall from our earnings calls, we're actually talking about that. China has always been in expansionary mode. So, we expect that to continue. But we think over time, you'll start to see a tapering down of the replacement cycle in liquid chromatography. But again, keep in mind, it's still an attractive market, even when it -- they're still advanced, but probably like 5% or 6% growth rate as opposed to 20-plus. Helpful. So also, in terms of announcement, you announced a partnership with Akoya last week. So, I was just wondering if you could dig into that. Why was Akoya the right partner to partner with from a technology perspective? And then more generally, why do you view Spatial as an attractive market? And is it safe to say that it actually could do more in that area going forward? Yes. So, we're delighted with the partnership we announced earlier this week. And we know Akoya quite well. In a -- for a period of time, we actually were directly invested in the company. So, we're a big believer in their technology, their capabilities and where things can go on the Spatial front. And we saw this as a natural extension of -- if you say, a real recognition of the strength of our Omnis sustaining platform. So, we thought this is a great way for us to participate in the space with Akoya, it's nonexclusive. And we think there's more that can happen in the space for Agilent. Helpful. PFAS testing. That's an area that you and some of your peers have started to talk about much more meaningfully recently. So, can you talk about -- you highlighted some of the regulation here today. But what should we look for going forward? Are there any other regulations coming down the pipe on PFAS? And how meaningful of a market can that be? Yes. I think you're going to expect to see more regulations. And a lot of it is being driven in the United States at the state level. I think you'll start to see things happen at the national level. We expect the same thing to happen in Europe as well as China and Japan. So, this is a $200 million market. We think it's growing greater than 10%. We expect that growth rate to continue for a number of years. Helpful. And then shifting over to M&A. You guys have noted that you're willing to do maybe a larger deal here. You also spoke recently and said maybe looking at a public company. So, can you just dive a little bit deeper into that? What areas of the portfolio do you think could be best? There's obviously been a lot of beat-up names in our sector as well. So what areas are you really looking at for M&A? Yes. By the way, our recent comments aren't anything new. It's just a restatement of what we've always said, which is we have the ability to do larger deals relative to -- our till date was the BioTek acquisition, but we have really strict parameters in terms of how we think about M&A, both in terms of maintaining investment grade. It's got to be accretive. It's got to be the right kind of deal that we can make it work for our customers. I mean, excuse me, our shareholders as well as customers. What I would say is -- I realize that this is an interesting microphone. Okay. Sorry about that. I think the areas that we have been investing in, you've seen us do deals, cell analysis, genomics and diagnostics, they still remain the priority areas for the company. Yes. I think one of the things that we're looking at is making sure that we're in markets that we know, and the beauty of the end markets that we play in are large already. And so, I think there's a lot of opportunities and targets out there. And I think with our strong balance sheet and cash flow, we're -- our funnel is quite healthy. Yes. And again, I keep coming back to our comments about Bs, we talk about our build-and-buy growth strategy. The buy is all optionality for the company. We don't have to do deals to make our model work. But if we can find great companies, we will move on them. Helpful. And then last question, just on leverage. Just given this market and what we're in today, what are you willing to go to from a leverage standpoint for looking at some of these deals? Yes. We've been on record in saying that our goal is to make sure that we maintain investment grade. And it's even more important in today's environment than in the past when money was, I would say, almost free. But where we are today, we still have plenty of leverage to get there. And I think we'd be comfortable with several turns but, again, being focused on maintaining that investment grade.
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Good day, and welcome to the Steel Dynamics Fourth Quarter and Full-year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After managementâs remarks we will conduct a question and answer session and instructions will follow at that time. Please be advised this call is being recorded today, January 26, 2023, and your participation implies consent to our recording this call. If you do not agree to these terms, please disconnect. Thank you, Jenny. Good morning, and welcome to Steel Dynamics Fourth Quarter and Full-year 2022 Earnings Conference Call. As a reminder, todayâs call is being recorded and will be available on our website for replay later today. Leading todayâs call are Mark Millett, Chairman, President and Chief Executive Officer of Steel Dynamics; and Theresa Wagler, Executive Vice President and Chief Financial Officer. The other members of our senior leadership team are joining us on the call individually. Some of todayâs statements, which speak only as of this date, may be forward-looking and predictive, typically preceded by believe, expect, anticipate or words of similar meaning. They are intended to be protected by the Private Securities Litigation Reform Act of 1995 and should actual results turn out differently. Such statements involve risks and uncertainties related to integrating or starting up new assets, the aluminum industry, the use of estimates assumptions in connection with anticipated project returns and our steel, metals recycling and fabrication businesses as well as to general business and economic conditions. Examples of these are described in the related press release as well as in our annual filed SEC Form 10-K under the headings Forward-looking Statements and Risk Factors, found on the Internet at www.sec.gov, and is applicable, in any later SEC Form 10-Q. You will also find any referenced non-GAAP financial measures reconciled to the most directly comparable GAAP measures in the press release issued yesterday entitled Steel Dynamics reports fourth quarter and full-year 2022 results. Thank you, David. Good morning, everybody. Thank you for being with us for our fourth quarter and full-year 2022 earnings call. And as I think you saw, operationally, our teams had a very, very, very solid fourth quarter. Our New Millennium Building Systems platform generated record steel fabrication earnings, Sinton is showing significant operating improvement with a clear path to profitability in the second quarter of 2023. Our new aluminum group is making great progress on our aluminum flat-rolled investments, and I will share more details later in the call. Relative to full-year 2022, the entire Steel Dynamics delivered an exceptional performance with record sales, earnings and cash flow generation. I think it was a tremendous achievement, and Iâm incredibly proud of our team. They are the foundation of our company, and they are the ones that have truly driven our success over the years. It is their culture of excellence and the strategic positioning executed over the last number of years that allows us to maximize opportunities resulting in higher lows and higher highs through all market cycles. However, none of this matters without keeping our teams safe. Often, employees are described as a companyâs most important resource. But for Steel Dynamics, they are more than that, they are a family. And now we number over 12,000 strong. We are continually focused and provide the very best for their health, safety and welfare. We are actively engaged in safety at all times at every level, came in to top of mind and an active conversation at all levels through the organization. And with that focus, the teamâs safety performance improved significantly in 2022. We but there is certainly more to do as we will not rest until we consistently achieve our goal of zero injuries. Thank you, Mark. Good morning, everyone. I add my sincere appreciation and congratulations to the entire team. We continue to hit new milestones throughout the company achieving record annual performance in 2022, with record revenues of $22.3 billion derived from strong product pricing and volumes across all of our operating platforms. Record operating income of $5.1 billion and net income of $3.9 million or $2.92 per diluted share, and record cash flow from operations of $4.5 billion with EBITDA of $5.5 billion. As Mark mentioned, is truly an exceptional performance. Regarding our fourth quarter 2020 results, net income was $635 million or $3.61 per diluted share which includes additional performance-based special compensation of $24 million or $0.09 per diluted share that was awarded to all nonexecutive eligible team members and recognition of their extraordinary performance and costs of approximately $168 million or $0.67 per diluted share associated with our Sinton Texas flat-rolled steel mill ramp. Our fourth quarter 2022 operating income declined 35% sequentially to $759 million due to lower realized selling values and seasonally lower shipments within our steel operations, which individually generate operating income of $178 million with shipments of 3 million tons in the fourth quarter. Our flat-rolled steel mills were negatively impacted during the quarter with high-cost pig iron that was purchased earlier in 2022 during the early stages of Russia and Beijing of Ukraine. Based on current pig iron prices of $500 per ton versus our average cost incurred in the fourth quarter, earnings were negatively impacted by about $80 million. We expect to see that continue into the first quarter and the negative impact is likely to be around $60 million as we work through all the higher price pig iron before the end of the first quarter. For the full-year 2022, operating income from our steel operations was $3.1 billion, representing the second strongest year in our history, with record annual shipments of 12.2 million tons. Fourth quarter operating income from our metals recycling operations improved to $14 million based on increased volume and metal spread expansion despite lower average selling values. For the full-year 2022, operating income from our mills recycling operations was $130 million. Due to lower volume and average selling values, our spare scrap prices fell nine out of 12 months during the year. It was sequentially lower than the record results in 2021. Our Mexican recycling operations have proven to be a strategic key for both sourcing scrap for our Southern steel mills and driving profitability. I want to say a sincere thank you to the Zimmer and Roka team. We continue to effectively lever the strength of our circular manufacturing model, benefiting both our steel and metals recycling operations by providing higher quality scrap to our steel mills which improves furnace efficiency, lowers cost and reduces company-wide working capital needs. And once again, our steel fabrication operations achieved record quarterly operating income of $682 million as metal spreads continue to expand based on steady product pricing and lower steel input costs, which more than offset the impact of seasonally lower shipments. steel joists and deck remains solid as evidenced by our continued strong order backlog and which extends through the first half of 2023. Our steel fabrication platform also achieved another record year in 2022, with operating income of $2.4 billion eclipsing last yearâs record of $365 million. Congratulations to the entire team, well done. This demonstrates the power of our circular manufacturing model and the natural hedge our steel fabrication business provides to steel price shifts. During the fourth quarter of 2022, we generated strong cash flow from operations of $1.1 billion due to strong results in the release of working capital. For the full-year, we generated a record $4.5 billion, our cash generation is consistently strong based on our differentiated circular business model and highly variable low-cost structure. At the end of the year, we had liquidity of $3.4 billion comprised of cash and short-term investments of $2.2 billion and our fully available unsecured revolver of $1.2 billion. During 2022, we invested $909 million in capital investments of which over half related to ongoing construction of our four new flat-rolled coating lines and our aluminum flat-rolled mill investments. For 2023, we believe capital investments will be in the range of $1.5 billion, the majority of which relates to our aluminum flat-rolled investments and the completion of our flat-rolled coating lines. Since our last call, we also announced the location for our aluminum rolling mill as Columbus, Mississippi. Mark will share the strategy of the location later in the call. We are also incredibly pleased to have received near-term state incentives for the project, of $250 million with meaningful additional tax benefits to occur over the next 15-years. During the fourth quarter, we maintained our cash dividend of $0.34 per common share after increasing at 31% in the first quarter of 2022. We also repurchased $413 million of our common stock in the fourth quarter. For the full-year, we paid cash dividends of $237 million and repurchased $1.8 billion or 12% of our outstanding shares, representing a 53% net income shareholder distribution rate. At the end of the year, $1.3 billion remains available under our current share authorization program. Since 2017, we have increased our cash dividend per share by 119% and we have repurchased $4.2 billion of our common stock, representing 31% of our outstanding shares. These actions reflect the strength of our capital foundation and consistently strong cash flow generation capability and the continued optimism and confidence in our future. Our capital allocation strategy prioritizes high-return strategic growth with shareholder distributions comprised of a base positive dividend profile that is complemented with a variable share repurchase program, while we remain dedicated to preserving our investment-grade credit designation. We have strategically placed ourselves in a position of strength to have a sustainable capital foundation that provides the opportunity for meaningful strategic growth and strong shareholder returns while maintaining investment-grade metrics. Our free cash flow profile has fundamentally changed over the last five years from an annual average of $580 million between 2011 and 2015 to $2.6 billion today between 2018 and 2022. Our recently announced aluminum investment is consistent with our unchanged capital allocation strategy. We will readily fund our flat-rolled aluminum investment with available cash and cash flow from operations. We also plan to continue strong and responsible shareholder distributions as we have clearly demonstrated. We are squarely positioned for the continuation of sustainable optimized long-term value creation. Sustainability is also a significant part of our long-term value creation strategy, and we are dedicated to our people, our communities under environment. We are committed to operating our business with the highest integrity. In that regard, we are excited about our newly formed joint venture with Aymium, a leading producer of renewable biocarbon products. We believe our first joint facility could decrease our steel Scope 1 greenhouse gas emissions by as much as 35%. We have an actionable path toward carbon neutrality that is more manageable and we believe, considerably less expensive than may lay ahead for many of our industry peers. Our sustainability and carbon reduction strategy is an ongoing journey and we are moving forward with an intention to make a positive difference. We plan to continue to address these matters and to play a leadership role moving forward. As I conclude my remarks, I know there is some of you that follow more detail of our flat-rolled shipments. So for the fourth quarter, our hot-rolled shipments were 959,000 tons, our cold-rolled shipments were 109,000 tons, and our coated shipments were 1.1 million tons. Mark. Thank you, Theresa. Well, as was mentioned, steel fabrication saw phenomenal results in the platform in the year. And again, thank you to the Penal team. I think their effectiveness and their efficiency and their output per employee exceeds anyone in the industry. So congratulations to you and thank you for all you do there. It was another record quarterly performance, and record annual operating income of $2.4 billion for the year, with record shipments of 856,000 tons. Although the macro industries remain a little mixed, we believe nonresidential construction markets are and will continue to remain strong throughout the year. Despite lower ABI indications, I believe overall architectural firms remain optimistic for 23 Dodge Momentum Index improved around about 6% in December. And nonresidential starts and build rates are also forecast to remain solid through the year. I think the continued onshoring of manufacturing businesses and the infrastructure spending programs will start kicking in that will continue to provide momentum for construction spending. More relevant, I think our customers certainly tell us demand remains solid in spite of economic uncertainty, and it is certainly confirmed by current order rates, not only in the joist and deck business but also our structural products business as well. Our steel fabrication order backlog extends through the first half of 2023, with strong pricing dynamics. And with continued solid order intake rates, we expect to see continued strong volume and performance those operations throughout 2023. And the fabrication platform is not only a significant contributor itself, but it provides significant pull-through volume for our steel mills, allowing higher through-cycle utilization rates, and it also provides a meaningful natural hedge to lower steel pricing. Our MELâs recycling platform had a solid year, especially in light of the challenging pricing environment. During 2022, ferrous scrap prices declined nine out of 12 months and volumes were marginally lower. The team managed to achieve metal margins that were only $2 per gross ton lower than record 2021 results. After seven consecutive months of declining price during 2022, First scrap prices improved in December and January, and it is our expectation that pricing will continue a moderate seasonal increase during the first quarter. Our metals recycling geographic footprint provides a strategic competitive advantage for our steel mills and our scrap generating customers. In particular, our growing Mexican volumes will enhance our Columbus and symptom positions and the Zimmer and Roka acquisitions are performing very well, and integration is outstanding. Our metals recycling team continues to partner with our steel teams to expand traded scrap separation to provide more high-quality, low-residual scrap to our steel mills. The impact of these efforts, along with others in the industry, has demonstrated that innovation will provide ample scrap supply in the years ahead. Similarly, we are also exploring technologies for more effective aluminum scrap separation in anticipation of sourcing material for our upcoming aluminum flat rolled operations to maximize recycled content. Steel operations achieved record shipments in the second best annual earnings in 2022, again, outstanding performance by an outstanding team. So thank you for each and every one of you there, record shipments of 12.2 million tons, operating income of $3.1 billion. Our 2022 steel production utilization rate was 92%, excluding Sinton, compared to a domestic industry rate of 78%. And again, our higher utilization rates are clearly demonstrated throughout all market cycles. Our value-added diversified product offerings differentiated supply chain solutions provides stickiness and the support of our internal pull-through manufacturing volume has clearly demonstrated time and time again that we can maintain a higher utilization than our peers in the industry. As a key differentiator. It supports our strong and growing through-cycle cash generation capability and best-in-class financial metrics. Looking forward, customer order entry is good and backlogs are solid. In actuality, December was a historically high order intake month followed by another historic high order intake year-to-date. So we see a very, very, very solid market developing for the rest of the year. Auto production is expected to increase in 2023 from the lower 2022 rates. Dealer inventories have improved, but still remain meaningfully below historic norms. The build rate in 2022 was roughly 14.3 million units, and it is expected to grow a little to about 15%, 15.1% for 2023 and higher thereafter. Nonresidential construction remains solid as evidenced by fabrication backlog, and as I said, the long product steel volumes. Residential construction has certainly softened. It is impacting HVAC, appliance and other housing-related products, but fortunately, much of our portfolio is biased toward replacement. Oil and gas activity is driving improved orders for OCTG and line pipe and solar continues to grow. And I think generally, this market strength is clearly supporting market price appreciation and in particular, the challenges with OMS in Mexico, has certainly changed the regional sort of markets and the Mexico a stand in Mexico and the U.S. market is certainly benefiting from that. In Sinton, the downstream coating lines are running well. They are running below full capacity, though, as the rest of the mill continues to work through start-up items. The hot mill, and that is the good news, the homes turned the corner, running more consistency, approaching 65% capability month-to-date. We have been experiencing very, very long sequence lengths on the case recently up to 22 hours at a time. We are achieving days in excess of 85% capacity, and we should be around about 150,000 tons for the month of January and improving thereafter. Our current utilization is certainly being impacted by certain supply chain issues related to bearings and roles. This is specific to the casted roles in the segments. But we expect to have this resolved before the end of the first quarter, which will allow for a much stronger production for the rest of the year. Additionally, high-priced pig iron inventory is being drawn down through the quarter and the raw material input cost was normalized for Q2 through the rest of the year. While financial performance will likely be flat there in the first quarter, as we consume that high-price pig iron we expect significant events in both productivity and earnings in Q2. Mill production dimensional capabilities improving there. The hot strip mill design is certainly allowed for thermal mechanical rolling, allowing production of higher strength grades with lower alloyed content and associated alloy cost, and we have already been approved and shipped some API grades. I think experience to-date certainly affirms our technical and process choices, and there is no doubt that this is the next-generation electric arc furnace-based flat-rolled steel technology of choice going forward. We continue to grow our exceptional through cyclical operating and financial performance continues to support our cash generation and growth investment strategies. We have the four value-add flat-rolled steel coating lines under construction. These projects have gone well, and they are targeted for start-up in the second half of 2023. We have a galvanizing line and paint line going in at Sinton and similarly into Heartland, and we are seeing very good customer interest for that new volume. Currently, we are the largest domestic nonautomotive coater flat rolled steel with and annual coating capacity of over six million tons, these four new lines will increase that capacity by an additional 1.1 million tons. We have created unique supply chain solutions for our customers, which allow our downstream lines to remain always fully utilized with our highest margin products. Switching to aluminum, market response from both current and new customers across all markets has truly been incredible. To recap the project itself the 650,000 metric ton per year aluminum flat roll facility. The main mill facility will be located in Columbus, Mississippi. It is close to the Southeastern markets and well positioned to serve Mexico. It is on the KCS rail line, which connects us again to Mexico to bring slab up and material back down to Mexico and it also connects to Canada to bring primary aluminum down from the sources up there. We intentionally located it on the TVA power grid to allow supply green energy. And we have water access by the Tom Big B waterway. So the transportation structure is good for us. We attained an attractive incentive package and having our current our Columbus steel mill close by. It allows us to draw on that facility for talent or professional services, and there will be a transition or transfer of many of our folks there which will have an immediate infusion of our culture to that aluminum facility. So we are excited about that. The mill itself will have on-site melt slab capacity of roughly 600,000 metric tons and will be supported by two satellite recycled aluminum slab casting centers. One will be located in the Southwest U.S. and one in SLP Mexico. Both sites, we have - letters have been sent in place, and we are under due diligence, but I believe it will serve us very, very, very well. And obviously, the strategic thought there was to place the slab centers in areas of surplus scrap and the California Western market and Mexico will have an abundance of UBC material. The mill itself, again, is going to be equipped with the two cash lines, the coating line, downstream processing and packaging lines. We have actually expanded the product scope there to include additional scrap processing and treatment to maximize recycled content. It is a state-of-the-art facility, and we will be serving the sustainable beverage and packaging markets, both body and TAM, the automotive sector and industrial sectors. Breakdown would be 300,000 tons of can sheet, 200,000 tons of auto and about 150,000 tons of industrial, or the principal equipment is on order, allowing for a pretty firm startup of the mill mid-2025. We believe the Mexican slab center will start up in the second half and the Southwest U.S. slab Center early 2025. The total project cost, including the recycled slab centers has grown a little from our initial $2.2 billion estimate. The increase is somewhat associated with - now that we have truly defined the equipment costs. But we have also added scope as I said, we put in a scrap processing and treatment and segregation at both the slab centers, which has increased that number a little and today, we estimate a firm budget of about $2.5 billion. It will be 100% funded with available cash and cash flow from operations. So there is no additional debt or financial needed to push this thing forward. And we clearly expect to see about $650 million to $700 million of through-cycle annual EBITDA, with an additional $40 million to $50 million arising from our recycled Omni Source efforts. From an investment premise and we have talked about it before, but we see the aluminum market, not unlike that in the steel industry, when we started SDI some 30-years ago. It is an industry that has essentially older assets, there has been little reinvestment over the years, heavy legacy cost, there is inefficiency and sort of high-cost operations. And the advantage compared to any other steel market that we have entered is there is actually a supply side deficit. Every other market in steel has always been oversupplied, and we have had to use our culture and low-cost strategies to penetrate those markets. With aluminum, there is a clear, clear supply deficit will certainly aid the ramp-up and a very, very quick profitability of that project. Certainly business alignment, we believe it is sort of an adjacent industry, so to speak. It is going to allow us to leverage our core competencies of constructing design, constructing, ramping up very, very large capital assets. It will allow us to leverage our recycling footprint, Omni Source is the largest North American recycling of nonferrous products, including aluminum. We recycle over GBP 1.2 billion, half of that is aluminum to there. I believe we will certainly be able to infuse the project with our culture, and that will power a very low cost, very high efficiency operations. So we are very, very excited and we are certainly excited from the reception we are getting from those aluminum customers. Looking forward, we are certainly excited and passion by our future growth opportunities as they will continue the high returning growth momentum we have consistently demonstrated over the years. We were recently added to the S&P 500 Index. I feel that is a true testament to our people and to the financial strength and maturity of our company. We are arguably one of the top five steel producers in the world as measured by market cap today and the third largest in North America by capacity and we certainly have the best financial metrics of any of our peers. And all these achievements have been achieved in a relatively short time frame, and that could not be accomplished without the phenomenal commitment of our extraordinary people. Everyone has had an impact and everyone contributes each and every day. We are celebrating our 30th year in business later this year, and there are only better things to come. Our teams and the culture they create on our foundation, and I thank each of them for their passion and their dedication. And in turn, we are committed to their wealth firm, their health and their safety. And I remind those listening today that safety for yourselves and each other is our highest priority each and every day. Our success is also driven by the loyal support of our customers who have become partners and friends over the years and together, we have created many innovative supply chain solutions, creating value for all. And we look forward to providing similar value and optionality to all our new customers as we continue to expand our product offerings in the steel arena, but also in the new aluminum market that we are entering. And finally, thank you to all that have invested in us. There is a growing number that recognizing the power of our culture, the resilience of our business model and the potential outsized depreciation that are significant yet disciplined growth will return. We certainly look forward to creating new opportunities for all of us today and in the years ahead. Good morning, Mark and Theresa and thank your taking my question. I would like to start with the aluminum rolling mill and what progress you have made there. Maybe curious as to how many sort of contract negotiations or discussions you have started to have with different customers. Maybe what end markets you have been targeting so far and as you think about how Steel Dynamics may ultimately disrupt this industry, are there any indications that the pricing construct that we have historically seen of this industry could change. Thank you good morning and thanks for your question. I do believe that - when one says disrupt an industry that can be taken both positively and negatively. I think from our perspective, we look at it from a very positive nature, creating optionality for the customer base, many of our existing steel customers also buy and consume aluminum and so it is great to be able to create further value for them. I do believe that our advantage and we have seen that over the last 30-years in steel, in that the power of our culture allowing us to leverage state-of-the-art equipment tends to drive very, very effective, highly efficient, low-cost operations and in any commodity any commodity market, the low-cost producer will survive and thrive and allow superior financial metrics through the cycle. And so the mill itself, the combination again of our culture, as stated on the equipment, just simply the plant layout, the high recycled content that we will enjoy the improved yield impact through the process, the low overhead cost all will combine to provide a very low cost solution and allow us to, I think, penetrate those markets quite effectively. Will that change the pricing environment? I donât think so. We will be just a partial participant initially anyway in that marketplace. From a progress perspective Emily, I think that Mark mentioned earlier that we do have locations that we have in mind and we are negotiating right now for both of the recycled slab facilities plus we now have a location. And so there is a lot of excitement happening in Columbus, Mississippi. Last year, we spent about just a little over $120 million on the investments going forward, just to kind of recalibrate since we do have an increased amount of $2.5 billion. In 2023, we are likely to spend somewhere between $900 million and $950 million in capital, in 2024, $1.2 billion, with the remaining $200 million to $300 million during the startup year of 2025. So the teams are pushing forward very quickly. Thank you very much Mark and Theresa. So on capacity, I would like to discuss capacity utilization, both for the industry, the company as well as the expected ramp-up of the fourth value-added current lines. So you guys have been running as you described in earlier comments at a higher capacity the decision in the industry. But now the industry in the U.S. is running around just slightly above 70%, 75%. How long can this persist, do you think, given that prices are increasing, supply discipline has been there so far. But there are some folks out there that are doing as well as you clearly by the numbers that you have posted. So how do you see the situation evolving Mark perhaps on these? And then in Mark, how do you see the ramp-up - the expected ramp-up of the capacity utilization of the four value-added lines. You mentioned that you see 80% in 2023 for Sinton, but any color on the fourth order lines would be great. Thank you Carlos, you were like a machine gun there. So Iâm not so sure I got all your questions. I think from a ramp-up, I will work backwards, but from the ramp-up of the coating lines, those will be, I think, very, very, very strong. Obviously, we have many, many galvanizing lines, prepaint lines throughout the company, and we will harness all our technical resources there to get those lines up quickly. We certainly have the substrate available to fully load those lines. So I think the ramp up, again, those lines of start up at second half, perhaps fourth quarter and will ramp up quite quickly through the rest of the year into the following year. As it relates to the first part of your question, Carlos, around utilization for the industry. I would point out that even if you go back to more challenging times like 2015, et cetera, our utilization still remained very high, and that is because of the power of our pull-through volume, which we would anticipate as well. But we are really optimistic for 2023 with the additional on shoring of manufacturing businesses, which you are seeing in reality as well as with the infrastructure program and other investment opportunities. We think that steel demand in the U.S. will continue to stay steady to potentially increasing as well as the trade benefits of melting and casting in the U.S. for the U.S. producer. So yes, flat-rolled prices specifically have improved recently, which we think that they should have. We donât think that, that is going to have a negative impact. We think that will be a positive impact, and we think both industry utilization rates and ours specifically, should remain steady to improving in 2023. Hey good morning guys. I wanted to ask about the downstream, the fabricate segment please. Just a little clarity, if you could, on the guidance. As I understand it, you talked about some slippage from very high levels, but still above historical levels. But historically, EBITDA per ton prior to 2022 is $190 a ton, and 2022 is [$28.50] (Ph). Iâm just wondering if you could provide a little more color on where we should fall between those two extremes. And maybe if you could, it would be helpful. I know Nucor mentioned a year-over-year comparison? Or if there is anything that you can provide a little more clarity on that, that would be great. I think one has to recognize that the industry has gone through quite a consolidation comparing it to some years ago and that has allowed sort of market strength or strong market pricing compared to history, and that will continue. The year as it is unfolding, we are entering the year with an absolute solid backlog through the middle of the year for sure. The order input rate is indeed off the kind of the frenetic crazy pace that it was 12-months ago. But it is very, very, very solid, and we believe that it is going to be a very, very good year for us at year-end. And I believe there is some concern maybe as I said earlier, the macro indices may not look as rosy as some would think. And some believe that there is economic uncertainty out there, as I hopefully articulated, we donât see the gloom and doom that everyone else is seeing it. Our order input rates across all our sectors with the 1 exception, a little off on residential is solid. And our December bookings record level on a historic basis similarly year-to-date. So we just see strength through the year through our lands through our order book. Okay. Mark, does that strength on volumes, strengthen prices into margins I mean do you expect year-over-year to be up and just like Iâm saying it is a big gap. I get that it will be higher than it is been historically, but any color on if we should expect some continuation of what we saw in 2022? Well, I think the steel space will -- I know Iâm saying that the steel space will appreciate from the lows. Obviously, we are seeing the hot-band pricing off the market pricing of 650 and it is up away over 700. In fabrication, the spreads will likely come off a little. They certainly havenât to any large extent at this point. You are certainly seeing people say, well, our projects are getting delayed, we are not seeing any cancellations at all. We are seeing projects delayed some. But in my mind, it is not an unhealthy thing in all honesty, because it is just protracting or extending the cycle - the business cycle in that arena. Yes thanks good morning Mark and Theresa, how are you? Good. I just want to follow up on the fabrication comments. So in the past, you have talked about you have had backlog basically priced through the middle part of this year, and I think you had discussed I believe pricing in the 5,000 or higher level. So I just wondered if you could confirm that, that is kind of the price level your backlog is at. And then if you are sold through the first part of this year, I assume you are bidding projects now for can you comment on price levels you see there? And then with respect to some of the delays or project push outs from what we have seen, the data center and some of those areas are still very strong oil the Amazon type warehouse spent a lot of those have been canceled. So if you could just kind of help us maybe understand a little bit of the DNA of the backlog would be helpful. Good morning Curt. So from the perspective of pricing, Obviously, we are not going to give specific pricing. But you would have seen that the pricing held in very steadily in the fourth quarter from an average perspective. And we have seen very steady pricing in the backlog as well. So I would err on the higher side if you think about what is in the backlog. And that is why we have great confidence in the earnings resiliency of the fabrication business through at least the first half of this year. And the order backlog, it is an interesting question because it is broadened out, wherein as it was very concentrated in warehouses, it is broadened out now into more, I would say, infrastructure type hospitals, schools, churches et cetera, so that is a good thing and that is what we think we are seeing more of. We expected very strong volumes for fabrication in 2023 from what we are seeing so far. And Mark mentioned the order entry activity is very good from a historical. So then you can contemplate what you think steel prices will be to make an estimation of whether you think we will continue to see expanding spreads in fabrication or not. That is what we saw in the fourth quarter definitively. And just the one comment, though, I think it was mentioned that the distribution warehouses are again canceled. We actually are only seeing that in one customer. Well, actually, not a customer of ours, but one company the distribution warehouse business in our backlog is solid and not getting canceled out. So that is not a comprehensive issue. And just to reemphasize what Teresa said on earlier on the reshoring. Reshoring is real. It truly is. That is going to be supportive of that business. And if you look through just the size of some of these factories, the battery manufacturing facilities is a huge, massive, massive facilities that will require a lot of joists and deck. So again, it is off the frenetic pace that we saw, but it is a very, very, very solid sector for us for the rest of the year. Okay. I appreciate that. And then just a follow-up on Sinton. What were the volumes shipped this quarter and we look at start-up costs for the year is roughly $430 million. So those material drag on your profitability. Can you comment on maybe when you would expect to maybe breakeven with respect to start-up costs and do you have any guidance for what start-up impact would look like in the first quarter? Thank you. Yes. So from a volume perspective Curt, Sinton had shipments in the third quarter of around just under 270,000 tons, and it increased to just under 340,000 tons for shipments in the fourth quarter, and we expect to see that improve in the first quarter and then have a significant improvement in the second quarter of 2023. From an impact, we still expect to see losses as they work through the higher-priced pigeon which is obviously matching against lower steel prices than they were at this time last year. And so like it will be - it should improve over the fourth quarter losses pretty significantly, but still be higher than we would like to see maybe around the $10 million mark. Hi, thank you for taking my questions. Maybe just a quick follow-up on Sinton. Are you able to share any EBITDA annual contribution you are expecting for next year or maybe kind of a sense of how this compares versus the normalized EBITDA target you mentioned and given maybe a slower start-up and then some ramp-up of the coating lines as well in Q4 that is going to help. So any kind of a sense you can give us that would be great. So I think Mark mentioned the ramp-up for the two additional value-add lines that will be in Sinton the third quarter of 2023. Those should ramp, we expect fairly quickly to start benefiting their product mix. We are not going to give full-year guidance for Sinton as far as EBITDA. But I would tell you that I think Curt mentioned earlier on the call, that the losses in 2022 were over $400 million, and it is going to swing to a significant positive for 2023. So just that differential alone will have a significant momentum benefit to our earnings in 2023, but it is just too early for us to give an estimate, but it wonât hit through cycle EBITDA in the year where we are still ramping up production. Okay. That is really helpful. And my second question is more on the demand side. You talked about steel demand increasing in 2023. Can you give us a sense of what kind of number you are seeing and maybe diving into your key end markets also there if you are able to share some quantitative number that would be great. I guess from our perspective, the higher demand translates to, in large part, to price up point and spread support. Our operations are already running at quite a high utilization rate. Further demand, obviously, is certainly going to help our Sinton facility. And given the market sectors, energy is very, very strong in that area in Texas. That is helping us. And the challenges that we are seeing in Mexico and the imports of sheet coming up from Mexico into the Southwest markets, but also even under the Midwest have essentially mitigate they are staying in Mexico now. So that is going to create good demand and great dynamics. So from a market perspective, we will certainly be able to support all the capability that the ramp-up will allow. Thank you very much. Just one question for me. Just switching gears a little bit over to the long steel segment, what are you seeing there in terms of potential new orders coming in from the infrastructure bill, the IRA. Are you seeing anything yet there? We have obviously seen rebar is kind of coming down for the last six, seven months. It doesnât feel like the infrastructure build is kind of abating yet. But what are you seeing on your side to kind of stop the rebar price decline? Well, as we have suggested in the past, we are not big in the rebar markets in at. But nonetheless, from our structural long products perspective, the infrastructure bill or spending is not necessarily kicked in yet. It typically takes six to nine months for that to materialize. And obviously, it is too soon. But come the summer of this year, I think you will start to see some benefit there. Hi good morning Mark, good morning Theresa, thank you for todayâs call. Maybe could I ask about the dividend outlook and just kind of get your thoughts on return of capital. So last year, you bumped the dividend quite substantially. And this year, you have expressed some confidence in symptom and Sinton wasnât contributing, in fact, was a drag in 2022 so maybe just kind of your thoughts around 2023. Thank you. Good one. Iâm smiling because Mark tosses things my way, and it is funny how he does it. But from a dividend perspective, we do like to grow the dividend in a way that is consistent so that we are constantly having increases across the spectrum. And I think as I mentioned, since 2017, we actually increased the dividend by almost 120%. And we like to do that lockstep with free cash flow increases that are through cycle like Sinton. I would expect that we should have a pretty significant increase coming forward as well. We like to do those traditionally in the first quarter time frame. We have additional projects that are a little bit smaller, but that are coming online in 2023 that will add to through-cycle earnings. And given our stock price, which has been fantastic, driving up recently, you should expect to see strong shareholder distributions continue, and that would include a strong increase in the dividend coming forward. Thank you very much. [Operator Instructions] Our next question is coming from John Tumazos, of John Tumazos Very Independent Research. John your line is live. Thank you. I try to keep a little spread on non-scrap cost of goods sold per ton just taking your total corporate revenues per ton and pretax per ton and subtracting scrap profits and it peaked a year ago at 673 and was only 4.56% this quarter. Are the bigger contributors to that the much lower price of purchased steel for your galvanizing and painting, et cetera, divisions first, lower profit sharing improvement in the Sinton mill as it ramps up, and hopefully, it will be the lowest cost when it is four and maybe a mix shift into some. So please explain - by the way, Nucorâs non-scrap cost of goods sales went up and were the highest in the last two-years in the current quarter. So there is the opposite direction, but that is a separate problem to figure out. John, great to have you on the call as always, and thanks for the question. I think the biggest parameter is substrate costs. As we have - over the years, we have ramped up the tech substrate, Holland substrate and even at Sinton, we actually pre-purchased about 150,000 tons, maybe a little more to load the downstream coating lines in preparation for when the hot mill started up. So you are certainly seeing that influence our costs, for sure. And the other thing that you hit, John, was spot on as well. It has to do with mix. So if you think about the increase in the impact from our fabrication business, that we would have had some change in that as well. So I think it is both mix and what Mark talked about is the steel substrate. In your steel mills, with the normal non-scrap cost of goods sold be closer to $200 a ton or $250 tons or $300 tons. We have always tried to not share that information, John. So I would prefer to stay that way. I would tell you though that, one, our conversion cost is probably as good as anyone in the world. And number two, the people donât necessarily recognize the offsetting sort of efficiency or effectiveness of volume. So on our process lines, carbonizing lines prepaint lines, even though some of the input costs have appreciated, the fact that our teams continually just improve productivity, put more volume through offsetting the sort of the overhead and the fixed costs. Our actual processing costs on those lines have been sort of almost stagnant for the last, I donât know, how many years. Thank you very much. There appears to be no further questions in the queue. I will now turn the call back over to Mr. Millett for any closing remarks. Thank you, and thank you for everyone on the call for your time today. Certainly, thanks to our team. I want to remind each and every one of you that you do contribute, you do have an impact on our success and stay safe and keep each other safe. Customers, we can do it without you. And I would just like to reemphasize those that have invested in us, there is a growing cadre of folks that are building positions that - they really are recognizing the power of our culture. It is different. We are different, and we drive absolutely different results. Our business model allows us to perform and maintain a higher through-cycle cash generation than our peers. And I think hopefully, people are starting to recognize that that our capital allocation, our growth is incredibly disciplined, particularly on the acquisition side. And I think that that speaks to just our underlying results. It is interesting if one measures the earnings power of our company on an employee basis, we are substantially higher than anyone else out there in our peer group. And again, it speaks to our overall efficiency and effectiveness of the culture, the strategic decisions that the team has made over the years, and it will continue to drop to the bottom line. So investors that support us, again, many, many thanks to you as well and with that said, have a great day.
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EarningCall_1287
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Good morning, everybody. I'm Chris Schott at JPMorgan, and it's my pleasure to be hosting a fireside chat this morning with the Organon management team. From the company, we have CEO, Kevin Ali, as well as CFO, Matt Walsh. So Kevin and Matt, Happy New Year, and thanks for joining us this morning. I thought maybe to kick things off, the company just completed its first full year as a standalone company. And at a high level, I'd love just to hear your thoughts of kind of what's gone well and maybe what are the surprises as you start the company and operate as an independent entity here? Well, good morning, Chris, and good to be here. And yeah, I think from a high level, what I can say very briefly is the fact that we've been incredibly happy with the performance of our first full year out. We set out to do a few things at the beginning of this journey. First of all, folks didn't really recognize that the established brands business, which is 60% of our overall business. There was an assumption that it would continue to decline. And what we've been able to do, what the team has been able to do, I'm fiercely proud of what they've been able to do, is actually stabilize that business. And in this first year, in 2022, we actually saw growth in that franchise. Secondly, we said we were going to grow our strategic pillars by double digit. We grew biosimilars by double-digit rate and we grew our women's health franchise, including fertility, and of course, NEXPLANON, our key product by double digits. So that was actually in the midst of the traditional things that one has to do in spinning a company out with all the TSAs and all the nuts and bolts of that. So I'm incredibly proud of what the team has done. And I think that we're well on the way. And of course, now just last week, we announced our eighth deal. So we've done eight deals in literally 18 months. So we're very serious about ramping up essentially our pipeline, both in terms of early stage, mid-stage and as well commercialized assets. So we're really excited about our pipeline that we've built in a very short period of time. And so we're really thrilled. I think that you mentioned what was unexpected, I guess. I think what was unexpected is I was probably a bit naive to think that you could build Rome in a day. So realizing it does take time, and you do have to be patient, and we're only a year and half into it. But we've met every commitment we set in terms of our guidance. Every quarter, we've actually met our guidance and exceeded, in many instances, and we're really on track. Great. I know you've talked about becoming a leader in the women's health space. And I guess one question from investors is why women's health? And why do you think the company can succeed in this vertical when it seems like others have maybe struggled a bit to get the type of traction they want here? We know they say that timing is everything. And I tell you right now, if it was 5 or 10 years ago, I probably wouldn't have decided to go in the direction of women's health. But so much of what we do in this industry is contingent upon what's available in the R&D space. And so over the last 5 to 10 years, there's been some really interesting developments, a lot of green shoots kind of popping up all over the place and not only in the U.S., but in Europe, which we've done a number of deals, as well as the Asia-Pacific region. So there's been more emphasis put on the R&D area. Secondly, there's no other company in the world today that actually focuses on being a women's health leader. So being in that space we're actually kind of -- we're magnetizing it. So a lot of the folks that are working around the world on some early stage, mid-stage and late-stage assets are coming to us now because we've kind of stimulated. We've kind of catalyzed the whole area of women's health. And the timing is right. I mean societally, the timing is right. And the focus on the fact that the R&D efforts around women's health has been woefully underfunded. I mean I don't want to go into the statistics of it in terms of what you see in terms of what's being approved year-by-year, but really, really a lot of need, a huge amount of gaps and a great amount of opportunity for us to kind of step into that space and take a leadership role. So if I think about where others have struggled, was it the lack of pipeline? Is that -- was that -- do you think the -- or is it just more that it wasn't as focused and it was just kind of disparate assets? Yeah. I think if you're -- so I'll look at it this way. If you're a large company, a large pharma company, which many of us came, as all of you know, as a spinout from Merck. If you're a large company, a $300 million to $400 million to $600 million peak revenue business is not going to get you out of bed really. But for a $6.5 billion business, a number of $300 million to $400 million assets start to become very material and actually can become a transformative for us. So those assets -- so if you're a large company, the reason that they weren't really enthusiastic because they didn't see the multibillion-dollar opportunities and everybody, of course, started to migrate towards where currently they're migrating, in terms of oncology orphan and other CNS and other areas. So that's one aspect. The second aspect, if you're a small company, you probably didn't have what we have, which is a base of business like the established brands business and the biosimilar business that sheds off a lot of cash. I mean, our free cash flow every year provides us an opportunity to do meaningful business development. As I've said, we've done eight deals. So we can be an aggregator of these assets. And finally, because there's not a rush from large pharma to get in there, valuations are reasonable. So we can actually start to do more in that space. And so as a result of that, I would say, if you're a small company, you don't have a global footprint. We're in -- we're just like big pharma. We're in 60 markets across the world. You may not have essentially other parts of the business that can fund that journey. If you're a large cap pharma, you're not really interested in $400 million or $500 million business. So that's a kind of a nice niche that we've been able to build for ourselves. I think you mentioned double-digit growth in '22. I guess we think about the women's health business for '23, do you think the portfolio is positioned for another year of double-digit growth? And as part of that, is it coming from the core assets? Or do we start to think about BD being or some of the recently acquired and in-licensed products being a bigger contributor? Yeah. So I'll answer that, Chris, in two ways. First is that double-digit growth has been essentially what we've been experiencing with our women's health franchise. Specifically, if I split it out between our fertility franchise, which we consider a double-digit growth therapeutic area for years to come, because just the need is so incredibly great. And there's not a lot of companies in that space. It's just us and two other companies that are really kind of dominate or rather 85% share of that space. If I look at our biggest product, NEXPLANON, we're on track to be a $1 billion product in 2025 for NEXPLANON. And we've got essentially patent protection until 2027 with the opportunity to stretch it out to 2029, 2030 with a life cycle management opportunity we're pursuing right now, which we feel is highly likely of actually giving us an opportunity to stretch it that far. This will be a $1 billion franchise. It's our first $1 billion franchise with good runway in terms of patent protection. So what I would say is, yeah, we're going to be seeing consistently strong growth momentum from our women's health franchise. Now that's organically. The inorganic acquisitions that we've made, the Jada System, which is doing exceptionally well. We'll start reporting out on the performance of Jada this year in 2023. We're going to be launching XACIATO, which is our partnership with Daré for bacterial vaginosis. That's going to be a nice little addition, maybe not in '23, but in '24 and '25, you'll start to see more contribution. And then, of course, our earlier stage assets are really starting to be very nice. Our Forendo acquisition, which gave us an opportunity for a new mechanism of action in endometriosis, 6219 -- OG-6219 has actually started Phase 2, first patient in, in October of last year. So we expect to report out our data probably in the 2024 time frame for our Phase 2 data. This is a completely new mechanism of action, has tremendous growth opportunities. If we -- that comes to the market in the 2028-2029 time frame, it's going to be a major, major contributor for our future. So growth is really going to be there. What I would consistently say to you, Chris, is our baseline business of established brands will continue to be a business. Nobody thought we could do that, and now it's stabilized. It's actually growing this year. Our two growth momentums of biosimilars, which we've added more to that franchise as well as women's health will continue to grow double digit. Women's health, next month will be a $1 billion product in 2025. So overall, when you start to feather in all of these BD activities we're doing, we're signaling low- to mid-single-digit growth. Actually, it's more mid-single-digit growth right now that we see kind of coming up in the years to come. Start to feather all that stuff in and you start to see the opportunities exist to start to really accelerate growth. Yeah. Great. Thanks for that. You mentioned biosimilars kind of their growth pillar here. Just talk about how, I guess, strategic that franchise is to Organon -- because I feel like the strategy now, you've got a number of partnerships. So at some point, does it make sense to more vertically integrate, how core is this to the business? Just help us a little bit on that? Well, we started out Organon as being essentially a value-added partner, a commercial partner, access partner, pricing partner, government affairs partner, regulatory partner, to a number of developers. Our first relationship really was transferred over from Merck, which is the Samsung relationship that gave us five assets. Subsequent to that, in the last year, we actually did a deal with Henlius a very well-known biotech company that does biosimilars in China that has done international work already for biosimilar Prolia and Perjeta. And now basically an option to do a deal with them for YERVOY. So we're starting to expand, obviously, in different areas. It's very strategic. I can tell you why? Because if you're vertically integrated, you may miss the most important point, which is that, in order to participate and compete and succeed in biosimilars, you've got to be first, second or third. You've got to be in that first tranche of launches. If you miss that window, it gets to be much more difficult to succeed in the biosimilar space. So by being a value-added partner, we can pick who we want to partner up with based on our due diligence to better understand where they're launching. How -- are they going to be in the first tranche or not? That's first. Secondly, I really don't know what the biosimilar business is going to be in the next decade. After you get the IOs, after the KEYTRUDAs and OPDIVOs and all the others start to see the biosimilars introductions, what happens beyond that? So that's why I'd say it's a really good strategy for contribution to growth now. And on a return on invested capital is very good because we don't invest a lot of expenses on it. But for the future, we'll have to see. But by that time, we hope and we feel very confident that our -- the introductions that we have with our women's health business will take us continuing going forward. So the strategy kind of maximize your optionality Yeah. I know we've had a lot of conversation at this conference around biosimilar HUMIRA. It's kind of a big opportunity. So we'd love to hear your thoughts about how you see this market developing as we go through 2023 and beyond? Well, any meeting would not be complete without a question on HUMIRA, biosimilar. So yeah, we are actually in the first tranche with our Samsung partners. And the first tranche of launches, we'll be launching next summer, this summer, actually, with a few others. When you look at the U.S. market, you've got to basically say, this is a pharmacy benefit product. So what's going on with the PBMs? And essentially, as I meet with PBMs, what I understand from their point of view is put rebate structure, put pricing aside for a moment. Just talk to us about what are your needs. A, do you have high concentration citrate-free? And by the way, do you have a low concentration doses? Well, we do. So check that box. B, is this the first country you're launching your biosimilar? Or have you actually had real-world evidence so that we know it's safe and tolerable in other populations use? Check, because we've actually launched it in Canada and in Australia and Samsung is through their partnership with Biogen is launched it in Europe. So we've got plenty of safety data. Three, do you have a manufacturing network that can satisfy whatever demand we throw at you because it could be huge volumes you're talking about. Samsung happens -- rather Samsung happens to be one of the largest, if not the largest toll manufacturer in the world for biologics. So check that box out. Four, do you -- what's your pen device like? Because we like to use the word frictionless. Is it easy? Is it elegant? And Samsung has got a long heritage in device manufacturing. And so it's a fantastic device as well. And finally, where are you in terms of interchangeability? When is that indication coming? So as you start to check off all the boxes and you realize many of the other competitors may check two or three, but not all of them, you start to realize that you're very strong -- in a strong position to do one very important thing. Most PBMs will have one, two, three maximum biosimilars on formulary, plus the originator. You need -- in 2023 -- in the second half of 2023, when you're going to see a lot of launches, you need to be one of those two or three. And then when the dust settles in '24, you'll be able to see, okay, who's going to win this way. So we're in a good position. Can I ask just when I think about '23, it does seem like AbbVie has locked up quite a bit of formulary access that's effectively parity to a biosimilar. Should we think about this being an interesting commercial market this year? Or is it more '24 and beyond the sales opportunity? I think this year, most PBMs will go to parity. So if you're a physician, you're -- if you've got parity, which means you can pick whatever you want, they'll go with their knee-jerk resin, which is HUMIRA. But going forward, as things start to change in the marketplace, and I can tell you what I -- when I meet with PBMs, they want biosimilars to succeed. They don't want to see a future where originators essentially evergreen the field, in terms of continuing to do that. So if you're talking about a $20 billion, the largest LOE in the history of the pharma industry, a $20 billion net revenue in the U.S., going from $20 billion to, say, $4 billion or $3 billion, right? Then it starts to become less interesting probably for the originator because you're getting a lot of pressure on the price. So '23, I think, will be a slow ramp-up year with really focused on formulary inclusion, '24 and '25 will open up. And with those initial formulary kind of decisions -- do you expect those to be fairly sticky. So if you're kind of there at the start, it's kind of almost like your business to lose going forward when the volume comes around? Or could we see there more changes as we go forward? That's a great question. I think it depends on two things. One is, it depends on the PBM's appetite to reeducate physicians on how to use the pen device and what to look for and all the things associated with that biosimilar. But secondly, what it depends on what kind of discounts are provided in the early stage? And is the PBM going to shift for one or two percentage points? And probably because if they're comfortable, they'll settle in, in terms of when you're meeting their criteria in terms of the kind of discounts that you're giving. And maybe the final question is, I think you've mentioned that market compression over time, just thoughts in general of where pricing or what kind of TAM are we ultimately kind of pursuing here for the industry? For the biosimilar, yes. So look, we all know the branded sales, but what's the kind of feeling like the biosimilar opportunity you're going to be⦠I think by my view, and this is just number one. I think by 2025-2026, you might range anywhere between 80% and 90% discounts potentially. Okay. Perfect. Maybe going over to the established brands division, I think as we kind of talked about earlier, I think you were originally talking about this as a business that could erode over time. Looking at 2022, obviously, a lot better performance there. Can you talk about just what's driven the strength in that business so far and maybe what we can expect in 2023 from the franchise? Well, I wish I could give you on the established brands business, which is, again, 60% of our base of our business. I wish I could give you some nuggets to say, if you do these three things and you have these kind of global products you'll succeed with established brands, where others have not. Because most of the others have actually continued to decline. What I can tell you is the following. We don't have, in our portfolio of established brands any commoditized generics, which are -- these are the originals. These are the original products like SINGULAIR or others like PROSCAR [indiscernible] and others. These are the original products that have gone off patent. In many countries outside of the U.S. that will be China, parts of the emerging markets, of course, Southern Europe, they still have a tremendous kind of value for patients. And it ranges from completely out of pocket, like, for example, what's starting to emerge now in China, all the way to kind of higher co-pays in Southern Europe, but people will go for it. Now the second point is you really have to have an incredibly entrepreneurial group in each country because I can tell you, across the world, in all the subsidiaries we have in the 60 countries we actively participate in, no one country is like the other in terms of the contribution of the portfolio. That tells you that folks are looking under every stone to drive this business. We took a business, and again, as I said, I'm fiercely proud of what they've been able to do, we took a business that was in double-digit decline and now it's single-digit growth year-to-date through Q3. So when I signaled to the investment community that the long-term aspect and people were kind of shaking their heads, long-term forecast for this part of the business, and it's important because this throws off a lot of cash that we can reinvest. It provides oxygen, so that we can reinvest in women's health and some biosimilar business is that it will be a stable business. So one year, we might grow by 5%, one year, we might decline by 2%. Next year, we might be zero, the next year, we might be 1%. Put a line through it, put a regression line through it and you say, that's a flat business. Once you establish that, that's a stable business that throws off good margin business throws off a lot of cash, then you can start to say, okay, now I can start to look at other -- their growth aspirations -- because they don't have this leaky bucket that's driving everything down. It's anchoring their business. So I think so far, what I understand from investors and a number of other analysts, I think you're starting to believe that this is a stable business, somehow something going on different at Organon, where they've been able to do this. Yeah, absolutely. And I guess in that context, I mean, the growth you've seen year-to-date, it does seem directionally the business is trending at a good place. Should we think of there being anything that particularly strong this year that might be harder to replicate next year. Yeah, there was a couple of onetime benefits, tailwinds in Japan. They had a number of generics that were withdrawn because of quality issues. The Japanese regulatory authorities are very conservative. So I don't know if some of them may not come back, some of them may. So that tailwind will decrease, but it still might -- a little bit of it might be there. We had a delay of a launch of an inhaled product for DULERA in the U.S. generic didn't show up. So essentially, we had the benefit of that. We had a couple of other kind of onetime benefits that helped us. VBP which is essentially the volume-based procurement process in China, that's their way of kind of rationalizing price and moving forward in the public sector didn't happen the round that we thought when it's supposed to happen. So it just happened around 7 in October of last year. So now we're starting to get back into kind of the normal routine things. So going forward, what I can tell you is it's a flattish business. Okay, great. You mentioned China. I know it's an important geography for this business. Can you just talk about what COVID shutdowns have meant to that kind of, I guess, region or country? And as we think about reopening, is that a tailwind for⦠I think it will be. I can tell you that, Chris, that over the years where other competitors have had these huge products, the Lipitors of the world, $1 billion product franchises in China, they got just massacred, where essentially, we're very diversified. There's no single product in China that represents more than 15% of our business. So each round, I think we're up to round 7 now, we finished in the rounds of VBP, we've had something happen. So currently, 50% of our business has gone through by the end of this year and '23, 75% of our products will have gone through. In the meantime, in 2017, actually, we started -- at that time when I was at Merck, we started kind of a retail business unit because we saw that there was things happening in retail sector, activity happening. And now the retail sector represents 50% of our business, growing double digit, and that's been able to offset many of these kind of hits that we've had from volume-based procurement. Through 2023, we'll still face some downfall, but not in a single year have we ever declined in China. So once we pass through '23 and we start to go to '24, we'll have gone through most of the kind of the leaky bucket sorts. And we'll move on to really more solid growth. Okay. Perfect. And you mentioned VBP, some impact this year. Can you just help quantify what products and maybe the scale of those that are hitting this year? So in round 7 at the end of last year, essentially our largest -- one of our largest products, which is a cardiovascular lipid lowering product actually gone into the round 7. So we're starting to face that. We'll lap that next year in November. Round 8 and round 10 potentially could take place. Round 8 will definitely take place and 10 -- so we're talking about essentially three products or so, maybe four that actually go through that process. That's what kind of tells me by the end of next -- by the end of this year, 75% of our portfolio we're going through. But then it becomes -- it no longer becomes 50% of our business, starts to shrink and starts to have less of an impact for us. And the other retail business, which includes the e-commerce side will start to grow. And then that will overtake and then we'll your growth trajectory. And maybe last question in this division. Is established brands an area that we can think about business development? Would that be something that makes sense for Organon? Yeah, absolutely. I mean if we -- but not -- I wouldn't say we are interested in a portfolio of declining products in somebody else's problem. No, no. I'd rather go after a single kind of base hit where I see a product maybe that's gone through the LOE effect that has kind of stabilized that we can start to throw into and kind of bolt into our business and then start to grow. I start to potentially look at areas that are derm, pain. There are other areas that are not necessarily as affected by the LOE events throughout the world. So yeah, if it makes sense, if it's accretive in the near term. I'll give you an example. We brought back -- I wouldn't call them -- I would call them the established brands of the women's health sector. Bayer had, for whatever reason, had some of our contraception, combined oral contraception products in the Asia-Pacific region, specifically in China, Vietnam and other countries. And we brought that back, we actually paid them to bring it back. And so we're already manufacturing it, but that's almost accretive in year one and it's growing incredibly enough. So that's the kind of thing that we want. Maybe shifting to the P&L. I know you talked about the need to make investments in both R&D and SG&A to generate this growth over time. How do we think about the investment that's -- the impact those investments are going to have on the P&L as we think about 2023? Yeah. So I can take that one. So let's take a step back for a moment. So when Merck prepared Organon for spin, they sized the cost structure really to accommodate the portfolio of products that we're launching. There was no placeholder or consideration given for how Organon would grow. Merck figured well, they have their own management team, their own board. They'll figure that out. And so we have been pretty clear in even the communications right before the spin, that we would be reinvesting our profits to create a pipeline of opportunities to grow revenue. And that would show up in two places on the P&L, would show up on the R&D line, obviously, as we would be putting in place a portfolio of new product candidates. You'd also see it on the SG&A line for commercial expenses for these products that would launch if we were buying things in that where currently marketed products are imminently accretive. And so that we've been steadily moving in that direction since the spin. And of course, the big investor question is, as well, what does the next quarter look like? What does the next year look like? Is there a minimum point that we can think of before things start to turn around? So it is a question that we get a lot. And so in advance of providing formal guidance for 2023, which we'll do in mid-February when we release earnings, we decided to soft guide towards the latter part of 2022 to start to get people grounded. And so we had told folks that if you looked at the second half EBITDA margin that would be implied by our third quarter actuals and our fourth quarter guide, that would be a good directional indication where margins would be headed for 2023. And that's still the case. So there's no new information today, Chris. As we finalize our budget for the year and look at where FX rates are headed, that information is still good. And that's -- that, I think, adequately reflects what we see as the needed reinvestment to make sure that we can deliver that low to mid-single-digit revenue growth, not just out to 2025, but even well beyond that. That's a very good question. Yeah. So across our industry, for those of you that aren't familiar, Chris is pointing out that -- as you bring in new opportunities, there are upfronts. There are milestone payments. These are lumpy type outflows. They're more related to almost business development or M&A type cash flows than they are real R&D expense, and it's always been sort of a gray area. And so the SEC has mandated that we include these payments in whatever adjusted income reporting that we do. And when we gave that soft guide, there was about $25 million of that kind of milestone type included for deals that we've already completed. And that number in 2022 actuals is about $107 million, so people can compare. Okay. Great. I think I asked you this last year, is in a similar setting. Can we think about '23 being something that's starting to approach say, trough, but that is starting to get to a point where your cost base is at an appropriate level to kind of support the business going forward? Yeah. So the answer I'll give there, Chris, is it reflects all the scenario, a multitude of scenarios that we're running on what the future could hold for the eight deals we've already done. And it does feel like we are starting to get towards a trough there. Yeah. So yeah, there's always the question of, well, if we're going to be hitting the trough, then where do you think normalized margins for the business would be? And that will depend heavily on the commercial success of the eight deals that we're pursuing and whatever new ones we will layer on in 2023 and beyond. But -- so it's hard to make a commentary on that, Chris, right now. Okay. And then maybe last one, just on FX, I know that was a huge swing factor given the exposure of our portfolio. And just any strategies of just to either hedge the business out or kind of dampen some of this volatility that we're seeing from currency? Yeah. So one of your first questions was what was unexpected or what was a surprise? And from my share, we've got 70% of our revenues denominated ex-USD, but we report in U.S. dollars. And so we spend -- and it's great. Everything is going well operationally, but we've had really the strongest U.S. dollar in the last 20 to 30 years, unexpected. And so really, the strong revenue growth that we've been seeing in local currency, investors have not been able to see. And so Kevin alluded to -- we've had solid mid-single-digit growth in the established brands business. Investors have gotten to see none of it because 90% of that particular part of our company is ex-U.S. revenue. So we always get the question, well, why not hedge? And so the answer to that is we do some hedging. I would say -- I would call our hedging activities, we have a balance sheet hedging program. So we hedge known exposures where we've got large trade receivables or payables. We've got dollars going out on CapEx spend or large intercompany flows. Those are all hedged to derisk those. We do not, at the moment, do anticipatory hedging of our P&L. This is largely a financial reporting issue. We're actually pretty well naturally hedged on a cash basis. All of our manufacturing is outside the United States, half of our employees are outside the United States. So that is -- that provides a natural financial hedge. So this is more of a financial reporting issue than an economic issue. And we haven't found -- we just don't believe it's in shareholders' best interest to be addressing a short-term financial reporting issue by putting cash out to hedge revenue. Ultimately, you're not going to outrun spot rates. They're going to catch up with you. And so we've taken the position that let's just take our medicine as it comes. It's easier to explain to investors than trying to explain actuals plus a hedging overlay. And now I think that the dollars -- the pendulum is starting to swing back, we'll actually have some of the reverse issue in 2023, hopefully. And then I'll be having to explain why we've had higher numbers than reported than we've been saying in local currency. Okay. And maybe one kind of last cash flow question. I know you've talked about some onetimers in the business as we went through '22. How do we think about kind of normalized cash flow and cash conversion for Organon as you kind of move past some of these events? Yeah. So let's start with the divid [ph], right? It's a great place to start to answer that question. When we launched, we're launching into a spec pharma space, which is very heterogeneous, and there are not a lot of comps out there for Organon. So the thought was, let's put a nice attractive dividend on the company, and that will provide a baseline for the valuation. And that at the time the dividend was sized to be low 20s percent of free cash flow before any onetime items related to this spin. So that math is still good math. So that would say that this business should be generating nicely north of $1 billion of free cash flow before -- and when we say onetime items, in our case, it's really separation-related spending. We're still doing that. Most of that will be done by June of this year, but for the global ERP implementation that we're doing, which will dribble in 2024. But that investors should be expecting that this business can generate north of $1 billion of free cash every year, and that really has -- our thinking hasn't really changed since the time of the spin. Okay. Great. Great -- can I just go? On the capital deployment front. I think we talked about the different divisions and some smaller acquisitions you've done. What is the, I guess, capacity and appetite to look at larger, maybe more transformational deals? And what would you want to kind of conceptually what would you want to be looking for in a longer transaction? Yeah. So as I answer that question, -- we'll talk about ability -- it doesn't necessarily play intent. So when we were creating the capital structure, we could have lobbied for an investment-grade rating. We wanted the BB rating because it gave us more flexibility to do exactly what you're talking about if the situation ever presented itself for us to do a larger, more transformative deal and without endangering the rating. And so the conversation that we had with the rating agencies at the time was within the rating that you have, we could see leverage going up into the mid-4s, with a trajectory that it could get down below 4 within a two-year time frame, that wouldn't -- if you were to expand capital that way, that wouldn't necessarily endanger the rating. Our rating is very important to us. We've got roughly $9 billion of market value of debt out there. So it's something that we obviously pay a lot of attention to. So that's the ability. People can back into how large of a deal we could do. As far as intent goes, we -- the business is doing everything we thought it would. We're not feeling the pressure to do a large deal. But that said, every now and again, you will have an opportunity to really accelerate the achievement of your strategic goals with a significant inorganic transaction. So we're well aware that those possibilities are out there, and we certainly do them if the conditions were we're right, but we've had a lot of success with the smaller deals so far, easier to digest. We can get them done at a good pace, and we can execute well on those. And so that's been going great. Okay. And does that -- I guess is the success you're having with those smaller deals and stabilizing things like established brands. Does that make a larger transaction less interesting for you? I know certainly the right large deal you'll always look at. But I guess, as just the framework that you're even looking at BD changed a bit now that you have a bit more experience for the business? The right deal is there, and I'm kind of the -- of the two of us, I'm the shopper -- he's the one who says, no, don't think about that. So no, I mean, we are always on the lookout for strengthening our position, specifically in women's health. If we can accelerate that time line in terms of being a global leader, we're almost there, but essentially accelerate it, take a stand on it, sure, we'll look at it. But it's not distinctly only in women's health. I mean there are other things out there because remember, women's health are two different areas. One is essentially those conditions unique to women and the other is kind of disproportionately impacting one. So that kind of opens everything -- and so yeah, we're always in the mode. Okay. And maybe one last question. Higher interest rate environment. Can you maybe just talk about, A, what that means for your existing debt? And then on this business development kind of question, does that change the way you turn your appetite if there was a larger deal to take on more leverage? Great question, Chris. So we are -- in our debt stack, we have a fixed floating mix of 60% fixed, 40% floating. If you include cash, it's about 65% fixed. So there's really no concerns that we have from an operating perspective about operating leverage or the increase in interest expense that we'll see as a result of rates going up. So it's not really an operational issue. What it has done is it has raised the bar on M&A that -- on the M&A analysis and decision-making that we do. For deals that bring near-term growth, whether it's currently marketed products or imminently marketable products, we're still going to run after those just as hard. Where we see it starting to impact, is the decisions that we might make for early-stage deals. Those deals are effectively riskier now because of the near-term benefits and 100% probability of debt reductions. So that's kind of how we think about it. Okay. Very helpful. I think we're just out of time. Really appreciate the comments today and look forward to the updates as you go along.
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Welcome to Johnson Controls First Quarter 2023 Earnings Call. Your lines have been placed on listen-only until the question-and-answer session. [Operator Instructions] This conference is being recorded. If you have any objections, please disconnect at this time. Good morning, and thank you for joining our conference call to discuss Johnson Controls first quarter fiscal 2023 results. The press release and all related tables issued earlier this morning, as well as the conference call slide presentation can be found on the Investor Relations portion of our website at johnsoncontrols.com. Joining me on the call today are Johnson Controls Chairman and Chief Executive Officer, George Oliver; and Chief Financial Officer, Olivier Leonetti. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements. 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 Johnson Controls. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors and cautionary statements in our most recent Form 10-Q, Form 10-K and todayâs release. We will also reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are contained in the schedules attached to our press release and in the appendix to this presentation both of which can be found on the Investor Relations section of Johnson Controls website. Thanks, Jim, and good morning, everyone. Thank you for joining us on the call today. Letâs begin with Slide 3. Fiscal 2023 is off to a strong start with solid Q1 results. Our teams across the globe have executed well delivering strong financial performance for our shareholders, while pushing the pace of innovation to provide our customers with the next phase of digital solutions across our vectors of growth. During the quarter, we accelerated growth across to our service-based businesses, drove higher margins and delivered profitability at the high end of our adjusted EPS guidance range. Overall, organic revenue grew at a healthy pace and our $11.3 billion backlog remains resilient, growing 11% year-over-year. Our service strength was resilient and remains a key competitive differentiator. While order timing, supply chain realization and China policies have impacted our global products in field install order flow during the quarter, we are seeing incremental improvements in order momentum heading into Q2. As we mentioned over the last few quarters, we remain focused on the fundamentals of our business in improving our operational execution. Our teams have done a great job advancing our initiatives to accelerate growth and optimize the efficiency of our cost structure. During the quarter, we delivered $90 million in productivity cost savings, and are on track to reach our $340 million savings target over the course of this fiscal year. We are also committed to our prudent approach to capital allocation, reinvesting in new products and technology to drive long-term shareholder value while continuing to return capital to our shareholders. We recently announced our plans to enhance our growing industrial heat pump portfolio with the acquisition of Hybrid Energy. Acquisitions are an integral part of our growth strategy and by investing in Hybridâs patented high temperature heat pump technology, we are continuing to strengthen our leading global product portfolio and provide our customers with the most efficient sustainable building solutions. We are well-positioned to capitalize on large growth opportunities across our dynamic product portfolio and field business. Through our integrated domain expertise, global coverage and scale, we are leading the way towards smart, healthy, and sustainable buildings for our customers. While the global macroeconomic environment remains uncertain based on our strong start to Q1 and our expectations for the remainder of the year, we are raising the lower bookend of our adjusted EPS guidance range for the year. Now turning to Slide 4. During the quarter, our OpenBlue platform continued to expand as we enhanced our capabilities leveraging the power of AI and providing customers with unique insights. A good example is the deployment of OpenBlue enterprise manager at a leading tech manufacturer to help them meet their energy and sustainability goals. In addition, we have recently installed OpenBlue companion at their facility to enhance employee productivity and space utilization. From advancing predictive analytics to integrations at the edge, our full suite of solutions empowers our customers to meet their carbon emission goals and create a healthier, more productive workspace for their people. To date, we have enhanced the existing connectivity of over 11,000 chillers through OpenBlue, representing a 79% increase year-over-year. Moving on to Slide 5. Our digital service journey has accelerated since we launched our innovative OpenBlue platform in fiscal 2021. At that time, we entered the first phase of our digital transformation with a focus on enhancing data mining capabilities. Over fiscal 2022, we launched the OpenBlue gateway enabling data access at scale and increased connectivity across our growing installed base. We are now positioned for the next phase of our journey as we standardize our field operations globally. Linking the benefits of real time monitoring of connected devices to our extensive service network. We can provide our customers with faster response times while optimizing the deployment of our global field service presence. We are beginning to see the results of our digital offerings enabling service growth. During the first quarter, service orders and revenue grew 10% year-over-year, with continued growth, we are in a great position to reach the goal we set out at our Investor Day in fiscal 2021 to capture $2 billion in additional service revenue by 2024. On to Slide 6, with nearly 40% of the worldâs carbon emissions coming from commercial and industrial buildings, the goal of achieving net zero starts at the building level. Through our vast sustainable infrastructure partnership ecosystem, we play in an integral role in helping our customers achieve these targets no matter where they are in their decarbonization journey. Starting with our established advisory services and goal setting partnerships with KPMG and Accenture, we help customers take the first step to accelerate and solve their decarbonization and efficiency goals. We are also able to help fast track our customersâ net zero targets through carbon reduction services, collaborating with leading renewable energy supply and distributed energy providers. With our comprehensive customer solutions and strategic partnerships, we are positioned to take full advantage of favorable regulatory tailwinds and continued momentum. During Q1, we realized over $200 million in organic revenue, growing over 20% year-over-year with orders over the last 12 months, growing at 6%. Turning to Slide 7. The Healthy Buildings opportunity remains attractive as our customers invest in indoor environmental quality improvements post-COVID. Solving for the indoor air quality and energy consumption challenges of hybrid work models is driving a compelling intersection of our Healthy Buildings and sustainability strategic growth vectors. We are in a leadership position, thanks to OpenBlue indoor air quality as a service, which continued to gain momentum in Q1 as well as our leading IAQ and space management capabilities in OpenBlue Enterprise Manager. In our Healthy Buildings business, trailing 12-month orders increased 11% year-over-year, and our pipeline of $1.2 billion remains strong. Looking forward, we expect continued growth momentum as the value of indoor environmental quality improvements delivers benefits for our customers. On to Slide 8. We are honored to be continually recognized for our dedicated sustainability efforts. Among other honorable recognitions, two of Johnson Controls leaders were awarded for their efforts. Chief Sustainability Officer, Katie McGinty, was named one of 2022âs most influential women executives for sustainability leadership by Women Inc. magazine. Anu Rathninde, President of Asia-Pacific, received the ESG Exploration Character Award of the Year from the 2022 ESG Pioneer 60 awards by Jiemian. I am proud of our team for leading by example and executing on our values. Thanks, George, and good morning, everyone. Let me start with the summary on Slide 9. Total sales grew 4% with organic sales increasing 9%, comprised of 10% price and a modest volume decline. FX was a 6% headwind during the quarter. We saw strong performance across our longer cycle field businesses, which grew 10% in the quarter. Our shorter-cycle Global Products business grew sales 7%, impacted by a slowdown in residential demand. Adjusted segment EBITDA increased 15% with margins expanding 140 basis points to 13.7%. Positive price costs and improved productivity more than offset unfavorable business mix. Adjusted EPS of $0.67 was at the high end of our guidance and increased 24% year-over-year. During the quarter, we absorbed an additional $0.01 of FX headwinds versus the prior guide. Free cash flow returned to the normal seasonal pattern with the usage to start the year. In addition, inventory levels were impacted by softness in residential as well as continued supply chain disruptions, which while improving impacted our ability to satisfy green demand in commercial. Turning to our EPS bridge on Slide 10. Overall, operations contributed $0.19 versus the prior year, including an $0.11 cent benefit from our productivity programs for which we are on track to meet our targeted savings for the year. In the quarter, FX was a $0.04 headwind below the line higher net financing charges and corporate expense were offset by a lower share count and favorable non-controlling interest. Please turn to Slide 11. Total orders for our field businesses increased 5%. As George stated earlier, orders in the quarter were affected by timing and COVID related impacts in China. Order timing are the largest impact within our in-store business, which grew 1% in the quarter. We were encouraged by 10% order growth in our service business driven by double digit growth in both EMEA/LA and APAC. Field backlog remains at record levels, growing 11% to $11.3 billion, $800 million increase versus the prior year while growing $250 million sequentially. Our global products third-party backlog grew more than 30% over the prior year to $2.8 billion. Letâs now discussed our segment results in more details on Slides 12 and 13. Sales in North America were up 10% organically with broad-based growth across the portfolio. Our install business grew 12% with low-double-digit growth in both retrofit and new construction. Overall, HVAC and controls continues to gain momentum, growing mid-teens year-over-year, while Fire & Security increased high single digits. Order timing mainly impacted North America as orders increased 6% with solid growth of 7% in our service business. New construction orders grew over 50%, primarily in HVAC in aggregate Fire & Security orders grew low single digits. Total backlog ended the quarter at $7.5 billion up 16% year-over-year. Segment margins decreased 30 basis points year-over-year to 11.3% as positive price cost and ongoing productivity benefits were offset by unfavorable project mix. Sales in EMEA/LA grew 12% organically with strong performance in applied commercial HVAC and Fire & Security. Our service based business was strong in a quarter growing mid-teens year-over-year with recurring revenue contributing low-double-digit growth. Orders were up 5% led by over 20% growth across our Fire & Security platforms, which was partially offset by declines in HVAC and industrial refrigeration. Backlog was up 5% year-over-year to $2.2 billion. Segment EBITDA margins declined 310 basis points to 7.7% as a result of unfavorable mix and dilutive price cost, which offset favorable volume leverage and the benefits of cost savings during the quarter. Sales in Asia Pacific increased 7% driven by mid-single-digit growth in our commercial HVAC & Controls platform. Service performed well in the quarter growing low double digits, benefiting from our shorter cycle transactional business, primarily in HVAC & Controls. China grew 1% in the quarter impacted by COVID induced lockdowns. As China continues to reopen, we are encouraged with the momentum building within that region. Orders decline 1% as low-double-digit growth in service was offset by a decline in HVAC & Controls installation. Overall, install orders declined 5% organically. Backlog of $1.6 billion declined 1% year-over-year. Segment EBITDA margins increased 40 basis points to 10.5% driven by positive price cost and productivity savings, which offset lower volumes and FX headwinds over the quarter. Sales in our shorter cycle products business increased 7% in the quarter, benefiting from strong price realization of 11%. Commercial HVAC product sales were up low double digits with strength in light commercial driven by over 20% growth in North America and EMEA/LA respectively. Applied HVAC sales were up low double digits with continued demand in chiller within our data center and market. Outside of North America, our global residential HVAC sales were up low single digits. North America Resi HVAC declined 20% as the overhaul market softened and we were challenged by unfavorable product mix in the channel. Our HVAC business grew mid-single-digits led by more than 25 growth in applied within EMEA/LA, as well as strong demand from our Hitachi commercial heat pump in EMEA. Fire & Security products grew high single digits in aggregate led by continued demand in North America and in the Middle East for our Fire Detection products. EBITDA margins expanded 580 basis points to 20.3% driven by positive price cost and the benefit of productivity savings. Turning to our balance sheet and cash flow on Slide 14. We ended Q1 with $1.5 billion in available cash and net debt at 2.2 times, which is within our target range of 2 to 2.5 times. Now letâs discuss our fiscal 2023 guidance on Slide 15. We were pleased with our start of the year and are encouraged by the continued strength and resilience in our order and backlog. Our backlog grew double digits and remains at record level. We are providing Q2 organic sales guidance of approximately 10% growth with price being the principal contributor. Segment EBITDA margin is expected to expand 100 to 110 basis points and adjusted EPS is an expected range of $0.72 to $0.74, which represents year-over-year growth of 15% to 18%. On a full year basis, weâre raising the low end of the wide range we introduced to beginning the year. While we are encouraged with our strong start to the year and our current second quarter outlook, we continue to take a cautious outlook for the full year given the ongoing macroeconomic uncertainty. Our full year adjusted EPS guidance range of $3.30 to $3.60 represent growth of 10% to 20%. The top third of our EPS range signifies our base case scenario. This account for normalized GDP growth, continued growth, vectors acceleration and conversion of our existing backlog. The low end of this range provides a bookend reflecting a potential macro downside scenario, which accounts for a potential degradation of global GDP that we believe will be offset by our resilient services and commercial market presence, along with additional cost mitigation actions. On the top line, we anticipate high-single-digit to low-double-digit organic growth with price representing about 10%. We anticipate segment EBITDA margin expansion of 90 to 120 basis points as we continue to execute our higher booked margin backlog throughout the fiscal year. Full year free cash flow conversion is expected to be between 80% to 90%. Operationally, we continue to improve our working capital management and expect further improvements from the gradual reduction of inventories as the supply chain normalizes. As George mentioned, we are pleased with the strong start to the fiscal year. Whilst supply chain disruptions continue to impact our global products business, we see positive momentum in our field based services. Across our vectors of growth, our pipeline remains robust and we are well positioned to capture secular tailwinds while continuing to improve our operational execution as we navigate through the first half of the fiscal year. So â hi guys. So, yes, you mentioned field â timing for field orders coming up plus 1%. So maybe just continue just like double click on whatâs causing some of the delays that perhaps you didnât expect? China, I think I understand, but outside of China. Yes, when you look at our field orders, what is encouraging? Although, the install was up 1%, services was up over 10%, and weâre very encouraged with the progress weâre making there, Nigel. On the install side, itâs mainly a couple of factors here that impacted us here in the quarter. It was â the China â the COVID lockdowns, we have incredible pipeline, but because of the disruption and ultimately the delay in getting those closed impacted us in the quarter, and thatâs 1% to 2%. And then in our project-based business as we now drive our vectors of growth around sustainability and healthy building. Thereâs larger projects and a lot of these, itâs hard to predict that timing conversion and so that amounted to another roughly 1% to 2%. Those are the key drivers, as far as the orders â field orders. Nigel, the backlog is up over 11%. The pipeline continues to be strong double digits in our conversion. And so as weâre now executing on the strategy, we are encouraged that our conversion is going to continue very strong here in Q2 and beyond for the year. And then now the way that weâve been set up here with the backlog being up for the year really does give us a lot of confidence in our ability to be able to deliver on the guide that we provided for the full year. Great, thanks George. And then my follow-up questions on the margin expansion for the full year. Youâve raised the bottom end by 10 basis points. So Iâm curious how the mix between the segment change. and Iâm referring here to obviously the strengths we saw in global products, the weakness we saw in EMEA/LA. So just wondering if the mix of that margin expansion has changed at all. Weâre making tremendous progress on our margins and itâs not only â this has been over the last couple years instilling a discipline around price costs and more important about the value propositions that weâre bringing to the market with our vectors of growth. And so weâve got â you see that not only in our shorter cycle business with our global products and the strength that weâre having in margins thatâs combined not only the value proposition, but now also the additional productivity thatâs playing through and the leverage that weâre getting on that. And so as we project the current year, weâre going to continue, going to see momentum in margins, because the longer cycle business, weâve got strong margins and backlog. As we increase the velocity on the turn of these projects, youâre going to start to see much stronger margins come through on the rest of the year. So Olivier, maybe you can comment on the segments. Absolutely. So one clarifying point on the orders. We expect as an impact on orders due to the move of the orders from Q1 to Q2 orders in the field to be high single digits in Q2. Regarding the margin, we expect global product margin to remain strong for the rest of the year and we expect the field margin to turn positive in Q2, probably about 51 to 100 basis points at the segment EBITDA level and increase day after significantly with a strong increase as we end the year, Nigel, in the field business. Olivier, I want to pick up off that last point on field margins improving. And so you guys called out unfavorable mix both in North America and EMEA/LA, I want to understand that a little bit better. And then specifically on North America, I know that you guys saw this sequential improvement last quarter, but the margins now have been down year-over-year for the last seven quarters. So just help us understand whatâs driving the confidence in those margins getting better from here and what was the issue with unfavorable mix that was coming through the field business this quarter? So it would be from a project to â project mix or larger projects flowing through in the quarter. If you look at a high level and we have discussed that job before, we have booked orders at a higher level of margin all through last year. And those orders are now starting to flow through the field business. So as indicated to Nigel earlier, we expect the field margin to improve at a segment EBITDA level in Q2 by 50 to 100 basis points and keep increasing thereafter. That would include also our North America business. The expectation for the margin increase in segment EBITDA level for North America into two is expected the increase to be over a full points. So as we keep converting the backlog as we â which is at a higher margin, as we keep delivering our productivity initiatives, as we keep increasing the mix of our service business in our companies, which was very strong in Q1, we expect this momentum to continue in Q2, you will see the field margin business to increase, I would say, materially between Q1 and Q4, Joe. Okay. Thatâs good to hear. And I donât usually ask questions on the North America resi business, because itâs a small portion of the overall portfolio, but it was pretty interesting to see that business down 20%. I think you guys called out product mix in the channel. So maybe provide a little bit more color, whatâs happening there? That seems to be a little bit lower than what weâve seen reported so far from some of your peers. Yes. When you look at our North America resi deducted business, when you look at the overall market, itâs down in units in the teens, now we were down more than that. And itâs really two big factors here. This is where weâve had coming into the year, we still had continued supply chain disruptions. We also had the launch of our new product, the 2023 product. We worked through that, we worked through the supply chain. So although, we were down further in units, we had strong pricing coming through. We worked with our distributors and thereâs another key point to make on our field direct channel, which is a small portion of our distribution, we were actually up 13%. And so thatâs similar to what others have seen. On the distribution side, weâve worked with our distributors in making sure that now as we have continued to improve our supply chain through the quarter that weâre going to be positioned to be able to deliver on their expectations from a demand standpoint as we now go through the rest of the year. And so when you look at the rest of the year, we are projecting that the market will be down high single digits in units. Thereâll be continued strong pricing coming through and weâll be in line with the industry. And we believe that now with our recovery of the supply chain, we actually start to pick up some of the share that we had lost over the last year due to the supply chain. Good morning. If I look at roughly kind of the 350 or so where consensus is, it implies weâre using the midpoint of your guidance about $2, $2.10 or so of earnings in the second half. Thatâs about $1 per quarter by my math. Do you â is that kind of the right type of seasonality? Would you expect fourth quarter to be above third quarter and how materially above? Maybe just give us a little bit of a little more color on how the third and the fourth quarters break out EPS-wise? Yes. At the high level, Steve, when we look at our build for the year, we were in a very different place this year than we were last as weâre now continuing to accelerate our capacity expansion across our product-based businesses. And weâve seen a nice ramp, for instance, in our applied businesses. In some cases, weâre expanding capacity 2 or 3 times, and we tried to see that volume come through. And then we have worked with our supply chain. So weâre very much aligned now going into our seasonal ramp as well as the recovery of our backlog to be able to begin to accelerate here in Q2, and that will continue through the seasonality that we see in Q3 and Q4. And so weâre in a very different place than we were a year ago and being able to execute on that ramp. And Iâm very encouraged with the work that weâve done, especially across our applied business where, from a core strength, that is our strength, and weâre beginning to see that pick up across the board. So Olivier, I donât know if you got any additional. No, not much more to add. The backlog conversion now is going to have its full impact. It will be very strong from Q2 onwards. The productivity initiatives are still well on track. We are identifying new productivity initiatives all through the year. The backlog is very resilient. Our service mix is very strong, accelerating significantly across the portfolio. So we see margin expansion clearly in the second half, Steve. So like is $1 around the right number for 3Q and then it kind of steps up a bit from there? Or is it more fourth quarter weighted, maybe just a little more precision to get people in line? Okay. And then one â just one last one on non-res activity. You said that things are â you expect things to pick up here. What are you seeing in January on that front? I assume youâre seeing some positive things? And whatâs the latest outlook on how things trend in the back half of the calendar year? Yes. When we look at our pipeline and we track our pipeline very closely, especially as it relates to all of the â our growth vectors and then the overall general market, when you look at the Dodge number and when you look at that growth, we are lagging that. So weâre seeing significant opportunity there as that plays through. We are watching the ABI, which is longer term from projects that are coming to market. It did soften in November. It did come back and stabilize in December. And so for us, itâs â and then when you look at our mix of our businesses, with the demand for our core applied business, when we look at our chillers, when you look at industrial refrigeration, you look at our data center offerings, across our supply â across that portfolio, weâre seeing incredible demand. And weâre working to make sure that weâre executing on the capacity expansions that we made â that we started over a year ago to be positioned to be able to support that demand, and weâre making good progress, Steve. So from a non-res, as far as our mix and where we see our strength to be, we see continued very strong activity building in the pipeline. Good morning. I just wanted to start off perhaps with the inventory and the cash flow because I think the inventory was up about $400 million sequentially, and it seems like itâs a mix of kind of too much supply and too little demand in things like resi and then too much demand and too little supply in some other areas like commercial HVAC. So maybe just help us understand kind of whatâs going on in that inventory balance. And then what does that mean for the pace at which free cash flow improves over the balance of the year? Do you think free cash flow can be up year-on-year in the current second quarter or itâs more of a sort of second half recovery on cash? So if you look at, first of all, the full guide, itâs unchanged, 80% to 90% free cash flow for the full year. If you look at the seasonality of your question, we believe weâre going to go back to historical free cash flow generation seasonality. That means that we should be year-to-date at the end of Q2, close to breakeven from a free cash flow standpoint. You can infer from that, that we would be positive in Q4 â in Q2, Iâm sorry. So breakeven year-to-date at the end of Q2, positive in Q2. Youâre right. Inventory was the key variable explaining what happened in free cash flow in Q1. Largely, George covered that. Resi and some mismatch of inventory is what is explaining this trend. We believe that this is going to keep improving all through the year. We have detailed action in place. And we believe that breaking even after the first half is an achievable goal from a free cash flow standpoint. So Julian, just to add to that, as you look at our commercial applied business, in many product lines, weâre doubling; in some cases, tripling. And weâre in the process of building up and being able to achieve that output through the course of the year. So weâre in a build and weâre making good progress on the applied business. When you look at our total applied business with what we do externally as well as internally, itâs up very strong here in the first quarter. And then the second is what Olivier said, as we work through the residential disruption, itâs really comes down to one plant on supporting our residential business with the disruption that we had really coming into the quarter. Weâve worked through that, and weâre positioned to adjust. Given the mismatch we had, weâve lined out with our distributors relative to what they expect. And we have confidence that, thatâs going to normalize here over the next quarter or 2. Thanks very much. And then I just wanted to circle back to the North America Field business again, because youâve had, I think, seven quarters now of down margins year-on-year. The Q1 margin was 200 points lower than it was two years ago. And I think youâd mentioned mix as a headwind specifically in the first quarter, but clearly, there have been issues predating that, pulling down the margin. And it seems like itâs taken longer than youâd expected to get that North America field margin to turn the corner. So I think clearly, the guide embeds an improvement there getting to that $1 of EPS, for example, in Q3. But maybe give us a bit more color on what youâre doing kind of inside that organization to get the margins to turn around. And how much of the improvement in margin is that internal self-help versus getting some sort of macro or supplier benefits? And so let me touch on that, and Iâll turn it over to Olivier. When you look at the turn, so what weâve booked over the last â itâs really been the last year, 15 months, whatâs been turning some of the longer cycle projects that are turning now and you look at whatâs going to turn second, third and fourth quarter, a much higher mix, Julian, relative to the margin that we booked into the backlog. And that margin is tied to much greater value propositions. And then ultimately, in installed base, itâs going to spin off service. And so weâre going through the last of the tail that was prior to this inflationary period of projects that are still coming through. But I have confidence that when we look at what weâve been â how weâve been building these projects costing and then ultimately executing, youâre going to start to see a nice pickup in margins. And I think â and then the other factor is that the velocity of our turn, because of the improvement in the supply chain, youâll start to see much higher productivity because the velocity of being able to turn these projects more consistently as we work through the year. Those are the two big factors. Olivier, maybe you could comment on the margin rate. Absolutely. So as a byproduct of the speed of the backlog conversion, we would see, as I indicated earlier, Julian, margin expansion, I can go a bit more into the details of the numbers here. So probably in Q2, we will expect segment EBITDA margin to increase close to a full points. And today, for Q3, we are planning actually close to a 4 points margin improvement in this business, not assuming a significant change in churn rates of the backlog. Hi, good morning, George and Olivier, and welcome Jim to the call in our world again here. But guys, I think that the story really this cycle has been about pricing power. And Iâm kind of curious to see as demand kind of flattens out here and maybe some of the big COVID drivers kind of anniversary. How â whatâs your confidence that price is something that you can continue to capture? And I donât really mean in your backlog. Whatâs in the backlog is in the backlog, I suppose, but in forward contracts, you start to think about back half of 2023 and into 2024. Scott, as we look at what weâve done as weâve been executing on the strategy that we outlined a couple of years back and where we are in that journey, itâs really now capitalizing on a much bigger value proposition as we focused on our vectors of growth. And thatâs not only in how we pulled together our combined capabilities within our products. But now with OpenBlue and ultimately are creating solutions that deliver on an outcome for our customers. And the outcome is typically focused on energy reduction, obviously heightened indoor environmental quality and then ultimately leading to an autonomous building. And as we focused on our core and then when you look at the contribution that our HVAC business has to being able to achieve those outcomes, it is significant. And so the value proposition comes with being able to create a solution thatâs very different than what historically has been provided leveraging our technology and then being able to really leverage the core in how we ultimately deliver on that with the technology that we have in our products. And so weâre confident that when you look at how weâre pricing today, the value proposition we bring and the new products that weâre bringing to market, our new product investment is up about 25%, 28% year-on-year. Weâve got the leading portfolio in heat pumps. Heat pumps now today are going to be a big part of the solution and being able to reduce energy while weâre continuing to enhance the indoor air quality. And we have new heat pumps pretty much across the board where that technology is being applied across our entire portfolio from the most complex industrial applications with our chillers and industrial refrigeration across all of our commercial products rooftops as well as our applied air-cooled chillers going into data centers and then across our residential portfolio. So Iâm confident that with the technology, the value proposition and then our ability to fundamentally change how we serve our customers with solutions that focus on outputs delivering for them, weâre seeing significant momentum on that. Thatâs helpful, George. And when you break â I mean, it certainly makes a ton of sense in HVAC. When you think about Fire & Security, how has that sales pitch kind of changed over the last few years? I mean, I certainly understand the connected building, but how specifically has that value proposition, I guess, which is so tangible in HVAC, but perhaps less so in Fire & Security. Maybe you can update us there. Thanks. Yes. The way that weâve leveraged our Fire & Security portfolio today, itâs still very attractive. Itâs still 40% of our revenues. Itâs quarter building systems. On the digital side, they are critical systems that do integrate with an overall smart building. And because of the sensors that these systems bring into the building, very important for the data that we collect within OpenBlue and how we ultimately create a smart building. So it starts there. Now you would argue that thereâs more around the security systems. So whether it be access control, intrusion or video, those are very important sensors and systems that historically have been separate and apart but then ultimately converge with our building controls and the other digital systems within the building that with now â with OpenBlue, we can bridge all of those systems into one solution, into one data set. So it starts there. And then from a fire standpoint that when we install a fire system, that the value proposition that we bring through service is significant in our ability to be able to connect and monitor and ultimately be very proactive in how we support our customers through service. So those are the two â when you think about Fire & Security, the value proposition that it has into the solution set that weâre building and ultimately differentiating the outputs that we can create for the customers that we serve, Scott. Good morning. Thanks. Circling back to supply chain health. Can you give us a little bit of a better sense of what you saw across the business lines during the quarter, particularly in Global Products. Maybe quantify any impact on how much revenue was pushed and then just your line of sight on the supply chain helping that improving pace of backlog conversion. Yes. Looking at our Global Products, when you look at the impact that we had, and I think the other point to make here on our Global Products volume, we had a fire in a warehouse within our fire suppression business. It impacted the finished goods that we had stored. And although we work to try to recover that in the quarter, that impacted our growth rate at the product level about 2% or 3%. So that is a big factor. Weâre going to recover that volume here in the second quarter and most of it in the second quarter, but maybe into the third quarter. So itâs worthy to mention that. The resi demand hit us for another roughly 1% to 2%. And then when we look at China and then the ability to be able to â weâre significantly ramping up our applied businesses. So when you look at our applied mix, weâre up double-digit across the board. And so weâre confident that with the capacity expansion, with the work that weâve done with our supply base and making sure we have visibility to the volumes as we ramp, like I said earlier, in some cases, weâre doubling or tripling our volumes in our applied space. So Iâm confident that although â and then when you look at our total product units, weâre relatively flat because some of the units do go into our direct channel solutions. So weâre going to be ramping here. Weâre going to deliver unit growth here as we position for Q2. That will continue to expand as we go through Q3 and Q4. Those are the key factors, Noah, that have been impacting our ability to be able to turn. Okay. Very helpful. And then just wanted to circle back to orders timing. Maybe we can focus particularly on sustainability. We look at the pipeline growing, was it 26%, versus the orders growth in the quarter. Weâve obviously had a lot of significant relevant legislation and policy. How much of this is that playing into the actual timing as clients figure out the implications? And are we waiting for things like treasury guidance before more folks sign? Is there any kind of an expected air pocket here? Or do you expect that conversion to significantly increase in the next quarter or two? Weâre expecting that this is going to continue to significantly increase. When you look at the IRA, thereâs $369 billion in incentives over the next 10 years. We believe â and itâs all focused on electrification, which we deliver through heat pumps. Itâs focused on impact on grid capacity and generation, which we do incorporate renewable supply into our solutions and then just overall energy efficiency. This is right in our sweet spot. And so we think the $369 billion actually multiplied by 5 to 10 times given the amount of resource that will be put to work in being able to deliver on our customersâ sustainability goals. And so when you look at the pipeline that weâre working to convert, itâs well over $7 billion. We had â last year, that had ramped up to about $1 billion, last year, we see that accelerating over the course of the year. These are larger projects, so itâs hard to predict the timing of conversion. But our teams, weâve got the team on the field that with the depth and expertise, I think that fundamentally changes how we can go about serving our customers with the type of solutions that weâre developing. And all of that is delivered â when you think about the optimal solution, itâs not just the equipment because we have leadership equipment. Weâre developing a leadership portfolio of heat pumps, but its how the equipment comes together with our digital platform that ultimately delivers on our customersâ expectations. And thatâs whatâs going to, I think differentiate us as we build not only build the pipeline, but begin to convert and capitalize on the opportunity ahead. And just one last note in Europe. Itâs similar in Europe. I mean we talked about the IRA. But weâve been working very closely with the EU with a number of their strategies, the green deal, net zero by 2050. Theyâve got the EU level legislation around. They got climate law. They got an energy performance of buildings initiative. And then more recently, it was the REPowerEU focusing on the independent firm Russian fossil fuels. All of these activities, weâve been aligned working and making sure weâre aligned so that weâre going to be positioned to ultimately achieve the goals that theyâre setting out to achieve. Thatâs very helpful color, and Iâll correct myself, that Healthy Buildings pipeline was out 26% and sustainability up 20%. So thank you for the color. I just wanted to actually come back to, I guess, a couple of topics that have already been addressed, but just to really kind of clarify. First, just on the notion of margins improving on kind of acceleration of execution out of the backlog, it doesnât seem like thatâs what youâre guiding. I donât know if you updated the volume forecast for the year. But I guess your guide sort of assumes kind of little or no volume growth. So I guess the first question is, is it that you expect acceleration to happen, but youâre not quite willing to guide that way yet. Or is there some governing factor, supply chain, labor on the job sites, that sort of thing that youâre looking to get past first? So if you look at the margin acceleration, which is a byproduct of the backlog conversion, as you said, Jeff, that is not really a variable associated with unit volumes. If you look at the field business, which is about $16 billion of revenue for the enterprise, this is more and more a business which is solution based, where you need less and less a relevant measure solution because we sell services, we sell sustainability, we sell indoor air quality. So the margin acceleration is a byproduct of just the conversion, and we are planning to your point, for volume to be growing low-single digits, about 2% for the back half of the year. A comment on that, Jeff, as we have instituted over the last two years, the significant improvement in our ability to strategically price and then make sure that weâre within that pricing, weâre incorporating future inflation. So as weâre costing in these longer-cycle projects, making sure we have the right cost and the right terms and conditions and the like, that has significantly improved. And so when we look at whatâs going to turn in the next three quarters, a high percentage of the projects that are going to turn are in backlog. And the margin is as we have been working through the older backlog that was priced prior to the inflationary period, that is becoming less and less. And so weâre confident that whatâs in the margin in backlog is a significant step-up. Now itâs just our ability to be able to minimize disruption, get more precise relative to the material flows that support these projects. And by doing so, we accelerate the velocity of the turn. And what that does, it gives us higher productivity and then also, from an inventory standpoint, our ability to be able to recognize revenue with the execution on a shorter cycle. So thatâs a big element. And so I think weâre cautious relative to the continued improvement that weâre seeing in those factors, but weâre confident that the margins that have been booked are going to in turn and be significantly improved over the course of the year. And thanks for that and that partially addresses my second question. But I did want to come back to kind of projects and mix. So you pointed to kind of large projects being mix negative in the quarter. And I think a lot of the kind of OpenBlue healthy buildings, indoor air would inherently often be larger projects. Is it an issue that the stuff thatâs coming through the backlog is also as you say, maybe wasnât priced appropriately for the inflation that was coming but also just inherently had less of the newer stuff embedded in it? Really want to kind of understand if weâre waiting on big projects to come through that. In fact, when we convert them, theyâre margin-accretive to the equation. I mean itâs actually the opposite, Jeff. We â when you look at our core, we have focused our field-based business on our strategy to really differentiate and capitalize on the growth vectors, which is ultimately the energy reduction, the healthy environment and then overall automation of building. Making sure that everything we do is deploying our core capability, core technology, getting it connected and then ultimately converting it to a service. So by doing so, it has refocused the business so that weâre â the value proposition is greater with what we do. And taking out a lot of the historical contracting that we might have done that ultimately was low margin and didnât convert to services, thereâs a much higher focus on leveraging our core, obviously, leveraging digital and then ultimately delivering on outcomes that historically hadnât been achieved. And so I think from that standpoint, when you look at our applied product business, weâre up â itâs up double-digit with the applied products flowing into our channel, which ultimately is helping us create a bigger installed base. Itâs also getting the connectivity to that base, which then drives us to be able to create new value propositions with the data that ultimately we use from that installed base. I just kind of wanted to pick off where Jeff just left off because Iâm not sure Iâm totally getting it. So I mean, if we think about â it seems like unfavorable mix was the big cause of the weaker margins in the field business this quarter, but it seems like you do have confidence that then unfavorable mix will not be a factor throughout the rest of the year. So I guess, what is the risk that larger projects come through, again, greater than you expected in the second quarter to the fourth quarter driving then unfavorable mix again? Thatâs the piece that Iâm just not getting. Thank you. Yes, a simple fundamental is we track how we book and what was booked from a cost standpoint and how does that tie to the value proposition and then how it turns. And so Nicole, when we talk about mix, on a forward-looking basis, you have a much â every quarter, you have less of the older projects that maybe didnât incorporate the higher inflationary rates that we now have experienced over the last 18 months or so. And so when we talk about mix, itâs part of that as well as our ability to be able to then â everything weâve been booking from a strategy standpoint is more aligned to how we create an installed base and ultimately get a recurring revenue from that installed base with service. And that is â when we talk about on a go-forward basis, that continues to improve, recognizing that we still have projects that will be turning that didnât necessarily have that factored in. Okay. Thanks, George. Thatâs really helpful clarification. And then the second thing I just wanted to hit on is the gross â sorry, the Global Products margins have been really impressive and I think a big driver of upside or offset to field weakness for several quarters now. I guess like whatâs the confidence that you can continue to improve Global Products margins from here. At some point, do you kind of see somewhat of a margin ceiling? Thanks. Yes. If you look at today, so we believe weâre going to be able to maintain the margin in Global Products and keep improving the margin in the field. I know Nicole, just to go back to your prior question on mix, the backlog conversion is the big variable for mix improvement more than anything else. And we have a high confidence in that now happening with no improvement in lead time. Going back to your global margin question, you go back to what George has indicated, we are mainly exposed to the commercial market today in Global Products. Resi is a small proportion of our portfolio. And in Global Products, we are investing heavily in pump. If you look at the new product introductions today, 90% of them are very strong heat pump capabilities. We bought a small asset also in the quarter with [indiscernible] heat pump. So we believe that the channel, the strength of the portfolio is going to keep allowing us to maintain a strong margin in Global Products. And there was no â if you look at the macro, Nicole, today from a commercial standpoint, itâs still strong for commercial. Yes. Good morning. So just a follow-up on the IRA. Wondering if that is something that you guys expect to start booking this year and if we really donât expect to see any sort of shipments until 2024. Is that sort of the way you guys are thinking about the timing booking start this year and maybe start to see the revenue benefit next year? Yes. I mean weâre â obviously, weâre already working with customers and working through what this means and how they go about it and recognizing that weâre obviously part of that as this bill was formed. And so weâre definitely going to start to see some momentum here on the order side. And then depending on the timing, how that flows through the year and into next, weâll continue to keep you updated. But that â this is ultimately helping to build the pipeline that we have and the confidence that we have in being able to turn â but not only book but then turn sustainable solutions in. Itâs across all of our portfolio, right, from residential incentives right up through some of the more complex offerings that we have. And Josh, this is where the field presence is very important. We have today a field presence, allowing us to advise our customers about how to best leverage the benefits of the IRA. Got it. And then just on maybe a little deeper trip into the weeds on the IRA. I think thereâs like $5 a square foot in commercial energy retrofit incentives. My understanding is some of the stuff like OpenBlue is significantly below that per square foot. Like I guess like it seems sort of like a layup for customers. What would hold them back, if anything? Or is it just the industry, yourselves included, can only install products so fast? Yes. I mean itâs just purely â thereâs an educational element that weâre working through and understanding what it is and then what we can do and how we can go about solving the problem and being able to capitalize on the incentives. And like to your point, the value proposition that we bring with the output that we can create, again, it becomes very attractive for the customer. So it isnât a matter of â that I think that theyâre going to ultimately proceed. Itâs more just the timing of going through that initial upfront process in getting it defined and then ultimately being able to execute. But weâre confident, Josh, with the solution set that weâve built that weâre going to be well-positioned to be able to capitalize on the dollars that come into the market as a result of that. And some of it is, when you look at customers, itâs also changing how theyâre thinking about whether it be capital or OpEx and how these business models are configured and then how they match that to the benefits that they see. So weâre working through that. Weâve got a team thatâs working directly with our customer base in sorting that out, but weâre going to start to see momentum that on that both in the orders and then our ability to be able to convert. I was wondering if you could talk about any differences youâre seeing in this forward pipeline, order pipeline between Fire & Security and the applied HVAC market. I remember back when you had your Investor Day, you thought those markets would grow at a similar rate. And is that consistent with what youâre seeing today? Yes. So on the Fire & Security, we are seeing strength in the â with the Dodge construction and the activity coming through, and weâre positioned well on that on the â more on the retrofit side, we thrive and from a service standpoint and how we upgrade and ultimately reconfigure indoor space and the like. And weâre seeing a lot of that given the hybrid work and how people are coming back to work. And so that is â those are the factors that drive Fire & Security. We were up both orders and revenue up close to double-digit in both typically a little bit lower growth rate than what we see in HVAC. And then HVAC is really being driven by what weâve discussed here frequently here during todayâs call around the value proposition not only with the efficiency that we bring within the new equipment but the deployment of heat pumps, for instance. We are in a situation where weâve improved our technology with the temperatures that we can generate. When you take a chiller and convert to a heat pump and then be able to replace a boiler, significantly reduces the carbon footprint for our customers. At the same time, youâre getting 3 to 5 times the efficiency out of the unit. And so you get a tremendous payback. And so itâs through these models, Gautam, that as we begin to unleash what we believe to be a very attractive market and does play to our strengths, that is going to be a different demand cycle than what historically weâve seen in HVAC. One statistic, Gautam, to complement what George has indicated, our adjusted pipeline growth today is in the mid-teens, just reflecting what George has indicated. Okay. And then could you comment on your updated expectations for commodity inflation or deflation, I should say, this year? And then if you could just also comment on lead times that you guys are quoting in the applied commercial HVAC space. Thank you. Yes. So on the inflation as it relates to commodities, weâre watching that closely. Certainly, some of that has moderated. But as theyâve moderated, other costs have continued to increase. So thatâs something weâre watching closely. And certainly, I want to make sure that we stay disciplined with the impact that, that might have. I think whatâs important to us now is that the business proposition here is that weâre creating value not necessarily tied to purely price cost as what historically we would have done. So I think thatâs one factor. The lead times as a result of the strong demand, youâve got to realize, Gautam, that as weâve gone through the last year, weâve had significant pickup in our backlog around applied. And so on a go-forward basis, itâs important that we get â weâve been building our capacity. We were expanding a number of our plants, whether it be water cooled chillers or air cooled chillers or industrial refrigeration. Our data center solutions, weâre significantly increasing our capacity as weâve been ramping up, and weâve been doing this in line with the supply chain recovery that weâve been executing on. And so once â with this backlog, weâre trying to address the backlog so that we can open up capacity with shorter lead times to now be able to capitalize on what we see to be very strong demand going forward. So the lead times are being reduced. Theyâre not to where we like them to be. But with the additional capacity weâre putting online as we go through the year, weâre going to be positioned very competitively from a lead time to be able to respond ultimately and support the customer demand that we see. Can you give us what the lead times are today? What is it in like 9 months to 12 months? What do you think of it? They vary. So itâs hard to state any one, depending on the right from the residential to the large commercial, but weâve been reducing them significantly here over the last six months. We are now with the additional capacity coming on board, I would tell you, our volumes in our applied business on a run rate basis with our chillers and then our water cooled chillers and our air cooled chillers, weâre looking at volumes on a run rate basis that are going to be 2 or 3 times. And so as weâre putting those that capacity in place, it does give us an opportunity on a forward-looking basis to reduce the lead times that weâre quoting to our customers. That was our final question for today. I will now turn the call back over to the speakers for final comments. Yes. And Iâd like to thank everyone once again for joining us on todayâs call. As we have discussed, we have a very strong start to the fiscal year. Iâm very confident in our ability to execute and continue the momentum in the coming quarters as we step â really step up into the next phase of our digital transformation journey. And with that, I look forward to seeing many of you over the conferences over the next couple of â next month or so. And with that, operator, that concludes our call.
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EarningCall_1289
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Good morning, and welcome to the General Dynamics Q4 2022 Conference Call. All participants will be in listen only mode. Please note, this event is being recorded. Thank you, operator, and good morning, everyone. Welcome to the General Dynamics fourth quarter and full year 2022 conference call. Any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainties. Additional information regarding these factors is contained in the company's 10-K, 10-Q and 8-K filings. We will also refer to certain non-GAAP financial measures. For additional disclosures about these non-GAAP measures, including reconciliation to comparable GAAP measures, please see the press release and slides that accompany this webcast, which are available on the Investor Relations page of our Web site, investorrelations.gd.com. With my introduction complete, Iâd turn the call over to our Chairman and Chief Executive Officer, Phebe Novakovic. Thank you, Howard. Good morning, everyone, and thanks for being with us. Earlier this morning, we reported earnings of $3.58 per diluted share on revenue of $10,850 million, operating earnings of $1,230 million and net earnings of $992 million. Revenue is up $559 million or 5.4% against the fourth quarter last year. Operating earnings are up $41 million or 3.5%. Net earnings are up $40 million or 4.2% and earnings per share are up $0.19 to 5.6%. So the quarter-over-quarter results compare very favorably and are in most respects consistent with our forecast and sell side consensus. The sequential results are even better. Here, we beat last quarter's revenue by $876 million or 8.8%, operating earnings by $129 million or 11.7%. Net earnings by $90 million or 10% and EPS by $0.32, a 9.8% improvement. As promised that it would be, the final quarter is our strongest for the year in both revenue and earnings. In fact, earnings per share, operating margins, net earnings and return on sales improved quarter over the previous quarter throughout the year. It was a nice steady progression of sequential improvement. For the full year, we had revenue of $39.4 billion, up 2.4%, net earnings of $3.4 billion, up 4.1% and earnings per fully diluted share of $12.19, up $0.64, a 5.5% increase. So overall, the year was also reasonably consistent with our forecast and modestly better than the sell side. It was a very solid year in a difficult environment. Let me ask Jason to provide detail on our overall order activity, very strong backlog and cash performance in the quarter and the year. Yes. Thank you, Phebe, and good morning. Order activity and backlog were once again a very strong story with a 1.2:1 book-to-bill ratio for the company for the fourth quarter and a 1.1 times for the full year. Order activity in the Marine and Aerospace groups led the way. We finished the year with a total backlog at an all time high of $91.1 billion and total estimated contract value, which includes options and IDIQ contracts of nearly $128 billion. I should note that foreign exchange rate fluctuations continued to be a headwind, reducing year-end backlog by nearly $600 million with the vast majority of the impact in Combat Systems. Turning to our cash performance for the quarter and the year. It was another solid quarter with operating cash flow of $669 million, which brings us to $4.6 billion of operating cash flow for the year. After capital expenditures, our free cash flow for the year was nearly $3.5 billion, a cash conversion rate of 102%, slightly ahead of our target for the year of 100% of net income. As discussed on previous calls, Gulfstream enjoyed particularly strong cash performance throughout the year on the strength of its order activity and the Technologies Group once again delivered outstanding cash performance. That said, when we talked with you in October, we discussed three potential constraints to cash in the fourth quarter; the pending outcome of congressional action on the tax treatment of R&D expenditures; the timing of resumption of cash collections on the Ajax program in the UK; and an anticipated uptick in capital expenditures as we progress through our ongoing facility investments. As it turns out, the Congress did not act to remedy the requirement to capitalize R&D costs, we did not receive any payments from the UK, though we now expect payments to resume this quarter, and our capital investments were in fact elevated, consistent with expectations. I'll discuss that in more detail a little later in the call. The net result was a lighter fourth quarter from a free cash flow perspective but slightly better than we had expected and rounds out a very strong year in terms of cash performance despite the headwinds I discussed. I should also point out that free cash flow per share has grown at a 22% compound annual growth rate from 2019 through 2022. Thanks, Jason. Now let me review the quarter in the context of the business segment, paying modest attention to the quarter-over-quarter sequential and annual comparisons that are rather straightforward and set out in the press release. First, Aerospace. The story in aerospace is found in the sequential and year-over-year improvement as well as a continuing strong demand for Gulfstream aircraft, along with the overall strength of Gulfstream service business and the continuing improvement of Jet Aviation. In the quarter, Aerospace had revenue of $2.5 billion and earnings of $337 million. This represents a 4.4% increase in revenue and an 8% increase in earnings on a sequential basis. For the full year, revenue of $8.57 billion is up $432 million from the prior year, even though we delivered only one more aircraft than we did in 2021. The increase in both revenue and earnings was driven by higher service revenue at both Gulfstream and Jet Aviation. Earnings were also helped by somewhat higher margins on delivered aircraft. Fourth quarter revenue and earnings comparison on a quarter-over-quarter basis are as attractive because three aircraft we plan to deliver in the fourth quarter slipped into the first quarter this year. Gulfstream had 38 deliveries in the quarter when we had planned to deliver 41. As a result, aerospace revenue and earnings are somewhat less than anticipated by the sell side for the quarter and for the year, but generally consistent with our forecast. I should also point out that Aerospace margins improved consistently quarter-over-quarter throughout the year. Aerospace demand remained strong. The book-to-bill was 1.2 times in the quarter and 1.4 times at Gulfstream alone. Orders in the quarter were $3 billion, up from $2.7 billion in the third quarter. The aerospace book-to-bill for the year was 1.5 times. To give you a little more color, Gulfstream received 430 new aircraft orders over the past two years, over 400 net orders after default and backlog adjustments as a result of the settlement of a case in arbitration. All said and done, aerospace backlog is up 20% in 2022 and a staggering 68% over the past few years. As we go into the new year, the sales pipeline remains strong and sales activity is at a solid pace. At midyear 2022, we told you to expect revenue of about $8.6 billion and an operating margin of around 12.9%. We actually finished the year with a 13.2% operating margin. In short, we were spot on with respect to revenue and 30 basis points better on operating margin, which led to a $25 million more than forecast in operating earnings. With respect to G700 development, we estimate it will certify this upcoming summer but much depends on available FFA resources. So far, the effort has been very collaborative and is proceeding according to plan with no surprises. In summary, aerospace exhibited very strong performance in the quarter and for the year. We look forward to a significant increase in deliveries in 2023 at Gulfstream and improved operating margin, but more about that as we get into guidance. We also expect continued growth and margin improvement at Jet. Next, Combat Systems. After a relatively slow start to the year, Combat Systems finished with a powerful fourth quarter. In fact, the fourth quarter of 2022 proved the highest revenue and earnings for Combat Systems in over 10 years. Revenue in the quarter was $2.18 billion, and it's up 15.5% from the year ago quarter. Operating earnings of $332 million are up 18.1% on a 30 basis point increase in operating margin. OTS alone captured more than one third of its revenue and earnings in the fourth quarter. The revenue growth was largely driven by Mobile Protected Firepower, Abrams for Poland and the large international order in Canada. OTS enjoyed higher revenue across all lines of business with particular strength in artillery rounds. Not surprising, the sequential comparisons are even better. Revenue is up $391 million or 21.9% and earnings are up $61 million or 22.5% on the strength of a 15.2% operating margin. From an orders perspective, Combat had a very good year in 2022 with a book-to-bill of 1.1 times, driven by MPS, very strong international demand for the Abrams main battle tank as well as growing demand on the munition side of the business. By the way, Combat's annual performance is fairly consistent with the forecast we provided you earlier in the year. Revenue and operating earnings are up somewhat and operating margin is a little lower. In short, this group had a wonderful quarter, continued its history of strong margin performance and had good order activity and a strong pipeline of opportunity as we go forward. Marine Systems. The Marine Systems growth story continues. Fourth quarter revenue of $2,970 billion is up 3.4% over the year ago quarter. Revenue was also up 7.2% sequentially and 4.9% for the full year. Operating earnings are up about 1% over the year ago, off less than 0.5% sequentially and up 2.6% for the full year. Once again, this is the highest full year of revenue and earnings ever for the Marine group. A little perspective maybe of assistance here. Marine Systems has grown revenue from $8 billion in 2017 to $11 billion in 2022, this is a 5.3% compound annual growth rate with an average increase of $600 million per year. Earnings have grown from $685 million in 2017 to $900 million in 2022, a 5.5% compound annual growth rate. In addition, Marine had strong orders in the quarter, generating a 2.2 times book-to-bill, including the receipt of a $5.1 billion contract modification to Colombia. Our forecast to you in July of last year anticipated revenue of about $10.8 billion, operating margin of 8.3% and operating earnings of $896 million. We came in above that for revenue, a little lower on the predicted operating margin and right on the forecasted earnings. So Jason is going to give you a little color on the Technologies group, his new responsibility, provide a bit of perspective on balance sheet, other income and expense items, and I will close with our outlook for 2023. The technologies group as a whole had a very strong finish to a solid year and a very challenging operating environment. Revenue in the quarter of $3.25 billion was up 9.3% over the prior year and up 6% sequentially. Operating earnings of $340 million were up about 2% over the fourth quarter of 2021 and sequentially, were up an impressive 19%. The main driver of the fourth quarter performance was Mission Systems' ability to overcome some of the logjam in its supply chain and deliver some of the product that was held up at the end of the third quarter. While these issues have not been completely resolved, the fourth quarter performance gives us good reason for optimism that they're starting to see their way through this. For the year, revenue of $12.5 billion was up just slightly from 2021. Breaking that down, GDIT once again grew in the low single digits, up 1.6% after 2.2% growth in 2021. Mission Systems was down 2% despite the strong end to the year. Earnings for the year of $1.23 billion were down 3.8% on a 40 basis point contraction in margin to 9.8% as a result of the mix shift between product and service revenue as GDIT reported its highest margin since the CSRA acquisition and its highest ever earnings, but Mission Systems was down for the reasons discussed. With respect to backlog, the Technologies group had a solid year, notwithstanding an ongoing trend of customer solicitations pushing to the right and recurring award protests. GDIT received over $11 billion in awards during the year, almost 20% higher than 2021, representing more new work than any year since the CSRA acquisition. And Mission Systems finished the year with a 1.1 times book-to-bill and a capture rate in excess of 80%, putting them in a good position to emerge from the supply chain headwinds they've been facing. With that, I'll turn to some of the financial particulars before turning it back over to Phebe to give you our guidance for 2023. Starting with capital deployment in 2022. Capital expenditures, as I noted, were elevated in the fourth quarter at $494 million or 4.6% of sales. That brings us to $1.1 billion for the full year. At 2.8% of sales, full year capital expenditures are slightly higher than our original expectation due strictly to timing. We expect capital expenditures to start to step back down below 2.5% in 2023 and continuing to trend towards historic levels. We also paid $345 million in dividends in the fourth quarter bringing the full year to $1.4 billion, and we repurchased approximately 440,000 shares of stock in the quarter, bringing us to over 5 million shares for the year for $1.2 billion at just under $226 per share. With respect to our pension plans, we contributed $50 million in 2022 and we expect that to increase to approximately $200 million in 2023. This includes a modest voluntary contribution to one of our commercial plans, which was made this month and fully funds the plan that had a funding gap of more than $500 million within the past two years. Concurrently, we shifted the investment mix to hedge the plan's $2 billion of liabilities, thus eliminating any funding risk associated with market volatility or discount rate fluctuations. However, as a result of the change in investment mix, our pension income will be lower in 2023. Following this derisking activity, we expect our corporate operating expense for 2023 to be approximately $140 million and our other income to be approximately $80 million, a combined reduction of roughly $125 million in nonoperating noncash income from 2022. Speaking of pension income, the fourth quarter had higher than anticipated other income as we benefited from higher discount rates for measuring liabilities on our nonqualified pension plans, which are mark-to-market at the end of the year. We also repaid $1 billion of fixed rate notes in the fourth quarter. After all this, we ended the year with a cash balance of over $1.2 billion and a net debt position of $9.3 billion, down approximately $600 million from last year. We have $1.25 billion of debt maturing in 2023. Our net interest expense in the fourth quarter was $85 million, bringing interest expense for the full year to $364 million. That compares to $93 million and $424 million in the respective 2021 period. Pending our decisions with respect to the scheduled debt maturities, we expect interest expense in 2023 to remain essentially consistent with 2022. Turning to income taxes. We had an 18.1% effective tax rate in the fourth quarter, which brings our full year rate to 16%, consistent with our guidance. Looking ahead to 2023, we expect the full year effective tax rate to increase to around 17%, reflecting higher taxes on foreign earnings. The sum total of these below-the-line items versus the comparable levels in 2022 is a net negative impact on 2023 diluted earnings per share of $0.63. And finally, with respect to our outlook for free cash flow, following a strong 2022, we expect cash conversion in 2023 to be better than 100%, roughly in the 105% range, assuming the resumption of Ajax receipts in the first quarter, as I mentioned earlier. Thanks, Jason. So let me provide our operating forecast for 2023 with some color around our outlook for each of the business groups and then a company-wide roll-up. In 2023, we expect Aerospace revenue to be around $10.4 billion, up between $1.8 billion and $1.9 billion. Margin is expected to be up 140 basis points to 14.6%. Gulfstream deliveries will be around 145, up a little over 20%. This is all consistent with the multiyear forecast we gave you in January of 2021 and at the end of Q2. In Combat Systems, at this time last year, we had anticipated revenue to be down slightly in 2023, following a modest decline in 2022 with a return to low single digit growth later in our planning horizon. Since then, the threat environment has clearly changed. Continuing the better than expected performance in 2022, we expect the group to hold steady again in '23 with revenue of $7.3 billion and operating margin once again towards the high end of their reliable 14% to 15% range at 14.7%. The improved outlook is a result of strong order activity we saw in 2022, including the MPF award and growing international demand, particularly the tank order in Poland, which came in sooner than had been anticipated. We're seeing demand signals resulting from the war in Ukraine, but we've only just begun to see that manifest in our backlog at this point. To the extent those demand signals start to convert into order activity, we could see some opportunity for additional revenue in the latter part of the year, particularly in our armaments and munition business. As I noted earlier, Marine Group has been on a remarkable growth journey, averaging $600 million a year. Our outlook of $400 million to $500 million per year over time remains unchanged. However, the supply chain constraints of the Virginia program will drive some annual variability this year. As a result, the group's revenue for 2023 will remain essentially flat at $10.9 billion as well their operating margin rate at 8.1%. We anticipate a return to growth in 2024 and 2025 at around $600 million a year. We expect revenue in the range of $12.5 billion to $12.6 billion in the Technologies group. To give you a little color behind this outlook, GDIT will continue to grow at a low single digit pace consistent with the past three years. Mission Systems, however, will be challenged from a revenue perspective. Particularly in the first half of the year as they work through the lingering supply chain issues they've been dealing with for the past 18 months. As a result, their revenue will be down slightly compared with 2022. The resulting shift in the group's revenue mix, with stronger service activity but lower hardware volume would yield an operating margin in the 9.5% range, sustaining their industry leading performance, albeit slightly lower than 2022. So for 2023, company wide, we expect to see approximately $41.2 billion to $41.3 billion of revenue, an increase of almost 5%. We anticipate operating margin of 10.9%, up 20 basis points from 2022. This all goes up to a forecast range of $12.60 to $12.65 per fully diluted share. On a quarterly basis, we expect a pattern similar to what we've seen in recent years with sequential increases in revenue and operating margins throughout the year. As always, this forecast is purely from operations. It assumes we buy only enough shares to hold the share count steady to avoid dilution from option exercises. Beating our EPS guidance must come from outperforming the operating plan and the effective deployment of capital. Let me close with an observation. Our forecast comes from our operating plan. It is conservative as it must be in this environment of unpredictable financing of the government. However, the threat environment suggests increases in defense spending. In short, I see more opportunity than risk in our forecast. Thanks, Phebe. As a reminder, we ask participants to ask one question and one follow up so that everyone has a chance to participate. Operator, could you please remind participants how to enter the queue? I was hoping maybe you could touch on a couple of things. One, Jason, your new role and how you sort of think about balancing the act between the CFO and the operating segment roles and responsibilities with you intend to focus on there. And then maybe on the capital deployment front for '23 at 105%, obviously, you've got a lot of excess cash. Should we expect you to pick up repurchase activity in '23 versus '22 or relatively similar? Myles, I think with respect to your first question, looking at the new responsibility and that opportunity. First and foremost, it's important to remember that these businesses are run by two excellent and accomplished presidents. And frankly, I have the highest level of confidence in them and their teams. When I look back over recent history in this role, Chris Marzilli, really helps steer this business through a period of remarkable change and transformation, not to mention COVID. And I don't think as I look ahead that this market is going to become any less dynamic. So I think the focus really is on continuing to make sure that the businesses continue to focus on their bottom line, earnings and cash as always but frankly, also finding our way to a sustainable top line growth trajectory, and that will really be the emphasis. In terms of balancing the two, I'm humbled and honored to have this dual responsibility, fortunately entering my tenth year in the role as CFO. So I feel confident about the ability to handle both at the same time. So with respect to our capital deployment, we'll continue to invest in our business where prudent. We'll continue to maintain our dividend and we'll repurchase shares accordingly. So I don't see any big change in the priorities at least for our execution. Phebe, could you touch on -- you mentioned three deliveries that slipped out. Was that customer preference, was that supply chain related? And then it doesn't appear that you're going to -- your prior guidance was 148 deliveries this year, now you're talking 145. So it doesn't seem any makeup there. And then last thing, the 170, I think you forecasted for '24 deliveries. Does that still hold? So let me go in order. We had, as I noted, three airplanes have slipped into this quarter. One was simply an issue that we just couldn't get it completed in time and two of them were customer preferences for international deliveries. With respect to the production next year, we are confident that we can make that and our trajectory going forward past this year remains the same. So directionally and we're right on track, and we're comfortable we get there. I wonder if you could talk a little bit more about marine and the supply chain challenges at Electric Boat. And specifically, what we should be looking for in terms of any particular metrics, whether it's hiring or deliveries or certain milestones to get a sense that things are firming there and kind of also what the risk is of further deterioration in schedules. So let's deconstruct that and I think we have to posit few truth. We went into COVID with scheduled variants on Virginia. Virginia is also about a third of the Electric Boat revenue. COVID had a profound impact on many aspects of our lives, but particularly lasting one on the workforce. We had labor discontinuity throughout the United States and we also experienced something that we had not anticipated abnormally large retirement of experienced workers. In a business that is heavily manpower dependent, these impacts had a disproportionate effect on additional schedule variants. We are working with the Navy who's been quite active and engaged in helping develop a plan and a really detailed action list on how to address these issues and shipbuilding and the supply chain are fixed by incremental improvements over time. So what do we see at the moment? We see stabilization in the workforce. I think across the nation, we've got a little bit better labor dynamics than we did immediately coming out of COVID. We also have additional experience in what some of the challenges have been. So the way I look at it, this year will give us a bit of a chance to dig further see funds to the velocity of the material coming into Electric Boat. And that ought to be a good thing for all involved despite and notwithstanding the considerable issues around schedules. I would note that the Submarine Industrial base for the two submarines last year, and we're going to deliver two more this year. So I think maintaining that cadence of delivery is important. But in much of shipbuilding, milestones are difficult to identify really until you get the ship in the customers' hands. So as I said, we're working very closely with the Navy to ensure that we could just get back some of that schedule variance on the remainder of the Block 4 ships and on the Block 5 ships. And maybe just to follow up specifically on that. Most of the discussion -- our discussion today and then the trade press has been about Virginia. How's the Columbia schedule holding up? Phebe, maybe just to stay on Seth's line of question just on Marine. Maybe you could just -- there's been a lot written about just the industrial base, and you just mentioned it. How are you thinking about just maybe the CapEx profile and in particular, things start to get unveiled on [ACAS], what the plans might be there? Just should we expect any further step-up in CapEx [Technical Difficulty]? Not with respect to [ACAS]. And I think we have, as I've said on earlier calls and to many of you in person, we'll just take our lead from our Navy customer on how they want us to respond to all of this. So this is really an intergovernmental series of discussions and agreements and we will, of course, support whatever the Navy plan is going forward. And just as a quick follow-up, just maybe just in general on the supply chain. You talked about the constraints in marine and some of the issues at Mission Systems. Has it gotten worse [submission] or do you think it's actually kind of stabilized? And this is just -- if is what it is, what's going on in the marketplace? So I think with respect to Mission Systems, we have to really focus on what it is we're talking about here, which is really chips and microelectronics, right? So unlike some of the other parts of the business, which are heavily labor and availability of workforce driven. So this is really, obviously, for Mission Systems an issue that's impacting industries much broader than just us or us in the aerospace and defense side. And I think when these issues first surfaced, Mission Systems did a really nice job of developing workarounds, right? Finding alternate sourcing, certifying substitute parts and so on. So all of those actions were predicated on the expectation that the supply chain would kind of come through this and get over the hump within, call it, a year plus or minus. But frankly, as we've continued to work our way through it, it's become clear that we're not always at the top of the priority list for some of these sources of supply. So when they saw the bottlenecks we were dealing with were going to persist somewhat longer than expected, the team really adapted to this new normal with a whole new set of tactics. That includes procuring key components with longer lead times anywhere from 12 to 18 or even 24 months, as well as working with key suppliers to improve the forecasting that we were giving them and the reliability of demand so that they could have confidence in where we were going and allocate additional capacity to us and our priorities. So all of that is in place and underway. As you might imagine, some of those things take a little longer to yield results. So that's why we're expecting that to kind of come through in the second half of this year. But we do feel like they've got a good plan in place, they've taken great corrective actions, and we just need to see that all sort of roll out and to get to the other side of this, but it's likely to be toward the second half back into this year before that all takes hold. You've talked about this a little bit in your prepared remarks about the impact that the Ukraine could potentially have on land systems. Maybe from a bigger strategic point of view, it seems like in the past, the logic has always been the Army was a bill payer for the Navy and the Air Force. Is that -- are we learning a different lesson now out of the Ukraine and what kind of implications potentially does that have for your land systems business? So if you look at the services funding over, I'd say, in the modern air post World War II, the Army gets funded when they're tactical challenges and tactical problems, either a hot war, relatively cold war or preparedness, this is an issue where we've got both strategic challenges in which the Navy and the Air Force tend to get funded. And as I noted, the threat environment has materially changed. So that has driven increased interest in a number of Army and land forces capabilities. And as we've begun to see those show up in our in our backlog and in our order book, but we've got more room to grow and more room to go there as some of this demand converts into into actual orders. So when I think about what's going on in Europe, our European combat vehicle business has done quite well in securing a number of contracts, both historically but increasingly recently and on a -- what we expect on a going forward basis. They've been active in Poland, Romania, Switzerland, Germany, Denmark, Spain, Sweden, Luxembourg. By the way, I wrote all those down because that's a lot of countries. So I think the closer you are to the threat, the more urgent you feel your funding requirements. So all of which is to say, we have changed our expectations for Combat Systems growth. By the way, overarching all of this is a need to increase our ammunition and projectile output, and we've been working with the Army for the last three, four, five months on exactly that kind of plan. So as we've always positive, the threat environment really drives demand for defense products and we're seeing some of that now. Jason, I want to take the opportunity to ask you a question about the Technologies Group. I know you've been in the seat for just a small amount of time, but I'm maybe curious to know as you settle into your seat, the kinds of investments that you think you might want to make either in technologies or new products and services or in processes [BD] in order to accelerate revenue. Just kind of get your first impressions on the needs there in the group and what might change with you now taking over leadership of that group. So I think the way to think about this group between GDIT and Mission Systems, technologies taken together, is that we currently are and have been for quite some time, in a model and of the capability set that a lot of the peer companies out there are trying to get to. That is a well balanced and comprehensive set of offerings between the traditional federal IT services offerings as well as cyber, hardware and other elements of that portfolio. And so I don't think we have to necessarily play catch up as much in that game. I think there's always opportunities to refine and enhance the portfolio. As I mentioned earlier, this is not going to stop being a dynamic environment. We are, as always, have continued to invest internally in new technology capabilities, that will continue to be the case. As you know, I'll say what I know Phebe would say if she were talking right now. We're not going to speculate about M&A. There's always the possibility for bolt-on acquisitions. I would note, by the way, since you brought up the point that since we acquired CSRA in 2018 and essentially transformed the face of this group with the size and capability of our federal IT services business. There have been -- if I look at GDIT's competitor group, call it, the top five or six main peers, there have been some 40 to 45 acquisitions in that space that those companies have taken on and we have not done any. We've done a couple of small bolt-ons in Mission Systems during that time, but nothing in GDIT space. And so it's interesting to see how the others are behaving in the aftermath of that activity and a lot of the consolidation that's happened in the industry. But I think we put ourselves in very good stead and we see a lot of a lot of others following suit. So I don't think there's a massive sea change in what we have planned ahead, but we'll continue to focus on maintaining our leading position in the market. So your margin was up a little bit sequentially at Gulfstream and yet my understanding was you had some software warranty charges in the second and third quarter associated with the G500 and 600. So Were there any other -- what were the reason the margins weren't a bit better there in aerospace? The margins are pretty darn good. We have performed what we had told you. And so we were pretty pleased with that. I would note that one of the headwinds is R&D. So the additional work that has been required from the airworthiness directive and the new FAA requirements as a result of the [MAX] have driven increased R&D. And we'll continue to see some of that and then that will begin to unwind. But I think those are very strong margins and better than we had anticipated in our guidance to you. And Jason, the guide for Mission Systems margins is down over 200 bps from where you've been. Once things start to sort out, where do you see Mission Systems margins can go? Can they go back to where they were? So I want to make sure I think you're saying technologies as a whole because we don't really give -- or business unit specific margin guidance within the group. But given what you're saying, I think if you look back to prior to the CSRA acquisition, when the IT services side of the business became, frankly, our largest business group and the lion's share, the sort of two thirds, if you will, or more of the technologies group. We used to -- the combined margin of those businesses used to be in the, call it, the low double digit range, it's usually between 10% and 11% on a fairly consistent basis. Since we acquired CSRA, we've averaged over the past five years 9.8% margin for the group. So what we're seeing right now is really just a shift in the moment where we've had GDIT come through that significant integration effort for the first couple of years followed immediately on the footsteps of that with the impacts of COVID, they've really embarked on a nice steady trajectory now of low single digit growth for several years now, and we expect to see that continue. As Mission Systems in the moment is dealing with the supply chain issues that have been, I think, well addressed, their volume is down a bit. So what we're seeing in terms of the group's margin, aggregate margin, is really nothing more than a shift in the mix between the two. So that's with the increased service side of the business and the lower volumes on the product and hardware side of the business. So as Mission Systems comes through this and gets back on track to a growth level, which we do expect to see happen once they come through these issues, you ought to see the margin on an aggregate basis tick back up. And by the way, that's not -- shouldn't overlook the fact that GDIT on its own is continuing to improve and harvest its margins as it grows. I think I said before, they had their highest margin as a business since we acquired CSRA and their highest earnings contribution to the company ever. So everything, I think, is headed in the right direction, just got to come through the supply chain issues at Mission Systems and that will help influence the mix, and we ought to see a trend back up toward the 10% level over time. Just following on to Ron's question earlier on combat and that was set in the flat outlook for this year, but you talked about the international demand, and it seemed like Congress added quite a bit of money for Stryker and Abrams to the '23 budget. So can you give us any sense of kind of the CAGR that you think is a reasonable expectation after 2023 when things begin to -- or when the demand begins to actually convert for you? So I think what we're looking at now is low single digit growth. So if we see anything over time that accelerates that, we'll certainly let you know that that's our best planning in the moment in consultation with our customer. Maybe overall on the defense portfolio as a whole, all three segments. When you think about it, you're guiding the business flat on the top line perspective and EBIT as well. The budget is up 10 and you have some pretty good programs in there. How do you think about that delta and when it catches up to the budget and EBIT growth resumes? So I think that's more in '24. One of the big issues there, as I said, is Virginia. But look, the way I look at the defense portfolio, we have an extremely strong backlog and now it's just a question of executing, executing across that portfolio. So I'm not too worried about growth on the defense side at all nor on the aerospace side. There is one thing that I think we're focused on, we should be focused on, and I neglected to mention this earlier. But with respect to execution, one of the things that we can do on Virginia and frankly at [EB], in general, is to continue to improve our operating performance. That provides us more ability to cover some of the perturbations that are coming out of the supply chain. So I really think about all of this as execution. Growth comes when it comes. We've got the backlog to support it. And so I like the position we're in, frankly. And then if I could ask one more. I don't know if you provided it. Can you give us an update on the G700, G800 certification processes? So we still expect the G700 to convert -- get certified this summer. And the G800 will be about six months after that, so we don't see any change in that. And the relationship has been going very well with the FAA. So we are continuing to look forward to finishing all the certification processes. Now that -- I will tell you that is outside our complete control, a lot of this is FAA resources and their ability to focus, given all the other demands that they have on them, but so far so good. Sorry about that. I was muted. I wanted to first ask, within Aerospace, really good growth in the services business. What's the outlook for services growth in '23 as part of the aerospace guide? And can you talk a little bit about investments that you're making in that business? We expect low single digit growth in our service side. And we continue to invest prudently when we see the need for more service capacity. But at the moment, we're pretty -- nothing really outstanding in that regard. You've got the capacity to accommodate what we see as reasonable steady growth. And just a quick clarification on the 700 certification this summer. As obviously, you commented you're working with the FAA closely and a lot of this is -- or some of this is out of your control. How would you characterize your visibility or sort of the ongoing risks around I guess, FAA capacity to support that? I mean do you feel like you're well through that risk retirement or is there still substantial uncertainty and risk associated with that summer time frame? I think the FAA has done a good job managing its portfolio and a series of complex and multifaceted requirements. And so far, we are sticking to what we believe is a reasonable expectation for the certification. Just a couple of quick ones from me, Phebe. First of all, on Ukraine, it looks like they're going to get Abrams tanks. At what point does capacity in some form or other particularly staffing become an issue? And then secondly, just for Jason, what sort of book-to-bill have you assumed in aerospace for 2023 in your cash flow guidance? Staffing is not an issue here. There is plenty of capacity on the combat vehicle side, both tracked and wheeled. So to the extent that the US government intends to execute any contracts with respect to some of these bilateral agreements that they are developing, we can -- it's well within the capacity of the industrial base to accommodate. And then, Rob, with respect to your second question, as it relates to aerospace book-to-bill, much like going into 2022, we've assumed a return to a 1:1 book-to-bill and that is one of the predicates for our cash flow forecast. So to the extent they outperform, obviously, that could provide some upside. Phebe, you touched on it a bit in your prepared remarks. I was curious if you could comment a bit more in depth on the sales pipeline at Gulfstream and the latest trends you're seeing there, both from individual buyers and the corporate buyers. And then for Jason, I was just wondering if you could identify what the unbilled receivable balance was on Ajax at the end of the year and how much of that you expect to burn down this year? With respect to our pipeline, I noted that it remains strong. I would also say that corporate America has been very active, both public and private companies, high net worth individuals. Europe remains slow. Mid East just picked up. Southeast Asia, let's say, not China, has been increasingly active. So we've got a good demand across all of our offerings in all of our aircraft. And then on your second question, as it relates to the Ajax unbilled, that's at the end of the year, roughly $1.7 billion is where we stand right now. I don't want to get into the specifics of how much we expect to collect this year, that's part of ongoing discussions with that customer. But needless to say, as I mentioned in my remarks, we do have good reason to expect those cash receipts to resume before the end of this quarter. And so we'll start to see that unbilled balance come down. Phebe, going back to an earlier question on entry into service for 700 and 800. When would might we expect the R&D to decline, I don't know how much the 400 would use, and what would the incremental margins at Gulfstream look like once that happens? I imagine that's 24 or is it 25? So I think we expect R&D to begin to go down at the end of next year. And look, we have Gulfstream is an extremely high performing operationally strong company. And so I think we have demonstrated incremental improvement in margins as our operating efficiency and discipline in our supply chain, engineering. And really on the shop floor, all of that has improved. So I think there's upward over time, margin opportunity, but we're not going to get into parsing specifics until we have good clarity. But we're very comfortable that we will improve steadily and repeatedly. And just a clarification on the FAA, you talked about it earlier. Are they still in the discovery process as they evolve their system after what's happened at peers over the past couple of years, or is there a set process that is in stone at this point? Yes, I think that that's a broader question than I'm able to answer. What I can tell you is that our relationship and working relationship with the FAA has matured significantly. And we think we all have a very clear understanding of what the new requirements are and how to execute them. And thank you all for joining us today on this call. As a reminder, please refer to the General Dynamics Web site for the fourth quarter earnings release, highlights presentation and outlook. If you have any additional questions, I can be reached later today on my office at (703) 876-3117. Operator? There are no further questions at this time, which concludes today's conference. Thank you for attending today's presentation. You may now disconnect.
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EarningCall_1290
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Good afternoon. I'm Chris Schott at JPMorgan, and it's my pleasure to be introducing Viatris today. From the company, we'll have a presentation from CEO, Michael Goettler and then we're going to open up to a Q&A session with the broader management team. With that, I'm going to turn the stage over to Michael and we'll be back post the presentation with some Q&A. Thank you, Chris. Thanks. Thank you. All right. Thank you, Chris and good afternoon everybody. This is actually our first as Viatris, which was started in November 2020, our first in-person JPMorgan meeting. So, it's really, really nice to be back. And obviously, we are extremely proud in the last two years and a few months of everything that we've accomplished to get to this point, but more importantly, excited at the path that we have going forward. Now, I am obliged to say something about forward-looking statements. Obviously, we will be making forward-looking statements. Those statements have uncertainties and risks with it. And I refer you to the slide deck to read this full disclaimer. The second thing I want to say is that because we're in a quiet period, we'll not be making any comments on quarter four or 2023 outlook. But suffice it to say, we feel very good at where we are. We feel very, very good about 2022. So, in terms of agenda, what I'd like to do is give a very short strategic overview. As you know, in November, we announced quite a lot of things. And so I give an overview of that and what we've accomplished and where we see the strategy going forward. I'll then hand it over to Rajiv Malik, the President of Viatris, to talk about the pipeline, which is a very important component of our path to growth going forward, right? So, it's a very important component. And within that, the newest component is our new Eye Care division from the acquisition of Oyster Point and Famy Care, led by Dr. Jeff Nau, who is also with us and will give you a quick overview of the new eye care division. So with that, couple of highlights and key accomplishments. In terms of business performance, we now have up to Q3, seven consecutive quarters of solid operational performance and that doesn't come from just sheer luck, that comes from purpose and strategy. It comes from purposeful, smart investments in our base brands business to stabilize that business going forward. It comes from execution on the pipeline, but it also comes from diversification beyond our core generic business. Our U.S. generic business now represents only 11% of our overall business and we move up the value chain into more complex products and innovative products and that adds stability and predictability to the business. We're also now fully integrated. As you may remember, we were created by the combination of legacy Upjohn division of Pfizer and Mylan Pharmaceuticals. We're now fully integrate into two businesses. We're on track to complete $1 billion of cost synergies as promised by the end of 2023. We have essentially exited all of what was approximately 1,000 transitional service agreements that we still had with Pfizer. That gives us not only the independence and flexibility to do what we need to do, but also substantial cost savings. So, we're confident in the achievement of the $1 million [ph] in cost synergies. In terms of pipeline, we continue to add and continued to add to a durable organic pipeline and that's really two components. One is approximately $500 million in annual new product revenue that comes from our existing pipeline, and that is sufficient to offset the erosion that we have in the base business, actually not only offset, but lead to slight growth. Within that, we have our complex injectable franchise that's very differentiated that potentially adds $1 billion in peak net sales by 2027. Within that also is a select novel and other complex product business that also adds approximately $1 billion in net sales by 2028. That leads to the $500 million per year in new product revenue. The new Eye Care division comes on top of that and that will be our third franchise that can potentially add $1 billion in peak net sales by 2028. So, that's on the pipeline. Capital deployment, we're consistent with what we laid out. We've always seen Viatris evolving in two phases, a Phase 1 and a Phase 2. Phase 1 was focused on deleveraging and rebasing. We have retired $2.1 billion in debt so far up to the third quarter in 2022. That's $4.2 billion from 2021 and 2022 and we're on track to our target of $6.5 billion by the end of this year and reaching a roughly 3.0 leverage target as we laid out. We also continue to return capital to shareholders through our continued dividends, but now also through share repurchases. We already have an authorization of $1 billion and we're going to start executing on that in 2023. And then in November, we laid out a lot of strategic initiatives. Since then, we closed the Biocon transaction that immediately brings in $2 billion capital in gross proceeds to the company and sets the business up for long-term success as a vertically integrated champion. We've established now and are integrating the new Eye Care division, led by Dr. Jeff Nau. We laid out a path to divest certain business, which were the OTC business, the API business, women's health business, and some select markets. That process has been initiated and we continue to be confident to announce these transactions by the end of the year as well as confident in the valuation ranges that we laid out. So, that's on accomplishment. All of what that does is set us up really for Phase 2 2024 and beyond. And we continue to be confident in the direction that we set out and for 2024, what the starting point -- what really will be the true starting point. So, 2023 is kind of the last transition year of Phase 1. It completes the Phase 1, it's the last transition year and what we want to do in that Phase is we continue to execute on our base business, we continue to deliver on organic pipeline, we have some important launches coming up. We complete the plant divestitures by the end of 2023, as I say, it out. And then with that completed in 2024 and with the deleveraging target that we have, we essentially have an unencumbered free cash flow 2023 going forward. And we laid out very clearly what our capital allocation priorities for that are. 50% of that very strong free cash flow is going to go to dividends and share buybacks in 2024 moving forward. So, you put all of that together, you take the strength of the earnings potential, you take the growth opportunities, strength of the pipeline, you take the strength of the balance sheet, right? And you take the capital allocation policy with the share buyback, we think all of that makes for a very compelling adjusted mid-teens earnings per share growth story for 2024 going forward. And with that, one important component of the growth story is the pipeline. I'd like to hand it over to Rajiv Malik to say a few words on that. Thank you. Thank you, Michael and good afternoon everybody. Let me take from where Mike left. In fact, we talked a little bit about our pipeline on November 7, Michael a little bit mentioned in this slide. I would like to give you a little more insight and appreciation about some chunky pieces which you can put value to. And two of those are, of course, our injectable franchise, which we talked about, complex injectables and some other select novel and other complex products. Along with that, I would then have Dr. Jeff Nau talk about a very exciting new Eye Care pipeline. So, let me start with the components of our pipeline. What you see on this slide is what makes $500 million per year or annual launches, approximately $500 million, that's what we give a range, $450 million to $550 million. In addition to a geography-focused pipeline, whether it's for North America or whether it's for Europe, we have now a pipeline which is dedicated for China, Japan, and various other markets in our diversified network. But more importantly, I think there are two chunky pieces. On a risk-adjusted basis, these two buckets of complex injectables and 505(b)(2)s have approximately $1 billion -- not less than $1 billion, I would say, by 2027-2028.That's how we have valued those. And I'll give you a little more insight into that. What is it made up of? Now, first of all, with complex injectables. And what -- why do we call it complex, either it's complex drug substances, difficult to synthesize or difficult to characterize or it's a complex process, difficult process, how to -- just setting up the manufacturing train or it's complex drug devices because most of these injectables are our own drug devices. So, for example, the Glucagon will fall into category of a peptide, which is a complex substance. Iron complex is complex drug substances. But the paliperidone, the Invega Sustenna or Trinza, they fall in the category of a complex process, which is like microspheres -- or nano emulsion, sorry. And Sandostatin like products fall in the category of the microspheres. So, all of these products have definitely a higher hurdle, either they are difficult to develop or they're difficult to manufacture or they are just difficult to get over the hurdles of the clinical or bioequivalence and having regulatory pathways, which you have not been very clearly laid out. But we have now been working on this bucket for the last about seven, eight years very actively and we have 39 products in this pipeline, 10 of which have already been filed and under review by FDA. And well-positioned for seven, we believe, for the first-to-market opportunities. So, pretty exciting bucket. Now, why it's exciting because they do fall in the category of the generics, but they have a very different analog. And I think best you can relate to is a COPAXONE analog, which we would say it's more sustainable, more sticky, more durable. They might have a little bit slower ramp, but also they are sticky, and they stick there for a period of time. The next bucket of complex products, we call it as 505(b)(2). And the best example I can give you is the [Indiscernible] once monthly. So, instead of biweekly, they are once monthly, we just done with our Phase 3 clinical trial and are looking forward to its submission by the quarter -- first quarter. Now, why it's important. It's just not a compliance. I think we've got a very solid Phase 3 data, not just meeting the primary endpoint, but several other secondary endpoints, which are exciting and will help us maybe hopefully get a better level. Meloxicam fast-acting is an opioid sparing, which is very well advancing. And again, I will like to call out BOTOX, which is first -- again, we are trying to create the pathway of a first biosimilar BOTOX, very much on the way. And I think with Revance now daxibotul getting approved, it's the same signs basically from the toxin point of view, we feel we are very much on track to bring this product by 2026 to the market. So, -- and another product which is exciting in this bucket is Xulane Low-Dose, which we are developing it in the Phase 3. So, if I just take these two buckets, they are -- they form that bucket of $500 million. It doesn't include our Eye Care vision, as Michael mentioned. And look, I'm very proud of what we have so far achieved of our track record, but I'm equally confident that the pipeline we have on our hand, we're going to execute it successfully. Thank you, Rajiv. I'm pleased to be able to introduce you to the new Eye Care division at Viatris. And when we talk about what we have built with the acquisition of Oyster Point in bringing the capabilities to the table, I think it's really important to understand that we have built really a world-class eye division with this acquisition. So, we have an experienced team that's in place. We have one of the largest commercial salesforces in the United States for front of the eye with over 146 reps. We have a pipeline that I'm going to talk about with a number of Phase 3-ready assets and some assets that are actually under review at the moment. But most importantly is we have the global capabilities and the global supply chain to now leverage and take all of these products throughout the world and so that's really exciting for a company that was in a position where we could really only focus on the United States. The first commercial product that we've brought to market from the team here is Tyrvaya, and you'll see here, this is the first and only nasal spray for the treatment of dry eye disease, and you'll see how it fits amongst the other products in the pipeline. When we look at the pipeline, I think it's important to not only look at all of the indications that we look to treat, but also the various stages of development. And what you'll see here is not only do we have products that are Phase 3-ready in a number of them, but in some very big areas where there's a lot of unmet need. And we also have some products that are early in development. So, we're really excited also about the gene therapy platform and that is an expandable platform that we hope to bring to market soon that will change the way we think about treating the front of the eye. We have products in the presbyopia space that we think are going to be superior than what's out there at the current moment. We have a blepharitis cream that we're excited about. And again, these are real close to market, and we're very excited about the near-term opportunities and being able to build out this Eye Care division. Thank you. So, as we move over to the Q&A section. I guess the first place I wanted to start was just maybe some of the key learnings as you set this company up over the past few years. So, I guess maybe what have been some of the positives? And what are some of some of the areas of surprises kind of pulled together the various assets to create Viatris? Sure. So, I think as I think about the last two years, I think the first thing, honestly, that comes to mind is everything that has been accomplished. I mean we should never forget this company was born in COVID. We brought two companies together, integrated two large organizations without ever being able to meet in person. And out of that create a very strong performance-oriented company culture, achieve all the targets that we have. So, I think first thing is thanks to all the 37,000 colleagues around the world that got us to this point. The second thing is as we now have seven quarters of consecutive performance. It gives us the confidence in really making sure we understand this business now. You wouldn't have seven quarters of consecutive performance and predictability and delivering on that, if you didn't. That gives us now the conference and you remember on November when we came out with an update on the strategic plan, we had a lot of things that we said there. And the confidence of that -- confidence of being able to say, this is what our true starting point in 2024 is. This is where we can see the CAGR going forward. This is going to be what the cash flow looks like, right? And then based on that being definitive -- very definitive about the capital allocation priorities, we wouldn't have been able to do that without the learnings and the confidence that we have of being able to stabilize the brand and the base business, the execution that we have on the operational platform, the execution that we have in the pipeline. So, that's I think top thing that comes for me to mind. When I -- I guess, on that issue of stabilizing the kind of base business, this erosion down to about 2% now versus maybe 4% or 5% you've been on, how is -- how have you been able to achieve that? So, can you just go into a little bit more detail of what's changed in terms of the support of those products and the way you think about investing behind them? Yes. So, let me, Chris, take you back. When we started this, we did have a lot of historical data of these two -- we came together, Upjohn had their products, Mylan had their products. So, we took this big -- one big component was the branded portfolio. How much of these brands will be declining? And we have so looked at historically Upjohn brands were declining maybe at 5%, 6% there were some LOEs. We extrapolated that we assumed -- we modeled 4% to 5% decline. We knew we could do a better job with that, and we did because legacy Mylan had set up that managing the established brands in an omnichannel way because we can't afford 25%, 30% SG&A, we have a different way of managing these brands. And I think we did that. And we see -- what we see today after seven to eight quarters, and we didn't have that data at that time. We are -- we have been managing these brands at not 4% to 5%, but 2% to 3% decline. Now, that added -- that gave us 200 basis points of improvement in the $9 billion branded bucket. The second bucket was, the volatility was, of course, the U.S. generics market, which we are still -- it is 11% of our total business. But I think that portfolio over the time has moved towards more complex hard to make products and very few commodities. So, the volatility of that is far less than what we had seen in the last few years. The third bucket of volatility of this decline was China. And for us, at a point in time when we became one, it was the second year of China implementing this healthcare reforms, VBP. I think after four years; China has done a great job of expanding the access to many of these volume-based products. And we got time to adopt and reorient ourselves because China today is operating very clearly in two segments, public reimbursement segment and private paid segment. We hardly play in the public reimbursement because we are not a part of VBP, but we definitely reoriented ourselves not just we are a great commercial infrastructure there, but the brand equity of these Lipitor or Norvasc. And the services we have been able to build about has helped us grow the retail channel. And who would have imagined that two years later, we are flat in that business because everybody has modeled it differently. So, I think you add -- take these three components Today, we launch see it as a 4% to 5% decline. We see maybe at best 2% to 3% decline. Now, you take -- if you go forward, $15 billion, $15.5 billion, whatever number you pick up 2% to 3% is about $400 million sort of erosion. And the pipeline I just mentioned, walked you through or annually, if we can have $500 million, that's more than to offset the decline and bring the base business back to 1% to 2% growth. So, sorry for long answer, but I think-- I guess the question is a follow-up on that. The ability to sustain that kind of more stable performance. I guess, one of the concerns I hear from investors is these businesses maybe a few good years and then something changes some of the markets, a downdraft and then stabilized again, like what -- can you just help us get a little more comfortable about the ability to keep that kind of performance going, going forward? I clearly see how you're building the pipeline out, but more just on the base business side? In fact, if I have to take that, I think there are no big LOEs in this market. There's no -- we are not dependent upon any one product or one big geography. It's a very diversified business. In our -- we always said, not all good things happen on the day, not patterns all happen in a day. But I think our comfort comes from -- if I just break this geographically Europe, which is a key part of the business, which is about $5 billion to $6 billion business for the last six years, we have seen 1% to 2% erosion. And our own internal growth on our portfolio is about 3% to 4%. So, we have been growing Europe with about2% to 3% growth. Why I feel more confident but -- because many of these markets were not huge markets for us, like China was legacy. We didn't have a pipeline for China. We didn't have a pipeline for Japan. We didn't have a pipeline for rest of the world markets. Today, going forward, we have a dedicated pipeline I just show, just to offset some of these tribulations. So, in fact, if I am looking forward, I'm looking at us as a much better shape to manage this volatility of these markets or of this business. Maybe one last one on the base business. With regards to China and VBP, is there anything we need to watch there in terms of any kind of last few products that could be of relevance or are we largely behind -- is that behind you? There are no -- any more products to VBP. China is always -- what we see going a couple of years further if I have to look for, I would say, this -- two years gave us time to build up the pipeline. I see another couple of years of flat or very minor decline in the hospital segment, which we can say. But we will be now bringing in the pipeline to offset that. So 2024, 2025 onwards, you will see our pipeline taking in to offset any of -- any more decline comes this market. Yes. And Chris, just to emphasize what Rajiv said about the diversity of the business, I think that's really underappreciated because even in our mind, we're still used to our legacy, right, and how important the U.S. and the U.S. generic business was. That is now 11% of the total business. 70% of the revenue comes from outside the U.S., right? Over 60% is branded, not generic. So, I mean, you look at all of this, and we can really confidently say now, as he said, something happens in one country, something else happens or another, we were able to offset that. And I think the seven past quarters have shown that, and it wasn't an easy environment. I mean you had COVID, you had all kinds of things happening and we delivered quarter-after-quarter. And I think that gives us confidence. Great. Maybe shifting over to ophthalmology and maybe a first question for Michael. When you were thinking about directions that Viatris could go, what attracted you to this vertical? And how do you see ophthalmology kind of leveraging the company's broader strengths? Right. So -- and I think Jeff should add to that as well. But look, when we laid out the strategy, and we said we're interested in -- and Eye Care were interested in dermatology, we're interested in GI. These three areas had a common denominator, if you will. And the common denominator is that these are not necessarily areas -- first of all, we see a high level of innovation, right? Then innovation is often not our but the risk, right? So, it's development risk, it's existing molecules being repurposed or from formulation, et cetera. So, it is not this heavy binary risk because we're not a research-driven organization, we develop and driven organization fits us. Number two, they are specialty driven, which means you don't need to build a 5,000 people, GP sales force to promote it. You heard Jeff, 140 people and it's a top sales force in the United States. So that's another one. It's -- a lot of the innovation comes from smaller players, not from the big pharma players. We're actually not competing directly with big pharma. And we're not necessarily going after the $2 billion blockbuster products. We're going after -- there's a sweet spot there. And so really on many criteria fits our platform, fits our capabilities. And I think we've shown now with the Oyster Point and Famy Care acquisition together, it's a very nice combination. We always talk about we want to have an anchor asset, right? You build a portfolio; you build a franchise around anchor assets. Oyster Point, Tyrvaya and the capabilities that come with it, the 140 sales force, the medical affair staff, the connections to the community and just the knowledge that access. And you combine that and the pipeline that we bring in to Famy Care, which, as you saw, multiple early stage, but also multiple Phase 3 ready or already in Phase 3 assets, so relatively near-term. And you combine that with our capabilities of a global regulatory platform, the supply chain that we have, the legal team that we have, the commercial presence that we have in all the countries, I think it really is clearly synergistic and we can take this to a whole other level. And Jeff, do you want to talk more about this? Yes, I think as you look at the capabilities in that slide that I presented, I think what's really important is to understand there really is no global leader in pharmaceutical development in eye care. There are people who play in eye care, but they are often very much focused in other parts of medicine. And I think building out a franchise that is purely focused in eye care. And many of the folks from our team come from both retina and front of the eye. So, we have those capabilities. We have the knowledge. Many of us built out big products like Lucentis. And so we're excited to be able to now not only be able to leverage all of this infrastructure that we're able to bring to the table and really become a product that we can bring direct-to-consumer marketing. We can enhance our regulatory reach across the globe, and there is a lot of innovation that goes on in ophthalmology. I mean there is no lack of start-up companies and small companies out there, and they also need for the sort of universe here to have big leaders in that space to be able to operate well as well. So, we're really excited to be that leader and to step into what we think is a really incredible void in this therapeutic area. I mean just to follow up. Can you just elaborate on the path to that $1 billion target by 2028? If I remember correctly, the $1 billion target is certainly well above where consensus was for Oyster Point. So, maybe just elaborate how much is U.S.? How much is ex-U.S.? How much is Tyrvaya, how much is the Famy Life portfolio? Sure. If you look at the pipeline about $500 million a little bit more comes from those dry eye assets roughly and then the rest would come from the other assets. About two-third of that revenue would come from the U.S. with about one-third outside the United States. And so I think that when you look at that pipeline, you see that it's going to build. I mean one of the nice things about ophthalmology and eye care is that these are not trials that last for years. These are quick development programs. If you look at what we did at Oyster Point, we filed our IND in 2019. And by 2021, we were approved and on the market. Many of these products are that far along that we're going to be able to execute and really bring something to the table. But I think it's a great question. Most of the revenue is going to come from that dry eye side. Great. Very helpful. On divestiture process, can we just get an update of how that's progressing? Anything to report in terms of--? Yes. And just to reiterate, the divestitures is the OTC business, mostly European OTC business. We call the women's health care business, it's the API business and then some select markets. And Biocon is closed, right? So, that chapter is done and completed and the cash came in that relates to them. And so on those four remaining products, divestitures, the process has been initiated. We're actively out there. We're having discussions. We continue to be confident in our ability to be able to make announcements in 2023, and we'll also continue to be confident in the valuation ranges that we originally indicated. And then we'll update you as we go along in the year. So, just in terms of how you selected the assets that went into that process. So, how did you land at these kind of four or five divisions that were maybe not as core as they may be once we're to the organization? Can I just get a little more detail there? But it really goes together with the strategy they were laid out, we said, who do we want to be in the future? What kind of -- what Viatris should be focusing on. And then you look at which of these businesses, which of these assets are core and essential to their future of Viatris and which ones are not. It does not mean they're bad business. They are very good businesses, right? So, there's also -- there's no pressure, rights, from our side. They're very good businesses, but we believe business that are better in somebody else's hand, and that's a filter we applied. Can I also just -- you mentioned the valuation ranges hold. I guess how is the current interest rate environment? Has that affected the type of players or any of the valuations we think about? Well, there are multiple players when you have strategics, you have nonstrategic, you have multiple potential players out there and some are more influenced or less influenced by that. So, at this point, we keep looking at it constantly. We're still confident in the ranges. Okay. And maybe one other question is just how much of a distraction has this process been to the broader organization? Are these fairly kind of insulated businesses? Or I guess how entrenched or how standalone are these franchises versus the broader organization? Yes. So, the first thing I would say is like seven quarters of consecutive performance, we feel good about 2022. So, it hasn't been distracting. It hasn't been distracting us from achieving what we need to achieve. We've been able to do acquisitions. We've been able to do all these things. And I think that's one of the strengths that Viatris has that we can have multiple balls in the air and execute very well on them. The businesses are -- I think it depends, some are very integrated and we'll need to go through a process to kind of clearly carve them out. Others are easier to separate. But we learned a lot from the Biocon transaction as well and can apply that going forward. We're much more experienced historically in acquiring rather than divesting. But with Biocon, we obviously learned a lot and applied that learning to the future divestitures as well. One question, I guess we get is how to think about the base 2024 EBITDA. So, can you just maybe talk about how bridge from, I guess, the $6 billion or so of 2022 EBITDA out to 2024. So, how should we account for those divested assets? I think there's some higher R&D expense sort of to think about as well? Yes. Sure. So Chris, I think the starting point is we very feel good about where 2022 is ending. That's important because that's kind of the exit point, shaping up to be to be great. So, as you pointed out, there are a lot of things going on in 2023, and kind of we talked about that. So, biosimilar business, done. Transaction is done. That needs to come out. So, we talked about a step-up in the R&D right? That's just a function of three or four things that are going on. So, first is the IP R&D rule that SEC changed, there's no cash impact, but geographies P&L will take a bigger load of some of the milestone payments that we do. Second is the Eye Care portfolio that Jeff talked about it, that's going to have an impact on that. And that our own organic pipeline that Rajiv talked about, there's got a big payback, but that's got an impact on the R&D line. So, that's the second piece. The third piece is the SG&A cost coming from Oyster Point, right? So, we got -- talked about the field force and the marketing. So, that's going to have an impact on our SG&A. And the last item, which is, again, as the divestments happen, that will have an impact on the EBITDA. But it's, again, all been calibrated and reflected. I think the important thing to note is 2024, when we talked about the long-term targets, these are all reflective of those long-term terms. And can you just help me think about the margins once we kind of factor these all in, kind of what's our baseline margin for the business look? And how does that trend in that, I guess 2024 through 2028 plan? So, again, margins, again, if I look at both parts, both the gross margin and the operating margin. So, again, gross margin function of the mix. As we move up the value chain, as we look at novel and complex product, that gross margin is going to be stable and steady post 2024, and we talked about that. So, clearly, that's the direction of the travel as for that is concerned. On the operating margin, there are a couple of things that we need to keep in mind. So, SG&A. Clearly, as you divest these businesses, the SG&A line will be a step down in the absolute dollars. And we've guided that over a period of time with all the operating leverage, SG&A will be high teens towards the 2026, 2027. R&D, a little bit of a step-up as we talked about it. but it's going to stabilize at about 6% on the R&D line from -- as a percentage of revenue. The last item, which is equally important is the interest cost. As we paid down significant debt, we'll see the interest cost coming down and that's going to help us maintain an operating margin. Great. Can I talk about capital deployment next? I think you'll have roughly $5 billion or $6 billion of capital to redeploy post this process you're about to go through. I guess maybe, first of all, how much of that needs to go towards debt pay down? And how should we think about prioritizing the remaining proceeds? Is that--? Great question. So, if you think about it in terms of what we talked about, the gross proceeds of $8.3 billion to $9.3 billion. Net of taxes, one-time cost and the Oyster acquisition, we talk about $4.9 billion to $6.1 billion. That money is available for three things: debt pay down and share buyback and investing in the business. How much debt pay down will be dependent on the EBITDA that is going to go away with this business. What we're committed is to maintaining the investment-grade rating. And we'll do as much debt as we require to pay down to get to our long-term target of three times the ratio. And the -- but there will be plenty of that cash left for share buyback and business development. You've commented over time kind of this 50% mix of BD, 50% capital return. If I kind of think about whatever is left to over post the debt pay down, is that a reasonable way to think about the remaining kind of slug of cash comes in with the divestitures? Or should we think about that maybe being more heavily skewed towards business development as you look to kind of reposition the company? Or is it too early to comment on? Too early? Okay. So, we'll see as we go along. Priorities for BD going forward. What are you most focused on at this point? I think we continue to be focused on exactly what we laid out, right? We have the three areas of focus, which is Eye Care, GI and derm. And -- but we're also sensitive to the needs of the remaining business, whether it's regional opportunities that exist, et cetera. But I think overall, what you will see is continued disciplined in our investments. I think you've seen us over the last three years being very disciplined, right? And really jumping opportunities that are standing out like Oyster Point and Famy Care was. And it's going to be continued tuck-ins and bolt-ons. That's the focus going forward. So, I guess maybe thinking about size and scope of something like Oyster Point, is that a good proxy of the type of--? I think it's a good template strategically, what we want to do because, again, it comes with anchor assets and in-line asset accounts with capabilities and pipeline. Whether we can always do this in one deal, like there's a one combined deal? I don't know, but I think it's a strategic template that makes a lot of sense. In terms of the ability to go larger, is that something that makes sense or is it going to skew smaller? Look, we're going to continue to focus on being investment grade, we're going to be disciplined and as I said, tuck-in and bolt-on is in focus. On the 50% free cash flow return starting in 2024, help me think about how much of that's going to be dividend versus how much is repo as you think about kind of the dividend payout and where that could go over time? We -- that's kind of a decision going to be taken by the Board. But I think it's safe to say that dividend is an important part of return on capital, but the distinction between dividend and share buyback will be handled at appropriate time. Okay. And maybe a final question for me is I know 2023 feels like more of a transition year. I know you're not giving guidance today, but can you just think of some of the pushes and pulls we should be kind of thinking about as we head into this year? Yes, I mentioned that a little bit. So, again, as I said, again, worth repeating is we're ending 2022 exactly where we thought, it's shaping out to be great here. So, that's giving us a little bit of a momentum as we go into this year. But with all the changes that are going on, Biocon business out, that's going to have an impact. Divestments as we announced that's going to be out. And then you have the step-up in the R&D, that's the other thing that -- we need to look at that. And then the SG&A impact of the Oyster Point, all that will be reflected in the guidance that we talk about that, and then we will share with you end of February, beginning of March. I think the other thing important to note that is, what we guided that once all said and done, all these divestments, the base business will generate again significant and steady cash flow. And we guided towards that, that it's going to be at least $2.3 billion of free cash flow in 2024 from the base business before any taxes for divestments and other things like that. Right. I think we're just out of time. I really appreciate the time, guys and obviously, a pretty exciting time ahead. So, look forward to the progress.
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EarningCall_1291
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Good morning. My name is Joanna, and I would like to welcome everyone to the JetBlue Airways Fourth Quarter 2022 Earnings Conference Call. As a reminder, today's call is being recorded. At this time, all participants are in a listen-only mode. I would now like to turn the conference over to JetBlue's Director Assistant Treasurer and Fuel, Joe Caiado. Please go ahead. Thanks, Joanna. Good morning, everyone, and thanks for joining us for our fourth quarter 2022 earnings call. This morning, we issued our earnings release and a presentation that we'll reference during this call. All of those documents are available on our website at investor.jetblue.com and have been filed with the SEC. In New York to discuss our results are Robin Hayes, our Chief Executive Officer; Joanna Geraghty, our President and Chief Operating Officer; and Ursula Hurley, our Chief Financial Officer. Also joining us for Q&A are Dave Clark, Head of Revenue and Planning; and Andres Barry, President of JetBlue Travel Products. This morning's call includes forward-looking statements about future events. All such forward-looking statements are subject to certain risks and uncertainties, and actual results may differ materially from these statements. Please refer to our most recent earnings release and our most recent Form 10-Q or 10-K for a more detailed discussion of the risks and uncertainties that could cause the actual results to differ materially from those contained in our forward-looking statements, including, among others, the COVID-19 pandemic, fuel availability and pricing, the outcome of the lawsuit filed by the DOJ related to our Northeast Alliance and the various risks and uncertainties related to JetBlue's acquisition of Spirit Airlines. The statements made during this call are made only as of the date of the call, and we undertake no obligation to update the information. Investors should not place undue reliance on these forward-looking statements. Also during the course of our call, we may discuss certain non-GAAP financial measures. For an explanation and a reconciliation of these non-GAAP measures to GAAP measures, please refer to the tables at the end of our earnings release, a copy of which is available on our website. I'll start, as always, with a huge thanks and shout-out to our 24,000 crew members. We overcame many challenges together throughout this past year, and we made tremendous progress in restoring the business coming out of the pandemic. And we're set up to further build on that success here in 2023, with a disciplined plan to continue strengthening our foundations, both operationally and financially. While we face economic uncertainty, we remain focused on what we can control, and we are leveraging our unique value proposition of offering both great service and low fares enabled by our low-cost structure. This will result in margin expansion and robust earnings growth. Turning now to slide 4 of our new deck template. We closed the year with significant cost and revenue momentum, resulting in an adjusted pre-tax income of $69 million for the quarter and earnings per share of $0.22. Reflecting back on the full year 2022, we made important progress in positioning JetBlue for longer term success. We hit a new record annual revenue result, a phenomenal achievement by our team, given we were only two years removed from the depths of the worst crisis in aviation history. We continue to see incredible demand for JetBlue's differentiated product of low fares and great service, which was recently recognized by The Points Guy with an Editor's Choice Award for Best Economy Class in the world. We launched a new structural cost program targeting $150 million to $200 million of cost savings by the end of 2024. This program is designed to ensure that we are offsetting some of the inflationary increases in our cost structure and help us maintain a low-cost platform, allowing us to continue to offer even more lower fares. We strengthened our network and built even more relevance for our customers, by adding more service to more destinations, including significant growth out of New York, enabled by our Northeast Alliance with American Airlines, as well as building out our transatlantic service between the Northeast and London with additional frequency. We also moved into state-of-the-art wonderful new terminals at LaGuardia and Orlando and recently secured our third slot pair at London Heathrow. Our ESG efforts continue to lead the industry. Last quarter, we announced our most aggressive emissions reduction target yet, with a plan that would effectively reduce our per seat emissions in half by 2035 compared with 2019 levels as part of our recently announced science-based target. JetBlue is the only US carrier today to be flying regular domestic flights with fuel supply by both currently available SAF producers, while supporting a portfolio of emerging suppliers with significant forward commitments. We also made great progress on our diversity, equity and inclusion goals. Our external customer research shows that JetBlue ranks number one for diversity and inclusion in accommodating travelers in our focus cities. And our Gateway Direct program open to our crew members aspiring to become pilots, people of color represent 82% of our classes. As we look ahead to 2023, we are capitalizing on the strength of our trusted travel brand to drive record customer engagement and continued revenue momentum. We are making steady underlying progress on our long-term initiatives to structurally improve our profitability and enhance our long-term earnings power, with a low fare offering that appeals to a wide range of customers, supported by our growing traction on our cost program. This gives me great confidence that we can restore margins towards 2019 levels, as we move throughout this year. Beyond 2023, we look forward to transformational long-term value creation for all of our stakeholders with the acquisition of Spirit, which will allow us to create a truly national customer-centric, low-fare challenger to the Big Four airlines. This will enable us to bring more of our unique value proposition to more customers across more destinations. As we said before, we continue to expect this transaction to close no later than the first half of 2024. Moving now to slide five. For the first quarter, which is a seasonally tough travel period, we projected an adjusted loss of between $0.35 and $0.45 per share. We expect continued revenue strength and execution on cost reduction efforts throughout the year, with a margin trajectory approaching pre-pandemic levels as we exit 2023, despite significantly higher labor cost and fuel prices. As a result, for the full year 2023, we expect to generate between $0.70 to $1 in adjusted earnings per share, which is inclusive of a new pilot deal that we hope will be ratified very soon. This full year EPS guidance reflects the improvement that we expect throughout the year and highlight the run rate earnings profile of the stand-alone business into 2024, as we execute on new and existing initiatives across the business. The contribution from our Northeast Alliance will continue to ramp in 2023. We are so encouraged by the improvement in economic growth in New York as measured by GDP after lagging the rest of the country last year. At the same time, both JetBlue and industry capacity in the region recovered more quickly than the rest of the US in 2022, which provides a sequential tailwind in 2023 as that growth matures. We continue to see incredible momentum in our loyalty program, which continues to not only exceed our expectation but also hit new records. We recently announced the evolution of our TrueBlue loyalty program, which Joanna will elaborate on shortly. With respect to our network, we are planning to take delivery of four A321LR aircraft this year to support our continued transatlantic network expansion. We are very excited to launch service to Paris this summer, marking our second transatlantic destination and our first in Continental Europe as we build customer relevance from our key focus cities. Our JetBlue Travel Products subsidiary took another fantastic step forward last year with 59% revenue growth versus 2021 and 136% revenue growth versus 2019. This progress is a result of continued product innovation across JetBlue Vacations, travel insurance and our new Paisly platform, coupled with increased customer awareness. When we started JetBlue Travel Products, we set a target of $100 million run rate EBIT by 2022 compared to $15 million of EBIT in 2019. I am so pleased to share that we are near the $100 million, with consistent $20 million to $25 million of quarterly earnings with growing momentum into 2023. We continue to be optimistic about the growth potential of this business and aim now to roughly double our current run rate EBIT in the next three years. Finally, we continue to make strides to transform our cost footprint. We remain on track to deliver $250 million of total cost savings through 2024 with execution on our structural cost program and our fleet modernization efforts, which Ursula will touch on here very shortly with more detail. In closing, I would again like to thank our crew members for your dedication and all of your incredible hard work in 2022. I am so optimistic about how we are positioning the business for long-term success and so proud of the role that all of you have played in that. We have a strong foundation in place to execute on our plan to structurally enhance our long-term earnings power and create value for our shareholders. Thank you, Robin. I would also like to thank our team for the hard work day-in and day-out and for the incredible job in closing out the year strong. You've persevered and navigated through many challenges this past year from severe weather events to ATC outages, all against a backdrop of historic demand for air travel. We also made great strides this year to improve our operational reliability. Following our operational reset last spring, we made investments and embraced a more cautious operating planning philosophy, which has served us well as evidenced by our execution in the back half of the year. And I'm very pleased to report that our completion factor for the month of December was north of 98%, which puts us at the top of the industry, an incredible achievement. Turning to slide 7. For the fourth quarter of 2022, capacity grew 2.4% year over three, in line with our initial expectations and despite severe weather across our system. Looking ahead, we continue to see results from our operational investments with strong completion factor trends as we continue to operate in a challenging ATC environment. We expect capacity to be up 5.5% to 8.5% year-over-year, both for the first quarter and for the full year 2023. Our capacity growth this year will largely come from increased utilization, which should also drive improved productivity. As always, we will remain nimble with capacity as the year progresses and take decisive action through the lens of margins. Given the continued fragility of the aviation ecosystem, we continue to plan our operation with a level of conservatism for the foreseeable future, including scheduled buffers as well as increased crew reserve levels. Last year, our network focus was primarily centered on ramping our Northeast Alliance and delivering on its promise, bringing low fares and great service to more communities and boosting competition in the region. Growth from the NEA far outpaced overall domestic industry capacity growth, bringing enormous consumer benefits in the process as we have successfully created a true third alternative for customers in the region. And during the fourth quarter, we announced exciting news with plans to add more destinations and choice out of the Northeast as we strengthen our footprint. Looking ahead to 2023, we also plan to add service across other non-slotted focus cities where we see meaningful margin opportunities. We expect to continue restoring our Boston network and increase capacity in Florida and in San Juan. We are also building on the success of our Mint franchise with further expansion at Los Angeles, as well as the launch of service this summer to our latest transatlantic destination and Europe's most visited city, Paris. In the fourth quarter, revenue per available seat mile was up 16.1% year over three, slightly better than our mid-December investor update, fueled by strong close-in demand to close out the year. The robust underlying demand trends, combined with the solid execution of our commercial initiatives, drove the highest full year revenue results in our history despite operational challenges in the first half of the year. As we kick off 2023, we are pleased to see the demand environment remains strong into a seasonally trough period. For the first quarter, we are forecasting revenue to increase between 28% to 32% year-over-year. Looking further ahead, we are excited to continue building on last year's record performance as we expect another strong year of revenue growth ahead of us, underpinned by robust leisure demand and multiple network and commercial initiatives. I am pleased with the early performance of our transatlantic service, which remains ahead of our expectations. Meanwhile, our Mint cabin remains a bright spot with Mint RASM continuing to outperform core, as you would expect, and all of our A321neo deliveries this year are in the Mint configuration. We are also pleased with the early performance of the NEA. Last year, we more than tripled our number of daily flights at LaGuardia compared with pre-pandemic levels, a tremendous amount of growth in a very short period of time. And these new markets will continue to ramp throughout 2023. We expect the earnings contribution from the NEA to increase over the coming years as this service matures. Turning to loyalty. This part of the business is performing exceptionally well and is on a very encouraging long-term trajectory. We saw yet another record in co-brand spend last month and we continue to meet our strong growth targets. Active customer engagement with our TrueBlue program is also at historic highs, reflected in the number of active cardholders and program activity. We achieved our best year ever in program enrollment, which was up 50% year-over-year while co-brand sign-ups were up 40% year-over-year. In December, we also announced the exciting new iteration of TrueBlue, which is launching later this year. Our new program is designed to appeal to a wide variety of customers, whether you are a Mosaic member or travel just once a year. It is a truly differentiated approach to loyalty, as we give more opportunities to all customers to earn rewards faster, drive utility through more options and choice and increase their engagement with the program in TrueBlue. The evolution of our TrueBlue program, including the launch of other airline redemptions and a new credit card portfolio, also supports our evolution to a travel brand, as our customers can earn points and qualify for Mosaic when booking travel beyond just flights. This is an important driver of our multi-year journey to grow this revenue stream as a percentage of our total revenue base and close the gap to best-in-class loyalty performance. I'll close with another huge thanks to our crew members for going above and beyond every day no matter the circumstances. The investments we have made position us well to reliably deliver the JetBlue experience, and this year is all about execution from planning our operation, to delivering our day of performance and to executing numerous revenue initiatives. And in doing so, we will build a better and stronger JetBlue for all stakeholders. Thank you, Joanna, and good morning, everyone. Thank you for joining us. I'd also like to add my thanks to our dedicated crew members for all of their hard work in closing out the year on a strong note. We achieved another quarter of profitability as our teams delivered for our customers. At the same time, we've been focused on building a 2023 plan to create a stronger JetBlue for all of our stakeholders. Turning to Slide 9. Our return to profitability in the second half of 2022 was an important milestone in our recovery. We effectively navigated a very challenging year, having set ourselves up for success back in the spring with an operational reset. And we've seen vastly improved operational performance and reliability since then. While we are expecting a net loss in the seasonally weaker first quarter, we're very confident that we're on a path to materially improve our financial performance through the remainder of 2023 and deliver a full year adjusted profit. We remain laser-focused on executing the commercial and operational initiatives Joanna outlined plus our ongoing cost discipline. We're pleased to have reached a tentative agreement with ALPA to extend our collective bargaining agreement for two years, which our pilots are currently voting to ratify. This gives us planning certainty, and we believe this deal will ensure JetBlue remains competitive, while facilitating a smooth transition to eventual joint CBA negotiations following our acquisition of Spirit. Our 2023 outlook for CASM ex-fuel and earnings per share assumes the estimated impact of this pilot deal, which is worth approximately one point to CASM ex-fuel in the first quarter and approximately three points for the full year. For the first quarter of 2023, we are forecasting CASM ex-fuel to increase 2% to 4% year-over-year. Our non-fuel unit costs would be up 1% to 3% year-over-year when excluding the impact from the CBA. Importantly, we are still on track to deliver on our prior goal to flat CASM ex-fuel this year when adjusting for the three-point impact of the ALPA deal. Last year, we launched a new structural cost program to help mitigate other cost headwinds and set an optimal cost foundation to support long-term margin expansion. These cost pressures are primarily related to maintenance and rents and landing fees, which are collectively worth a two-point headwind to CASM ex-fuel in 2023 on a year-over-year basis. The structural cost program is well on track to deliver roughly $70 million in cost savings this year and $150 million to $200 million of cost savings through 2024. Our work has already delivered roughly $30 million since launch, and we expect savings to accelerate throughout 2023. Some of the most meaningful drivers of this year's cost savings include improved productivity, optimized maintenance work scopes and enhanced productivity across work groups through our enterprise planning function. We also expect over $40 million of savings through 2023 and $75 million through 2024 from our accelerated transition from E190s to A220s. Combined, this brings total cost savings to $250 million through 2024. In addition to the higher labor costs, we're working hard to offset cost pressures from higher rents and landing fees tied to operating and growing in high-cost terminals across our high-value geography as well as elevated maintenance activity, given the age of our fleet. Turning to liquidity and the balance sheet on slide 10. Recall that we ended the third quarter of 2022 with $2.3 billion in liquidity. And in the fourth quarter, we paid down $114 million of debt, funded $324 million in capital expenditures and made a $272 million prepayment to Spirit's shareholders. We also signed an agreement to become a minority investor in the new JFK Terminal 6, which closed in November. As a result, we ended the year with liquidity of $1.6 billion or 17% of trailing 12-month revenue, excluding our undrawn $600 million revolver. For 2023, we expect cash outflows related to the monthly Spirit shareholder prepayment to total approximately $130 million for the full year. We're forecasting full year 2023 CapEx to be approximately $1.3 billion, consisting mainly of aircraft CapEx as we continue to modernize our fleet. This forecast assumes 19 aircraft deliveries this year. It's worth noting that much of our capacity growth this year will actually come in the form of restoring utilization. So if we do experience further aircraft delivery delays, we don't expect such delays to drive meaningful changes to our full year capacity guidance. We remain very focused on maintaining a healthy liquidity balance. Given continued economic uncertainty and fuel price volatility, we intend to finance a portion of our aircraft deliveries this year rather than using cash. That said, our long-term balance sheet priorities remain unchanged. We plan to generate solid earnings and operating cash flow this year. And following the close of the Spirit transaction, we expect the strong pro forma cash flow profile to support a quick deleveraging of the balance sheet from what we still expect to be a very manageable level at closing. Turning to slide 11 for a recap of our financial outlook for the first quarter and full year 2023. We have discussed most of these guidance ranges already, but I want to touch briefly on fuel, where we continue to see significant volatility in both oil and crack spreads. Last quarter, we executed some fuel hedges to protect against a spike in oil prices. As of today, we have hedged roughly 9% of our planned consumption for the first quarter of 2023 and will continue to be opportunistic going forward to help mitigate our financial risk. Given the volatility in the futures and regional markets, such as New York Harbor Jet fuel, we have decided to provide a range for our fuel price guidance moving forward. To conclude, I'd like to thank our team once again for all of your efforts to position us for long-term success. We're driving continued momentum from the back half of 2022, as we move into a stable and more normalized backdrop this year. I could not be more excited about the path we've laid out. We expect to generate our first full year of profit since the pandemic with an EPS in the range of $0.70 to $1. This guidance implies significant momentum in earnings, as our initiatives ramp and we deliver margins close to 2019 levels later this year. And we believe, our quarterly EPS run rate this year beyond Q1 is a better indication of our normalized earnings power into next year. The strong underlying revenue environment, combined with our continued execution on optimizing costs, gives me great confidence that we are on a path to generating strong margins and enhancing our earnings power. And we will work diligently to prepare for the acquisition of Spirit, which will only build on the strong foundations that we are laying today. I truly believe we are extremely well positioned for significant long-term value creation for our owners and all of our stakeholders. Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] First question comes from Michael Linenberg at Deutsche Bank. Please go ahead. Hey good morning everyone. I guess two questions here, Joanna, just first to you. You talked about the NEA and you said you're expecting another year of ramp. I think, Robin, you sort of echoed that as well. Any sort of financial details or anything that you can provide around that to give us a sense of baseline or maybe where it's going? And if you're loath to give us financials, anything maybe like number of passengers who connect per day between the two carriers or maybe one or two or three load factor points on your planes are tied to their American customers, et cetera. Just anything that we can sort of assess how it's ramping? Thanks. Thanks, Michael. Yeah, we're not going to go into the financials. It's obviously still in ramp-up, and we're very in a very good place, given where we are in the trajectory. Maybe a couple of things worth calling out, JFK will be at combined NEA flights 290. In April, we'll be operating 190 of those. LaGuardia will be at a combined 190. We will 52 of those, which triples our daily departures compared to 2019. And then growth, obviously, in Boston as well, will be at 220 in April from a flight departures perspective with JetBlue approaching 150. So we're seeing the NEA very much on the correct trajectory, a strong number of connecting passengers. We can go offline with you on specifics regarding that, but we're very pleased with the performance of the NEA and the acceleration that's given, frankly, to our New York markets and their recovery. Okay, great. And then just second question to Robin. Just on sustainable aviation fuel, it does seem like that you guys have done -- you've been actually pretty aggressive in going out and sourcing future needs. And I suspect that as we move forward, some of these benchmarks that the administration is pointing various industries toward will become mandates. And it does feel like that we can get to a point where there is very much a real shortage of SAF availability. Where are you on what you need to get to? I think it's 10%, I think a lot of -- is what the industry is aiming toward in 2030. How much of sort of where you are? And what are your thoughts on that about potentially leading to a shortage where carriers will have to rethink about their growth plans and this may be only a few years away? Hi, Mike, good morning. Great question, and thanks for asking it. Yeah, so to set the baseline, you're right. The industry target in the US is 10% of SAF by 2030. It is going to require a lot of ramp up from where we are today to get there. I think that -- I don't believe that a mandate is on the horizon all required because airlines are very willing to buy this fuel. They're very willing to make commitments. And also in the last year or two, we've seen a lot of willingness from corporate customers as well to participate in some of the additional cost of buying SAF, which is again, making it easier for the airlines to commit and corporate to also continue traveling. So that, together with some of the federal incentives that we saw roll out last year. So I think everything moving in the right direction but there's a lot more that needs to be done. As you would expect, we are in conversations with all the major producers frequently and we're very active in acquiring SAF when we're able to do that. Thank you. Next question comes from Savi Syth at Raymond James. Please go ahead. Savi, your line is open. You can proceed with your question. Hey good morning everyone. Thank you. Sorry, I had mute on. Just on the comments around increasing utilization to grow capacity and that should help productivity. Could you provide a little bit more color on how this still compares to 2019, given that it sounds like you still have a lot of conservatism here and what we could expect throughout the year? Does that get better as we head into 2024, or is this kind of a new normal? Yes. Thanks, Savi. Thanks for the question. So, you will see utilization improving relative to 2022 levels, but we will still be operating at a lower utilization level than 2019. We're very cognizant of the overarching operational environment and the need to ensure that we are protecting the operation. And that includes both aircraft time but also investments we're making around pilots that we made in 2022 that will continue into 2023. I will say, though, those are improving from a productivity standpoint. So we are peeling away some of those investments, but we will not return to 2019 levels from a utilization perspective or from a, for example, pilot resources or some of the buffering in the padding that we're putting in. Joanna, like do you think as you get to the end of 2023, is that what you expect to be kind of the new normal, or are you hoping that just things will ease as the next few years as well with ATC hiring and things like that? Yes. We're not expecting things are going to ease. I think frankly, two weeks ago was proof positive of some of the challenges that we are experiencing overall in the airspace that we fly into. JetBlue has significantly higher amount of exposure in that -- in the Northeast corridor, where nearly two-thirds of the ATC delays are present. Absent a step change from the FAA in terms of technology or the ability to handle the ATC throughput, we're planning for a more conservative approach. We are very connected with the FAA. They've been great from a transparency perspective and a communication perspective. But at the end of the day, we need to ensure that our operation is protected. So you will see us continue things such as incrementally more reserves, a higher percentage of out back flights that enables a cleaner cancel if we need to when we are in a disruptive situation, trying to base more flying out of crew bases. And then JetBlue is investing in some system improvements as well and have been for quite some time and then obviously, Spirit and diversifying our network. So bottom line for the foreseeable future, you should expect that some of these costs that we laid in, in 2022 will carry through into 2023 and beyond, although they are easing a bit as we return to a new normal, but it will not return to 2019 levels. That's helpful. And if I might -- just you talked about the TrueBlue revamp as well and it was kind of somewhat unique. I was kind of curious, what's the goal around some of the changes that you made. And how do you expect that to kind of flow through kind of either purchasing behavior or travel behavior? Sure. One of the things that we've been focused on is how do we really reward and incentivize all different types of customers, not just the customers who fly us frequently and who are Mosaic but also the customers who are infrequent and try to engage them. So, customers will have the ability to pick the perks that they like, and that includes customers who fly infrequently. We also are providing additional layers of Mosaic levels, which we think will incentivize some of our most loyal customers. But at the end of the day, this is a holistic approach to our loyalty program by bringing benefits to customers who fly JetBlue. And then customers also use the co-brand card, which is such an incremental -- an important part of our loyalty program. If you think of loyalty overall in co-brand, it represented 10% of our total revenue. We continue to see that increase quarter-over-quarter. We're very excited with the positive momentum that we have from co-brand and TrueBlue. The new TrueBlue program will only amplify that momentum that we are seeing. Hey, good morning everybody. So I was impressed that on United's call. Scott gave your operations a shout-out. Just wondering what's really driving the improvement in operational integrity. I know in American's case, paying pilots double time for Thanksgiving and Christmas obviously helped them. I don't recall JetBlue doing that. So was it really just the more cautious scheduling that Joanna mentioned in her prepared remarks, or is there a labor component to the improvement in operations? Yes. Maybe to give you some visibility, Jamie, thanks for the question. There's a few things going on. I think, first, from a planning perspective, we are trying to plan more conservatively, recognizing that we are disproportionately impacted with delays, given the geography that we fly into. So that's kind of the first thing. And that includes everything from increased level of reserves. So when things start to run late, our crew doesn't time out and we can replace crew to protect the operation or, in some cases, double crew if you need to, to some of our one-a-day markets in the Caribbean. A higher percentage of out back flights. That's a really important part of how we plan the schedule, particularly with the airspace we fly into so that if we do get into trouble, we can cleanly cancel a flight. And then as I mentioned to Savi, increasing the number of flying out of places where we have crew bases, which makes it easier to recover and get additional resources when we need to. The other piece that we've been on a multi-year journey around is modernizing the systems that we had in our operations center. I'll use an example. Last year, we introduced a new crew solver, which enables us to repair canceled flights and broken pattering crew pairings more quickly, which ultimately means that we can recover faster and take advantage of the resources that we do have without having those resources time out or lose track of them. So our focus has been on the Blue Sky days. We need to be great. And on the IROP days, the regular operation days where we have, frankly, more than most, we need to better manage how we plan for those days, how we execute day-of and then how we recover. Over the holidays, you saw a very clear focus on driving for completion factor, but also recognizing that when you start seeing lengthy delays, you've got to take quick action and address those lengthy delays so that they don't bleed into the following day and the day after. So it's multi-pronged planning, day of operational execution and then ensuring that our crew members understand and know the plan and are prepared to execute to it. Thanks for all that cadence. And second quick question. American and United both clear that their 2023 forecasts do assume that revenue and GDP recouple to pre-pandemic levels. As a younger growth year airline, I've never really framed JetBlue against this particular measure, but I do wonder if it's something you look at internally when coming up with your forecast for the year? Good morning, Jamie, this is Dave. I'll take that one. GDP is an important component in our revenue forecasting so we certainly use it. And for 2023, we have a pretty cautious forecast along with the consensus estimates back there, where we actually have a recession, a mild one for the consensus in the first half of the year and relatively slow growth throughout. But we have not -- we're still looking at a year-over-year basis. We have not pegged our revenue forecast to relinking what we saw pre-COVID. And if we did, there'd be quite a -- or if we see that, there would be quite a bit of upside on revenue. So what you're seeing from JetBlue is just year-over-year GDP combined with the JetBlue-specific revenue initiatives, continued contribution from the NEA, ramp-up of loyalty around JetBlue Travel Products. Those alone get us to our -- the forecast and guidance. Hey, good morning, everyone. Thanks very much for the time. So slightly altering what I wanted to ask, based off your latest response to Jamie, Dave. So you just mentioned that part of what's driving that revenue outlook is improvement in NEA, JetBlue Travel, loyalty, et cetera. Can you just give us how many points of tailwind you think that might be into 2023? Good morning, Katie, and thanks for the question. I don't have the exact, in front of me, points of tailwind. We're certainly talking low single digits, so just to give you a general idea of it. The NEA has become measurably margin positive over the past half year, which is terrific. It was more of an investment in the first early days, but it was measurably positive back half of last year and we expect that to continue to accelerate. Probably less than 1 point, but certainly measurable on that front. And then the other piece I just talked about as well is the other big input into the GDP -- excuse me, into the revenue forecast is competitive capacity. And as we think about how competitive capacity ramps up throughout the country as we recover, keep in mind that over half of JetBlue's flying is in slotted airports. And that capacity all came back last year, when they used a rule -- use or lose rules came back into effect. So in those slotted airports, which are half of our flying, there's capacity limitation that might have a disproportionate impact on the competitive capacity we see this year versus the industry at large. That's great. And maybe just a related follow-up on the Northeast Alliance. So I might be oversimplifying this, but American just called out on their call, they don't expect any further recovery from contractual corporate travel over this year. And to my understanding, Northeast Alliance is mainly aimed at better serving corporate clients out of Boston and New York. Can you just walk us through where the upside from the Alliance comes to JetBlue if contractual corporate revenue is expected to stay at current levels? Thanks so much for the time. Sure. Thanks, Katie. And overall, we have a relatively small part of our total revenue coming out of contracted corporate shares, so this is a smaller pool for us than the industry at large. We are seeing measurably in our internal data, as well as in the public data that's out there that JetBlue is taking share from, in the Northeast as a benefit of this. So we're seeing it in our new accounts. We're seeing a higher share from our existing accounts, and it's a bit visible in the public data, which is, of course, delayed versus what we have proprietarily. So as we continue to see the Northeast ramp back up, we expect to see a bigger pie in general and then with JetBlue's added share, that will certainly help us grow in these geographies a bit more than the industry overall. I'll also add from JetBlue's perspective, this isn't just about growing business. It's also about growing leisure for JetBlue. If you look at the route announcement we've made, we are collectively growing business, but also leisure and VFR routes. So in all scenarios, we would be better off with the NEA than without the NEA. And there's flexibility within that. So you've seen a number of new route announcements out of LaGuardia that are beginning later this spring. That's reflecting a pivot to some more leisure destinations. So at the end of the day, this is for JetBlue and think about our network footprint in JFK specifically and, to a lesser degree, in LaGuardia, this is about both business, but also very importantly, leisure. Hi. Good morning. Thanks. So a couple of questions here. The last comment in the script regarding earnings momentum later this year, leading to, I think you said, normalized earnings power next year or something to that extent. Are you using 2019 as a proxy for what normalized margins could look like? And, I guess, the reason I ask is, they range from basically 10% to 20% in the last cycle. So I'm just wondering if 2019 is a fair proxy or perhaps something a little better than that. Hi, Dan. Thanks for the question. So I was referencing, as we continue to build momentum throughout 2023 and the back half of this year, our intent is to build our margins close, very close to 2019 levels. So that's the first benchmark, right, coming out of COVID is achieving a margin level equivalent to pre-COVID, with the intent beyond 2023 continuing to grow margins over the long-term. So we have a lot of conviction in our top-line forecast and the JetBlue-specific revenue initiatives as well as delivering on the structural cost to get back up to those 2019 margin levels in the back half of this year. Okay. And then, I guess, following up on Jamie's question, the embedded in the outlook this year is continued contributions from the NEA. I know you expect to win the case and based on how it played out in court, my sense is JetBlue will probably win as well. But if there is an adverse decision, what's built into the full year capacity and revenue guide? And should we expect it to change based on a potential adverse decision? Hi, Dan, it's Robin. I'll take that. Look, we felt good about the case that we put forward. I don't really want to speculate on the downside because one, we felt we put a very case forward -- a good case forward. I think everyone in Boston and New York is enjoying more JetBlue flying as a result of the NEA. They've seen more routes. And back to the question earlier, it's largely leisure because they were all -- there were some leisure markets out of New York that we never had the ability to serve before without taking away from something else, and we can do that now. So, so many people have enjoyed the lower fares and the more choice. So it's hard to foresee a negative outcome. It is possible, clearly. It's going to be down to the judge and he's going to make a decision. And I think that if that comes to pass, we'll look at it. There's a number of options and we'll deal with it. But we're focused right now on hoping for a positive outcome and continuing the momentum behind the NEA because it will so much more competition and so much more benefits to everyone in the New York and Boston catchment areas. Hi. Thanks. I appreciate the questions. Just on fuel, which I guess was marked on the 13th of January, how do you calculate the jet crack spread? And if you calculated that today or yesterday or something before you were in the crush of earnings, where would you estimate that to be in a more recent time frame? And is there any hedge benefit embedded in the fuel guidance? Good morning, Duane. So you're correct. We marked fuel on January 13 and this is consistent the same day that we historically marked fuel for our Q4 earnings call. If we were to mark as of this past Friday on the 20th, we would have about a $0.15 higher impact in the first quarter. So that's just about over one point of margin in the first quarter. On a full year basis, we're obviously still within the upper end of our range, even marking to last Friday, the 20th. How we mark fuel, so the prompt 12 weeks are off of the forward curve. And then beyond those 12 weeks, we actually use Bloomberg consensus. And the latter part of your question, there is a small hedge benefit vetted into the first quarter due to the 9% hedges that we have in place. Great. And then maybe one for Robin. As you work down the path of the Spirit merger and learn more along the way, both about the process and about Spirit, any change in thinking about how complex this is going to be? I guess a different way to ask it, anything you learned that you wish you knew at the beginning of the process? Thanks, Duane. No, I mean, I think as you know, these are incredibly complicated affairs. I think the good news is that there are a lot who have gone before us. And we're always able to -- when you're following somebody else, you're always able to learn from what worked and what didn't work. We already have our integrated management team in place. There's a number of work streams going on. We have a team appointed. And I couldn't be more delighted with some of the work that's already underway to prepare for this. We are working on an assumption of regulatory close in 2024. We also have to go through a single operating certificate process. In recent mergers, that's been a 12 to 18-month time line after close, but you can start preparing for it now, which we have started to do. And we've got a pretty good understanding of the sequencing of decisions and what decisions we need to take, when to make this process as efficient as we can. So, overall, it's early. There's a lot of wood to chop, but I couldn't be more pleased with the start that we've made. And the partnership between the JetBlue and Spirit teams has just been excellent. Hi everyone. Thank you for the time. Just on Duane's question on fuel. I'm just curious, 40% of your fuel, I think, has historically been sourced in New York and that market's been particularly volatile recently. And I think there may be some more volatility coming up. There's a refinery going offline. I'm just curious, if you've thought about how you may source fuel differently in the future. Or is that -- is it just a function of where you're flying out of mostly in [indiscernible]? Yes. Thanks for the question, Conor. You're extremely correct in terms of the volatility has been pretty significant. Historically, New York Harbor has ranged anywhere from $0.07 to $0.08. And just here, last year, the average was about $0.48, and in January, we're sitting at about $0.53. So we actually go through an annual tender process, whereby which we determine which markets and which lines and indexes to purchase fuel on. So there is a potential opportunity for us to shift, if it's cost effective, some of our purchasing off of New York Harbor, just given that it continues to be extremely volatile. So we do go through an annual process and we'll evaluate that mid-year. Okay. Hopefully, it didn't add too much work for Joe. Just on the cost cadence throughout the year. When we think about -- I'm just trying to figure out if there's any lumpiness in maybe your maintenance schedules or anything like that. Like does it -- is it pretty smooth throughout the year? And then is there an offset from the structural cost program that kind of matches up with a lot of that, so it's, again, like a smooth CASM ex profile? And then just thinking about the exit rate there. Like why -- I mean, assuming that not taking account of your pilot deal, but just like assuming how that would trend throughout the year as you think about it into the fourth quarter. I realize there's a lot there, but if you could just provide some context on it. Thank you. In regards to CASM ex in 2023, 1H versus 2H, there's about a one point step-up in the second half of the year. And that's driven by two factors. Number one, we do have a pilot CBA pay rate step-up in the fourth quarter. And we also have some lumpiness in regards to the timing of our maintenance spend, which is typical, right? So those are two items that are the main drivers in the one point increase between 1H and 2H. The structural cost program builds pretty consistently throughout the year. So by the end of the year, our intent is to achieve the $70 million in run rate savings. And there's really not much lumpiness to that. Like I said, it's pretty consistent between 1H and 2H. Hey, I guess just to give -- because I think all the questions on cost are very -- have been very well put. And I know Joanna touched on this earlier and it's come up with other airlines. But just to kind of help people understand the sort of the investment going into some of the benefits around reducing operational risk. So Joanna talked about the ability to have more pilot reserves and starting up pilot. So approximately every 5% of additional pilots that you're hiring to fly the same schedule you had before, that's going to be just over one point of CASM in the year. Every time you take utilization down two points what you had before, that's about one point of CASM in terms of the impact. So these investments are quite meaningful, and that's why you're seeing them in the underlying CASM. And we do have optionality over time to dial some of those back, and Joanna alluded to some of that being dialed back this year. But I'm not sure that we can run certainly this airline like we did in 2019. And so we're going to have to be very measured and very thoughtful, and frankly find other opportunities in the cost structure to allow us continuing to make these investments. We have seen the benefit. Now you do see other benefits with these investments. So if you have higher completion factor, you have more on-time performance, that's going to help your operating cost. You'll protect more revenue because you'll be able -- have less in vouchers or refunds or travel credit. So the benefits are there, but it's going to, I think, mean a different revenue and cost profile in terms of where you spend, how you spend and where you see the revenue benefit to perhaps what we used to pre-2019. So there are opportunities over time to bring those costs back down, but we're going to have to tread into it very carefully to make sure that we're not, sort of, going back to some of the challenges that we saw and others saw earlier in 2022. Thank you. Next question comes from Helane Becker at Cowen. Please, go ahead. Helane, your line is open. You may proceed with your question. Right. Thanks very much operator. Robin, on the Spirit, I get a lot of questions from arbs who don't understand why you are planning for a first quarter or first half 2024 close, when it seems perfectly obvious to me that it would be in the second half -- first half of next year versus second half of this year. So maybe you could go through some of the hurdles that you have to go through before you can get the approval. Well, yes, so I mean, there's really two outcomes. We're able to reach an agreement with the Department of Justice. And if we do that, it's possible that could happen sooner, but the time line is down to the Department of Justice, and we certainly want to be respectful of that. The second scenario is that we don't get an agreement with the Department of Justice and they decide to sue us, and we go to court as we did in the NEA. And that process can take several months to go through. And so, I think, for both of those reasons, an assumption on closing this transaction in the first part of 2024 is the right one to make. Yes. That makes sense. Thank you. And then, as we think about the balance sheet, this one's probably for Ursula, is there an opportunity to accelerate debt paydown, or is that not something you would consider? Good morning, Helane. We have a significant CapEx commitment this year. We have $1.3 billion. We also have approximately $130 million associated with the Spirit prepayment. And then in addition to that, we have regular scheduled debt payments. So it's actually a pretty meaningful cash outflow this year. And given that, we're pivoting our strategy to go from purchasing aircraft with cash to financing. So the intent is to fund the business, but also build a healthy cushion to help support the purchase and the integration of Spirit as well. So at this point in time, we're not looking at potential debt paydowns. I would also note, our weighted average cost of debt is extremely competitive. And given where rates are today, we're actually probably in a more beneficial place than paying down low-cost debt. So the answer to your question is no, we're going to fund the business this year and prepare for the integration. Good morning, everyone. So, Joanna or Ursula, on the capacity guide for 2023, could you break out the moving pieces there, so departure, stage engage? I know you spoke about utilization driving a big piece of that. And then it also sounds like, again, I think you said this on the -- or you suggested this on your last call, but clearly calling it out this time is that, it sounds like the ASM guide for this year is essentially derisked as it relates to delays in aircraft. So am I interpreting that correctly? Sure, so maybe I'll start. So the full year guide is 5.5% to 8.5% so midpoint of 7%. The majority of this, as I noted in my script, is driven by utilization. So utilization is going to be up compared to 2022 as well as 2019. As Joanna highlighted, utilization will not yet get back to 2019 levels, given we are planning conservatively. In relation to the aircraft deliveries that we're taking this year, the planning assumption is 19. I'll note, they're very back weighted, so we take five in the first half of this year and then the remainder in the second half of this year. So my commentary in the script is even if some of those deliveries in the back half of this year end up slipping, we don't view our full year capacity guidance at any risk. So that's generally how to think about the full year guide. In terms of gauge and stage, stage is coming down slightly on a full year basis year-over-year, and gauge is going up slightly on a year-over-year basis. So all-in-all, we feel extremely confident in the full year guide. Okay. Thank you. And then on my follow-up, again, Ursula or Joanna. So the planning more conservatively with respect to the scheduling, and you talked about flying out of points there, emphasizing where their crew base is and to drive operational stability integrity. So is this part of what the transition plan, if you will, for this year, or is this the new go-forward operating plan? And if so, and I think Robin was implying to this in the comment from two questions ago, contemplated with how you're thinking about your long-term RASM and CASM ex-assumptions? Thank you. Yes, so I'll take it and then I'll flip it to Dave on the RASM assumption. So this is contemplated in our longer-term planning view. Unless there is a step change in capabilities that we see within the airspace that we fly. Two-thirds of the delays in the US, in the national aerospace in the US are largely in JetBlue's network. And so these planning assumptions contemplate that it stays relatively the same with like modest improvements, but nothing substantial because we just don't see a step change in capabilities coming in the next few years. Dave, on the RASM? Sure. And just to go a bit deeper, Chris, I mean, some of the things we're doing around scheduling more out of crew bases has just been swapping of aircraft type. For example, we've largely moved our E190 flying out of Florida as we soon will no longer have E190 crew bases there, whereas we used to fly a lot from non-base locations in Florida before then. So that's one example. Also working very closely across departments to plan further ahead, years ahead. So when we think about big infrastructure that we'll need, we're planning it earlier with both the revenue in mind as well as the operating team. So I think it's just good additional robustness we're doing. I don't expect material RASM impact from any of this, but I do expect better, sort of, cost and just general efficiency as we have more robust cross-functional planning even further ahead than today. And I think if you look at the holiday period, that very much played out in terms of the strong completion factor performance we had and our ability to deliver on the revenue plan that we had. And so to Robin's point, this is the new normal for the foreseeable future, and we're going to plan this way. And there are benefits that we will see play out in completing the schedule and not incurring many of the costs that you would otherwise incur if you're running late and/or having to cancel flights and the revenue cost. I mean, I'll give you a real life example. Let's talk about last night. So we had weather come into the Northeast. We were in ground delay programs and ground stops at all the New York airports. The ground delay program at JFK reached over 3.5 hours, which means every domestic flight coming into JFK last night had an average of 3.5 hours of delay. There were 749 cancellations in and out of the US yesterday. JetBlue was three of those. So our ability to kind of complete that schedule because we have planned more resiliently, executed whether on night, clearly drives the benefit of having not to refund those tickets, not at the expense of rebooking those customers. And I think the operational -- a more conservative operational philosophy change is just not how we have to think about operational costs, but over time, will drive some benefit on the commercial side as well. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.
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EarningCall_1292
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Good morning, everyone, and welcome to EQT's Year-End Announcement. In addition to Christian and Kim, today Gustav, Head of our Business Development team will be participating in our quarterly webcast and will do so from here on. We will present the results for about half an hour, as normal, before opening it up to Q&A. If you have registered ahead of the call, you should have received an email with your personal PIN code to participate in the Q&A, a new procedure. Thank you, Olof. Good morning and welcome everyone. 2022 was the most transformative year in EQT's history, despite the headwinds and uncertainties during the year. Through the combination with BPEA, add-ons and real estate and life sciences and new funds, we created a diversified global leader in active ownership strategies. We strengthened the EQT's Executive Committee, reflecting our diverse global footprint and on our added focus on scaling the platform. We had an active fundraising agenda with the successful close of a number of funds, including in growth and ventures, and made good progress in our flagship fundraisings. In the business lines, EQT continued to make selective thematic investments, and we drove and preserved value across all of our existing portfolios, with all key funds continuing to perform on or above plan. However, the deterioration in market conditions, of course, resulted in a drop in investment and exit activity and value creation was largely flat, despite robust performance in our portfolio companies. As a result, reported carried interest was lower and we slowed down our hiring pace with additional focus on cost and efficiency. And as you can see on the right, the combined EBITDA landed at EUR1.06 billion for the year. Having activated the latest generation of flagship funds, management fees are set to grow in 2023, while we do scale our global platform. Recently, we're seeing signs of the macro situations and markets turning more constructive, which is good, but we do plan for continued uncertainty. The fundraising market will continue to be affected by lower liquidity for investors for some time, which is now resulting in longer fundraising timelines. On the investment side, with a global platform, a team of exceptional people, and more than EUR50 billion of dry powder, I'm quite confident in our ability to seize investment opportunities ahead. And our deal flow remains solid. The long-term trend to investing in private markets remain strong, driven by our proven ability to generate good risk-adjusted returns. And many investors across the world remain under-allocated to the asset class. Having said that, deal activity across private markets is somewhat cyclical, as we saw in 2022. But at some point, markets and activity levels will rebound and the longer trend of private markets remains positive and growing. We've also seen a more constructive start to 2023. Whether the current situation turns out to be a shorter downturn or a recession, our priority is always to come out stronger, and this requires sharpening our future-proofing capabilities and continuous decisions in managing our portfolio and transactions. With EQT's governance model and the insights we gained from our 250-plus portfolio companies globally allow us to do exactly that, and that is to take action. Looking back, some of the best investments were made in times of volatility. After the financial crisis we did some strong deals, such as Atos Medical, KMD, Tampnet, and Anticimex, deals that delivered between three and 10 times gross multiples of invested capital. And since then, we've sharpened our thematic investment strategy, sharpened our portfolio construction methods, and have much deeper value creation skills and tools to create long-term value. Looking at past cycles, our key funds have always delivered at least two extra turns and as always, generated carry. And we have 10 years plus of time in each fund to secure such returns. But the journey hasn't always been smooth, we've seen IPO windows come and go, funding markets dry up, higher interest rates and deep recessions and market corrections like the dot-com implosion and the financial crisis. But we always maintain a long-term perspective. So in this recent hot cycle, we did not maximize leverage in our portfolio companies. We did not pursue hyped assets or financial engineering, like SPECs or cryptocurrency. Nor did we assume that valuation levels will remain at record high levels in our underwriting. And in fact, the average expected exit multiple in EQT IX was four times lower than the entry multiple. So we want to own the right companies and assets, supported by long-term macro trends which we can transform through active ownership. Resilient market-leading companies also see robust valuations throughout the cycle. And our deal flow remains strong, supported us by being local with locals in every single country where we invest. Our investment approach is built upon the belief that delivering strong returns goes hand-in-hand with creating a positive impact. And that these are mutually reinforcing, in fact. With our scale, the value of the assets we manage is more than EUR210 billion. We make a difference as an active owner, like committing all of our companies to the science-based targets. Over 1,000 clients globally trust us with their capital, and most of our clients are managing capital for pensioners and savers around the world. Thus, we have a responsibility to develop these companies in a manner which creates long-term value. Under EQT ownership, we work to future-proof our investments. We create more sustainable companies that will attract the best people and have resilient business models which digitize operations, invest in R&D and in people, and we build global platforms through consolidation. Of course, we also need to drive efficiencies and cost measures when needed, and drive transformation of industries like, for example, GETEC Energy Services, which we exited last year. Over the past years valuations have benefited from low rates and availability of capital. As these tailwinds abate, it will be more important than ever to transform companies and assets through active ownership in our view. To grow revenues, expand margins, gain market share, derisk assets. And this is what active ownership means. Take IFS, for example. Since 2015, we've appointed a new management team, upgraded the organization, almost tripled sales and more than doubled the margin. We've sharpened the company's focus on five core verticals, strengthened the sales force and accelerated new customer acquisition, becoming a global leader and making more than nine times multiple of invested capital. EQT is well placed to continue to make attractive investments is now clearly -- and now is clearly an interesting time to invest. We have EUR50 billion of dry powder at our disposal. We're local with locals, as I said. And we have the people and the EQT network advisors, more than 600 of them, to support due diligence and bring deep sector expertise to our companies and management teams. And valuations and the bid-ask spread between buyers and sellers is starting to settle. We invest in sectors supported by secular growth trends, often providing essential services to society. In private capital, we have Envirotainer and SPT Labtech in health care. We actively pursue public to privates like Billtrust and va-Q-tec, and corporate carve-outs as well. These are areas where we have deep experience, also including tech service transactions, for example, in Asia. In real estate, we're investing in sound locations, primarily in logistics supported by long-term trends. We improve the assets and we have strong relationship to lease space with our hands-on approach to global blue chip tenants. We upgrade those assets to the highest energy efficiency, making them more sustainable and more valuable. In Infra, we have strong deal flow across sectors, all of which are connected to important societal themes, such as climate and energy transition where the need for capital and competence is immense. With an estimated incremental annual $3 trillion of investments for energy and land use systems to deliver on net zero ambitions by 2050, as well as the digitalization of society and the aging populations. So I'd actually like to show you what this means in practice with a short video. I hope that brought some of our investments to life. Good. So resilience and value creation, these are not given in any business. We're continuously evaluating risks and reassessing value-creation plans in all of our investments. And to mention a few recent examples, we were early to extend debt maturities in our companies and focus on pricing and procurement when the market shifted. We reviewed and upgraded Boards and management competencies, accelerated bolt-on acquisitions and performed a full re-underwriting of the private equity portfolio to ensure that we remain on track in our funds. The conclusion is that, we have a robust portfolio. On average, portfolio companies grew revenues more than 20% last year and EBITDA growth was close to 18%. Having said that, we also do have pockets of underperformance. Certain companies have been impacted by COVID lockdowns, supply chain issues and rising labor costs. And while top line has been robust in most cases, some of these companies have seen slower EBITDA growth in the last year. In real estate, similar to other businesses, we're focused on sectors with long-term demand drivers and robust supply and demand fundamentals. Despite the uncertain market situation with higher interest rates and softer global demand for real estate, the net operating profit from our properties continue to grow close to double-digit. The fundraising market has become somewhat more challenging and timelines are being extended, also for flagship fundraisings. So fundraisings which took less than 12 months before the downturn, will now probably take more than 12 months to raise in the current environment. We have the capacity to make that happen. Looking back at the last four to five years, institutions have increased their commitments to alternatives. Fundraising cycles have been shorter than normal, and given the strong performance in private markets, institutions have reallocated capital from public to private markets. At the same time, financing in M&A markets were wide open and the net liquidity for clients was positive. The main driver of the softer fundraising market currently is less liquidity. As the financing, M&A and IPO markets were closed or constrained in 2022, institutions were getting some less money back. And thus new commitments actually exceeded distributions last year. Having said that, 2022 was a strong fundraising year for EQT. In fact, we raised more capital than we have ever done in any year before with EUR31 billion raised. EQT also has strong relationships with its clients. We distributed EUR40 billion over the last 24 months in exits, and we've continued to realize the exits, notably at or above valuation marks during the past year. We have a young portfolio and a strong performance across the board, as you see, and we're investing behind strong secular trends. As we enter 2023, our immediate priorities are to realize the full potential of our recent combinations. For example, the private capital sector teams are now working as one global team, sharing insights and working together. With a more challenging fundraising environment, we'll work with our clients to complete ongoing fundraises and scale our recently launched new initiatives. And we'll continue to optimize our global platform while strengthening our future-proofing capabilities across sustainability, digitalization and artificial intelligence with Motherbrain. We continue to evaluate and develop new products, which would provide access for a wider set of private wealth clients to invest with us. And, of course, we'll remain razor focused on performance, performance, performance. Thank you, Chris, and good morning, everyone. By way of introduction, I head up our business development and I'm part of the EQT's Executive Committee. In the recent years, I'm focused on growing our global presence, leading the acquisitions of Exeter, LSP and BPEA. Today, I want to start by providing an update on the EQT Exeter transaction and the development since the acquisition, now two years ago. Since then, fee-generating assets under management have grown by almost three times and EQT Exeter is today a global top-10 player within real estate. In addition to the EUR22 billion of fee-paying AUM, we have another EUR4 billion of commitments which will be fee paying as we invest the capital. Since the acquisition, EQT Exeter has had a very active exit agenda with over EUR10 billion in realizations, hence derisking the track record of the existing funds, both in the US and in Europe. These exits have been -- mostly been large portfolio realizations, where the funds have sold the assets, but EQT Exeter continue to manage the portfolios through so-called managed accounts, and therefore, also continue to charge management fees. This is due to the unique setup of the EQT Exeter, being a real estate operator and being vertically integrated with an in-house leasing team and an in-house development management team. At the same time, EQT Exeter has also been very active on the fundraising side, on the back of industry-leading returns, and today we have over EUR12 billion of dry powder to deploy. At the time of the acquisition, the key short-term lever was to scale up within logistics. And during 2022, we've raised both the value-add fund and the Core Plus fund in the U.S. The Core Plus fund is approximately three times larger than the previous fund. And the value-add fundraise is still ongoing with over $4.5 billion raised to date, hence more than doubling the size of the last fund, despite being raised in probably what's the most difficult fundraising year for a long time. The real estate market is experiencing uncertainties, with higher inflation, higher interest rates and global supply chain disruptions. EQT Exeter is, of course, also impacted by this, however, mitigated by the focus on sectors with long-term demand drivers in markets with stronger demand and supply fundamentals and also by the significant exit wave that we saw in 2021. Going forward, the focus is to take advantage of the repriced investment market with the significant dry powder, as well as to continue to expand into other sectors and asset classes, such as within multifamily. Now moving over to BPEA. We're very excited to have a scaled platform in Asia, especially in today's markets, where we see weakness in Europe and North America, whereas Asia is providing a very interesting diversification opportunity with an uncorrelated cycle and different drivers of growth and return. Asia is supported by positive long-term trends across GDP growth and middle-class population, creating significant investment opportunities in the years to come. As a result, the expectation is that private markets across Asia will grow significantly quicker than the rest of the world and that global firms, such as ourselves, will continue to take market shares. Having a large investment platform in Asia is also providing benefits with our Asia clients, as we can serve them better, provide better access to people and knowledge and build stronger relationships. The Asia market has been relatively resilient over the past year, with continued investment and exit activity, and financing markets have been and remain more constructive. As a result, BPEA has used these markets to return almost 50% more than been invested in 2022, further improving distribution to the clients. Fund VIII is just over 15% invested, which means that we have around $9 billion of dry powder to invest. The first joint step in building out the platform in Asia is the mid-market growth strategy, using the existing team and platform to invest across technology, healthcare and services and where we've already done a couple of transactions, taking advantage of the current market opportunity. A key focus during 2023 will be to continue to work on a global cooperation, use best practices and learnings across the platform, in areas such as, for example, capital markets, sustainability, value creation toolbox and digitalization. So moving into the client side, we continue to see a long-term growth potential within private wealth. Private wealth represents about half of the global wealth, and only 1% is allocated to actively manage alternative assets, which we, like many others, expect to increase over time. For us, this is a significant opportunity as private wealth today represents less than 10% of our commitments in the close-ended funds and we do not have any semi-liquid funds. As most of you know, private wealth and especially the semi-liquid market is currently experiencing some headwinds, which we are closely monitoring. We're focusing our efforts within private wealth on increasing the share from private wealth within our close-ended products by strengthening the relationships with our key distribution banks. And in addition, we're also working -- continuing to work around semi-liquid structures, and we expect to launch certain products during the course of this year. Thank you, Gustav. Having raised EUR31 billion in 2022, the market is becoming more challenging, as we said. But we raised EUR31 billion over the past year, and that includes Ventures III at hard cap, EQT growth above target, the EQT Exeter's fourth US Core Logistics Fund, and its second Office and Life Science funds. BPEA VIII closed at hard cap and we progressed various fundraisers, including our flagship fundraises. If you look at EQT X, which was initiated in January 2022, this has commitments of EUR16 billion as of today, including commitments of about EUR1 billion confirmed in the first weeks of this year. We expect EQT X fundraising to be substantially completed during the summer. When it comes to BPEA, we are establishing a mid-market growth strategy. And as you know, we launched Infrastructure VI late 2022 and we have closed out about EUR3 billion. We expect a similar pattern to EQT X for Infra VI, with strong re-ups in the first close. Demand for Infrastructure is healthy, and we expect the vast majority of our Infrastructure fundraisings, including Active Core in 2023. With regards to EQT Exeter, we raised $4.5 billion for EQT Exeter's US. Industrial Value VI Fund and expect to wrap up fundraising above the original $4 billion target. And we have two further EQT Exeter fundraisings in the market currently. If we look at our AUM development, in 2022, AUM increased by EUR39 billion or more than 50%. About half is attributed to BPEA. BPEA had AUM of about EUR22 billion as of closing. Step-downs of EUR9 billion refer primarily to the activation of EQT X and Infrastructure VI. EQT IX saw step-downs of about EUR2 billion and in Infrastructure V, step-downs impact about EUR5 billion. But Infrastructure V has made investments which had not yet closed and has capital earmarked for CapEx rollout, and this will actually increase the AUM by about EUR2 billion compared to the year-end numbers in our report. Closed exits in 2022 reduced AUM by almost EUR6 billion and the AUM number is also affected by FX. The BPEA funds are USD-denominated and at the current FX, the BPEA euro equivalent AUM number is about EUR20 billion. And the EQT Exeter funds are largely USD denominated and the equity and infrastructure funds also have USD sleeves, which are converted to euro as we report our AUM numbers. Let's next turn to the investment activity. After a busy year in 2021, we saw investment activity drop by 40%, while exit volumes dropped by 60%. Broader market uncertainties resulted in a gap between buyer and seller expectations and financing markets were clearly constrained, which limited the scope for larger deals, in particular. We still did certain thematic investments in 2022 and EQT X is now 10% to 15% invested. Infra VI announced its first investment in December and is 0% to 5% invested. And deal activity remained solid in Asia, as Gustav said, with BPEA VIII being 15% to 20% invested. Financing markets remain constrained and the rates are considerably higher compared to a year ago, of course, but there are signs of a marginal improvement in the debt markets. We continue to see debt packages of EUR2 billion to EUR3 billion being feasible and for the right situations, there could be scope to do larger debt financing, including bank funding we think. With regards to our existing portfolio, financing structures remain robust. Infrastructure, we recently completed certain refinancings, which were done at substantially similar terms to what we saw prior to the downturn. We have no material refinancings coming up, although we typically swap floating rates to fixed, which means we have some hedges being renewed. Whilst we expect near-term activity to be muted, it's a dynamic market with some signs of improvement. We may consider realizing certain infrastructure assets for example where demand for inflation and downside-protected assets is strong. We may pursue certain exits in private equity across the world as well. With regards to new investments, we are actively evaluating several thematic opportunities. In private capital, we're evaluating deals in our core sectors, including healthcare and tech. In real estate, we're active -- in real assets, sorry, we're actively looking at digital infrastructure, energy transition themes and we think it's possible, based on the investment pace that we currently see in our flagship funds that investment cycles are close to the three-year averages, which we have seen historically. Lastly, real estate activity levels have slowed down significantly and we are mainly doing smaller transactions at the moment, but see interesting opportunities as we said. Before handing over to Kim, let me also mention that lockups on about 7 million equity shares expired in 2022. The shares are held by Exeter employees, and the expiry is in line with the agreements set at the time of the combination with Exeter. To the extent any of these or other previously released shares were to be sold, the process would be coordinated by EQT AB. Thank you, Olof, and good morning, everyone. Let's start by reviewing our fund valuations over the past year. Fund valuations were largely stable for infrastructure and for BPEA, and somewhat down for our private equity business outside Asia. Our equity and infrastructure companies grew their top line on average at over 20%, and saw EBITDA growth of approximately 18%. Around one-quarter of this growth came from add-ons. So the underlying organic growth remains solid. Almost all of our companies in the key funds were EBITDA positive. So it's a robust portfolio with long-term financing in place and a strong ability to pass on inflation. Our core sectors and focus areas, such as healthcare, digital infrastructure and tech see continued robust interest and transaction multiples. However, a few portfolio companies saw headwinds impacting EBITDA growth in '22. We do expect to hold companies on average longer than in the recent past. This could result in somewhat lower IRRs, but gross MOIC expectations are largely unchanged. Next slide, please. Let's next break down the valuation drivers using three of our key funds which are fully invested and in value creation mode as examples. As mentioned, strong operational performance supported valuations in 2022, which is the case in all these examples. In EQT VIII, this was offset by lower reference valuation multiples. Across the key funds multiples were down by about 10% year-on-year. Not all multiples are down, some relevant transaction multiples and infrastructure are higher. Infrastructure valuation methodologies include both multiples and discounted cash flow analysis, and valuations are typically resilient. We have a few listed holdings in our private capital funds, in EQT VIII in particular, which are valued at the last closing share price of the period. On an average basis, our listed holdings traded down in 2022. On a general note, a meaningful portion of our equity and infrastructure funds, especially the earlier vintages, have already been realized. As those exits are cemented in the underlying valuation of the funds, this means only a portion of companies in those funds are actually seeing valuations move. On average, exits in 2022 were made at a 26% premium to the valuations of these assets in our funds, which supports our view that we had cautious valuations in our books coming out of COVID. Next slide, please. The lower exit activity and flattish valuations translates into lower recognition of carried interest and investment income in 2022. Management fees increased by 22% versus last year or 15% excluding BPEA. On a combined like-for-like basis, the growth was around 23%. In the reported numbers, EQT X was included only for five months, BPEA VIII only for two and a half months and Infra VI only since mid-December, meaning that we expect the growth to continue into 2023. As a result of a lower carry and FTE growth in 2021 and '22, our total EBITDA and EBITDA margin is down versus 2021. Excluding carried interest and investment income, however, the margin continues to grow as we have activated our latest generation of funds and we continue to scale our platform globally. We were very strict on our cost development in this market environment and have taken actions during the year and slowed down hiring, which I will revert to. Next slide, please. The closing of BPEA took place in mid-October, meaning our financials include two and a half months of contribution in '22. As previously communicated, the business model and financial profile of BPEA is similar in many ways to our own. The transaction is accretive as of closing, even though we do not expect any material cost synergies. Looking at our combined financials, i.e., if closing had occurred on January 1, then we would have had combined management fees of EUR1.6 billion and an EBITDA excluding carried interest of EUR826 million, which is equivalent to an EBITDA margin excluding carried interest and investment income of 51%. Including carry, the EBITDA margin would have been 57%. BPEA VIII started generating management fees in September '21 and the final close at hard cap occurred in September '22. Commitments raised during '22 generated slightly above EUR10 million of catch-up phase prior to closing of the combination. The increase in management fees year-on-year for BPEA's full year number is largely driven by the full year effect from BPEA VIII. As you may have noticed in the report, our effective fee margin increased compared to H1 and was 1.48%. This was driven by BPEA's effective management fee rate, which in general is higher than our other funds. Fund VII entered carry mode in 2022, driven by a combination of exits and rebounding valuations, driving the fund from 1.8 times to 2.0 times MOIC in Q4. BPEA VI also contributed to the full year number. Next slide, please. Around two-thirds of our cost base consists of personnel costs. Around half of the FTE increase in 2022 came from business combinations including BPEA, LSP, Bear Logi and Redwood. The other half is from organic growth, in anticipation of our next generation of funds in strategic growth areas, such as capital raising and private wealth, and in our future-proofing capabilities. As mentioned, during the year, we have slowed down the hiring pace significantly. We're focused on efficiencies and scaling the EQT platform. Areas where we may consider further hiring include private wealth and North America and APAC. Total cost per average FTE in 2022 is somewhat lower than in 2021. Variable compensation levels are lower for the year and the variable compensation going forward is depending on how the performance develops. With growth in headcount in more expensive regions and functions, the average cost could increase from levels seen last year, everything else equal. To summarize our financial year in 2022, our total profitability in 2022 is impacted by lower carried interest and investment income. Revenue growth excluding carry remains high and profitability is increasing. When looking into 2023, we expect this to continue following recent fundraisings, and a very cautious approach to cost growth. In an environment with significant uncertainty, we have a solid cash position and we are receiving our contractually recurring management fees in January and July. In addition, if we were to need it, we have an undrawn revolver of EUR1.5 billion. Carry expectations follow the same pattern as mentioned before, i.e., in the near term, carry is likely to be delayed, given market developments, but our carry expectations over the longer term remain. Thank you, Kim. So in summary, the market environment [indiscernible] 2022, but during that time we really strengthened our global platform. Our industry is seeing long-term growth and there will be a rebound in activity levels. And we saw some really bright spots here during early 2023. Overall, we're in a good place. Our deal flow remains strong, we had an active fundraising year in 2022, and we have a significant amount of dry powder to deploy in this market. The majority of our fundraising in 2023 is in infrastructure, where demand is robust and we are confident in our targets. With BPEA, we've created a scaled global platform, and I'm quite confident that we're in a solid position to navigate this market and use it to further strengthen our firm and deliver for our clients. Thank you. [Operator Instructions] And your first question comes from the line of Hubert Lam from Bank of America. Please go ahead, your line is open. Hi, good morning, thanks for the presentation. I've got three questions. Firstly, can you give us your outlook for FTE growth? I know you're saying it's -- you have more selective hiring now. What's your -- how much should we expect in terms of net hirings for this year? That's the first question. The second question is on the guidance of fundraising for BPEA and Exeter. For BPEA, you mentioned the launch of the mid-market growth strategy. How big should we expect that fund to be and do you expect that to close this year? And also for Exeter, you have a number of fundraisings going on as seen in slide 18, just wondering how much should we expect from these funds this year in terms of fundraising. And the last question is on management fees. Were there any late management fees in the second half, managed fee number? And also, should we expect late management fees to have an impacted in management fees for this year? Thank you. Yes, I'll take number one and three, at least. Yeah, on the FTE growth, you will see that -- I mean, we're not giving exact guidance on the headcount growth. You will see that the quarterly increase in headcount has continued to be smaller and smaller, and that probably gives you a pretty good idea of what it will look like, based on what the market looks like right now. We are an agile firm and should things change dramatically during the course of 2023, we will adjust accordingly, be that up or down. But I hope that increase, quarterly increase, and the trend in that increase gives you a pretty good idea of how FTE growth will develop. In terms of late fees during the second half, there were no significant late fees in our numbers here in 2022 second half. Next year, we will expect some late fees, but given, for example, Infra VI was activated here on the last year side, but how much that will be? We will have to come back to. And on the fundraising for BPEA and Exeter, for BPEA, we don't have the sizing on the page that you saw, because we don't include that for funds that are below EUR1 billion. So I think that's an indication of the size that it will not be above EUR1 billion. We have raised some capital for that at the end of this year and expect to continue that throughout 2023 and wrap it up before year-end. On the Exeter side, as we said, the Value Fund VI is -- we're wrapping that up as -- in the first quarter here and we have two other funds with the -- Core Plus fund in Europe with a target of EUR2.5 billion, and a multifamily fund in the US with a target of EUR1.5 billion, and we expect to fundraise those throughout 2023. And in addition to that, we'll probably have one or two additional funds being started during the year. Thank you. We will now go to our next question. One moment, please. And your next question comes from the line of Arnaud Giblat from BNP Paribas. Please go ahead, your line is open. Good morning. I've got three questions, please. Firstly on deployment, in the context of a challenging market for deployment. I mean, we talking about wide bid-ask spreads, changing financing markets which have affected frequent data with a substantial slowdown. That hasn't affected you as much. So could you perhaps talk about how you've been able to source assets, where others have had more difficulty? And then in the context of a more robust pipeline that you've talked about, could you indicate where -- whether the future opportunities may lie? My second question is on FTE growth. So clearly, it sounds like you've done most of the hiring. Are you today sized to be able to do PE -- I mean, all strategies and core strategies on a global basis? Is the current FTE base sufficient for that, or is it just a case where you're slowing down and building it out into the future? And my final question is, thank you for giving us an indication of where EBITDA growth has been. I think you said 18%. What's the outlook on that EBITDA growth for your portfolio companies for the next few years? Thank you. Thank you, Arnaud. On the first one, and then Kim will take the others. On the deployment, of course, that's -- it's always difficult to make an exact prognosis, but if you look over the cycle, over the last 30 years or so when we've been operating, the typical cycle -- the average cycle is actually three years. When times are good it's a little bit slower -- sorry, it's a little bit faster, and when times are weaker, it's a little bit slower. Given our deal flow, how much we've invested in the major new funds, I would expect that we're kind of back on that average three-year deployment cycle, which actually is a positive, because in the recent cycles we're closer to two years. First of all, it's quite challenging for us, because here you finish one fundraising, you go immediately to the next one. But it's even more challenging for our clients because they have a setup which is based on more of a three or a four-year cycle, which is closer to the average of the industry. How we're generating deal flow? Well, we are in this quite unique position where we invest behind long-term secular trends in different sectors and sub-sectors around the world, with global sector teams and competence, but then we're doing that in every single country we're investing in with local teams. So I was in Japan last week, for example, and we had a meeting with a company that we're looking to invest in. And, of course, we're doing that with the local teams. So when I'm there, I need a translator, but of course, when the local teams are there, it's totally connected [indiscernible] local language. So it's the combination of those two things that give EQT that uniqueness that we pretty much always have strong deal flow regardless of cycle. Kim? Yes, thanks. And on FTE growth, I'd say that we are in a very good spot given the investments into personnel that we have done over the last couple of years. So we are well-sized to capture the opportunities that the large funds we have available can be deployed. There are a few areas where we will continue to invest and those are the ones that I mentioned, i.e., private wealth is one area where we will have -- where we will increase headcount. And we will also selectively increase headcount in Asia Pacific and in the US, which are areas where we are still not as strong as we would like to be. When it comes to the sort of more central part of the organization, there will be very limited, if any, growth and the headcount going forward. EBITDA outlook for the companies -- portfolio companies and growth outlook for those, we don't really go into that level of detail. We've said what the EBITDA has been historically. And you have seen the valuation effect of that. To the extent, it would be dramatically different from these numbers. I guess it would have had a higher impact on our valuations. So that could give you a hint of it. Thank you. We will now go to our next question. One moment, please. And your next question comes from the line of Ermin Keric from Carnegie. Please go ahead, your line is open. Good morning, and thanks for the presentation and taking the question. The first one would be on the semi-liquid funds that you mentioned, or [indiscernible] you mentioned that you expect to launch in 2023. Could you give us any more color on that and how it will be distributed? And then another question is on the EBITDA margin. So excluding the carry, you say that expanded again. How much more do you see that being able to expand from here, or is there any cap on how much operating leverage you can actually achieve in the business over time? And then lastly on the Q4, we saw an increase in exit activity. Was that seasonally driven or is that more to do with, as you mentioned, the bid-ask spread has now maybe narrowed a little bit with market settling a little bit? Yes, sure. So on the semi-liquid side, where we are currently is that we are, as I said, planning for launches this year. We have -- we're starting to have the teams in place and also the structures. What we see is that, it will probably be a mix of both asset-specific funds, as well as more, let's say, broad private market structure. And I think the main distribution here is through the distribution banks, but of course, also through their existing clients, especially on the family office and private wealth side that we have already today. And in terms of margin, sort of FRE margin, as you call it, outlook, I'd say that in the short term you will see an effect from the large fundraisings that we have done or are in the process of doing, combined with the cost conscious and cost efficient way of operating that we have. That's in the shorter term. Our long-term margin target is, as you know, 55% to 65%, including carried interest, and we haven't changed that. But we do see potential to work further on our margin over time, but I'm not going to be able to give you a specific number on that. Chris, you on exits. Yeah. I mean we're -- given the fact that we are investing in these thematic sectors that are pretty robust over the cycle, if you look throughout the year, actually we are able to do different types of exits, whether it was dividend recaps, sales to strategics, sales of stakes to other financial firms and other private equity exits. So kind of the whole spectrum except for IPOs. Well, the IPO market was closed last year. So Q4, yes, probably some positive effect of people seeing that the macro conditions in the world are possibly improving now, or at least getting less worse. The IMF today came out and -- with a prognosis that Europe won't go into a recession this year. The US is not expected to go into recession. Asia has been pretty robust and China is opening up again. So that has, of course, helped the capital markets, as you all know, which means that -- I didn't comment on this earlier, but also means that the financial markets on the debt side are starting to open up a little bit. And there was an IPO launched in Germany last year -- I'm sorry, yesterday. And there are some more IPOs that people are talking about coming into the pipeline. So, we'll see how the markets develop, but probably there is -- whether that little -- we said in the presentation that we are seeing some bright spots in some of -- those are some of the bright spots that we hope, of course, will lead to a more sunny picture. But we remain paranoid and quite thoughtful about how we manage our portfolio. Thank you. If I just may, one quick follow-up on the carry for H2. Am I thinking right about it that it's basically just BPEA that's contributing and none of the EQT funds from before? I can comment on that, Chris. There's a very little carry contribution in H2 from funds outside BPEA, you're right in that. And there has been a few transactions here later on in the year, such as GETEC and Saur which have not closed yet. And as you know, we are booking carry in most cases only as and when the transaction is closed. So there are some, how should I say, accruals there, but that's the status right now. Thank you. We'll now go to our next question. And your next question comes from the line of Michael Werner from UBS. Please go ahead, your line is open. Thank you very much guys for the presentation. I have two questions. One on fundraising. Just focusing a bit on Infra VI, I think you really started the fundraising process at the end of August. You raised about EUR2.8 billion through year-end. How should we think about that run rate, which is a little less than EUR1 billion per month, especially for a fund that you're targeting for EUR20 billion? And is this one where because you're out there with EQT X at the same time, that's having an impact? And do you expect a bit of an acceleration as we go through 2023 in terms of the pace of fundraising there? And then second, just a follow-up on those semi-liquid structures at BPEA. How should we think about the pricing, the management fees on those relative to other AUMs managed by BPEA? And then, ultimately, is there a target in terms of size of those total semi-liquid structures for the year? Thank you. Thank you. Very good questions, I'll take the first one and Gustav the second. When it comes to the fundraising cycle, it's not like a public company situation where it's maybe more even month-by-month. These are -- and we have about 1,000 institutional clients around the world. And investors come into the fund at different times when they're done with their kind of internal process. And that's typically why you see these smaller rolling closes, until we get to the formal first close, which is quite significant, and that was around EUR15 billion or so for -- if remember right for EQT X. And then thereafter other investors start to come online and other channels, like private wealth, et cetera start to come online. So, there is no straight line or seasonality, and this is really depending on this whole process and lots of internal decisions at the investors. So I would say that the Infra VI fundraising is so far having that normal pattern, but both EQT X and Infra VI in this market where it is more complicated will take more time than it would when markets are really hot. And that connects to those comments we had on investor liquidity and other factors. Next, Gustav? Great. Yeah. On the semi-liquid side, I would say, on the management fee level, it's fairly similar to the levels that we have on a Group level, maybe a little bit higher, but in general about the same. And just to clarify, it's not specifically to BPEA, but the semi-liquids are -- if that was the understanding, it's -- they are a general across EQT. I think on the sizing question, we will not go out with a specific target. I think you should see this as a long-term potential. We will launch it during this year, it will not have a material impact on the size of equity in the beginning, but rather over time we see this as a good way to, let's say, target the private wealth market. Thank you. We'll now go to our next question. One moment, please. And the next question comes from the line of Oliver Carruthers from Goldman Sachs. Please go ahead, your line is open. Good morning, thanks for the presentation. Two questions for me. If we jump to slide 20 on your investment and exit activity, and simplistically across all your funds, but given that you highlighted, you are a net seller of assets at the Group level into the strong markets of 2021 and you're obviously at parity last year, through 2022. So if we join the dots in everything you're saying, EUR50 billion of dry powder, robust deal flow, and a fairly young existing portfolio, should we expect you to be a net buyer at the Group level across all your funds through this year? That's first question. And then the second question on Infrastructure, given both the need for private capital [indiscernible] but also the general positive shift towards ESG, what are you seeing in terms of interest for your latest Infra funds from new clients to EQT, either in Infra VI or in Active Core? I think some of the larger sovereign wealth funds who've historically shied away from committing capital to private equity funds are now more open to say renewable infrastructure as an example. So any color there would be helpful, too. Thank you. Thank you very much. Interesting question. And we try not to, let's say, guide too specifically in exactly how deployment will be and exits will be in a given year. But depending on how the markets develop and given the amount of dry powder that we have across the world, and you're exactly right, having made a very large number of exits across EQT Exeter and BPEA, an overweight towards deployment would be likely. So I think that -- you have a logical conclusion, although we're not going to comment on specifics. When it comes to infrastructure, yes, as you saw from the video, it is a very, very interesting space that Infrastructure is investing in are spaces across the energy transition, transportation transition, social infra, digital infra, and a lot of capital have also moved into that asset class, also from new investors, yes, and that goes for Active Core and Infra VI. And also, when times are more uncertain, infrastructure is a really nice asset class, because you have typically stable inflation-protected assets where we apply all of our toolbox to grow and develop those assets and create more value and drive that excess return. And as you know, we've been delivering something like 19% net returns in that strategy since inception. And we're one of the clear global leaders. So also there thematically you're right, but still it will take some time to finalize the funds, but we're having nice dialogues with new investors and very solid dialogues with existing. Any follow-ups? Thank you. We will now go to our next question. One moment, please. And your next question comes from the line of Magnus Andersson from ABGSC. Please go ahead, your line is open. Yes, thank you and good morning, guys. Just on -- starting on fundraising, I was just wondering whether you could comment about what markets are the toughest, the US or the European one, and also if you can say something about how different the Asian market is. And related to that, if you could tell us -- remind us about your geographic split of your fundraising, for example, for EQT X and Infra VI. That's the first one on fundraising. Secondly, just a follow-up on Ermin's question, that was on carry. When I compare your IFRS accounting with your adjusted numbers, we can see that the adjusted carry was EUR45 million, while the IFRS carry was EUR6 million. Is it fair to assume that the difference there is made up of BPEA? And finally, perhaps, I note that your net -- adjusted net profit was much lower than the general expectations and it looks like you had a quite high tax rate this quarter. If you could comment whether that was a one-off or if we should expect a higher tax rate going forward? Thanks. I'll start, and then I guess, maybe, Kim, you guys can take over and Olof also. On the fundraising market, I would say that the most mature market in the world, that's the US market. And that means that a lot of investors have been more highly allocated, some fully allocated to private equity. You've probably heard of the denominator effect and those investors have felt the denominator effect, whereas market valuations fall in the public markets and private market valuations have been a bit more robust, those allocations are impacted. So that's probably the market where there is kind of the more complicated discussions in the market between the different market participants. But it is, of course, the largest source of capital in the world, and a lot of those funds are continuing to grow and will continue to be very large investors in private equity and private markets for the long term. If you look at Canada, it continue to be a very strong market and the Middle East as well, and Asia. And in those markets, typically, a lot of institutional investors are still growing their AUMs, and they're growing their allocations to private equity and private markets in general, including infrastructure, real estate, et cetera. So that's basically how the market is playing out. Now, we're -- historically, you might remember that we have a relatively lower share of our capital from the US and a relatively larger share from other regions in the world, and I didn't comment on Europe, Europe is somewhere in the middle, pretty okay. So from that point of view, we're having positive dialogs around the world. And I'll let my colleagues comment on some of the specifics. Thanks. On carry, just a reminder that adjustment to carry is in order to make the carry that we have acquired comparable in accounting treatment to the carry we have had from before. So it is from acquired carry, in this case BPEA, you're right. And in terms of the tax rate, I mean, the general trend for tax is always upwards, there hasn't been any dramatic changes over the year to that and our tax rate on management fee earnings was in the region of 16 -- 15% to 16% for the year, maybe slightly higher than before, but not dramatically so. Okay. Thank you. Just my follow-up, if you could give us a feeling for the geographic split in, for example, EQT X and Infra on the fundraising. And secondly, just on the tax, so there is no one-off, we should expect 15%, 16% on -- is reasonable to assume going forward. No, we don't give exact split by funds, but it's about one-third from Europe, one-third from Americas, and maybe 25% from APAC. Yeah. And the rest is from the Middle East. And you could also say that if you look at the global market for capital sources, the US market is a little bit over 50%. So that shows you the skew that we have. Thanks. Thank you. We'll now go to our next question. One moment, please. And your next question comes from the line of Bruce Hamilton from Morgan Stanley. Please go ahead, your line is open. Hi, there. Thanks. Good morning, guys, and thanks for all the slides and the Q&A. Just a quick follow-up on the wealth opportunity. I mean, I agree, we think that that's quite significant longer term. But in terms of the how you would manage that product, so [CP REIT] (ph) is seeing some pressure. So how are you thinking about the approach in terms of liquidity terms, where you might sell it? I think Asia has been more volatile to [BREIT] (ph), for example. Or is it really down to investor education that is going to be the critical thing in ensuring that there's no misstep? And I guess also any -- what concerns would you have around any regulatory backlash given what's going on with be BREIT at the moment? Thank you. No, but I think first off, we don't have any products today. So, of course, the benefit that we have is that we can start off on a little bit of a clean slate. I think in general the semi-liquid markets will develop as a result of what we're seeing in the market right now. And that it will also be clearer for all participants what type of product this is, i.e., that it is a semi-liquid product and not a liquid product. So I think from that perspective, we see this as a pretty good time to actually start off because, of course, it will mean that we will not have a legacy portfolio, and we don't have a legacy impact of it. I think from a general point of view, in terms of where we see demand, I think, it goes -- we see this as a global product, but of course, our strong foothold from a branding perspective is, of course, initially in Europe and over time it will also be stronger in Asia and North America. Thank you. We will now take our next question. One moment, please. One moment. And your next question comes from Angeliki Bairaktari from J.P. Morgan. Please go ahead, your line is open. Good morning. Thanks a lot for taking my questions. Just a couple of follow-ups, please, on my side. Your outlook for fundraising reads quite bearish in your Q4 report, but you have mentioned today that you are seeing some bright spots in the beginning of 2023 when it comes to sort of deal activity, capital markets, et cetera. And I guess, more long term, from the conversations that you're having with your LPs, do you see that they still expect, overall, their allocations to the alternative asset class to private markets to continue increasing, or do you sense that some LPs are actually now taking some -- changing their thoughts given the interest rate environment appears to be somewhat more persistent and we effectively have a different backdrop? That's my first question. Second question on EQT X and Infra VI. What percentage of the existing capital commitments are from returning investors, from previous vintages, if you can disclose that, please? And then third question, the amount of leverage that you use now in deals today, given a more difficult financing market, at least until the end of 2022, has that changed at all versus history? I think, historically, you have indicated around 50% equity, 50% debt. Is that different today? Thank you. I'll take one and three and Olof you can take the middle one. The fundraising outlook, there was a strong word there, bearish. I'd say that what we mean is that we believe that the fundraisings will take somewhat longer time to complete than in a very hot market. Most of that is due to, of course, volatile financial markets, on the one hand, less liquidity with investors on the other hand. But we don't see any tendencies, to the bigger question you asked, which is, are allocations shifting away from private markets? No, we don't see that at all. Actually, we think it's the opposite. We think that the long-term trend is truly intact. A lot of investors around the world and also, of course, private wealth is very under-allocated to the asset class. I think this period of volatility has shown that private markets actually over-delivers in returns, as it has done over all cycles, and people want to have access to that. And I think also the volatility in the public markets probably will continue to drive capital to the private markets and many companies will stay private for longer. So we think that kind of ecosystem around private markets is very robust. So this is more relating to the market conditions and the time that it takes to raise funds than anything else. On the latter question, on leverage, leverage is probably not that different. We're a growth and transformationally oriented investor. So we're typically not maximizing leverage, but the size of transactions, the size of debt that's available is still lower than in the boom times. But in this market, you can raise EUR2 billion, EUR3 billion, maybe EUR3.5 billion of debt, which means we can do deals between a few hundred million and possibly EUR5 billion. So, the market is starting to be a little bit more open for kind of our sweet spot range. Olof? And then on the re-upgrades for the flagship funds, I'm not going to give a specific number of that, but what you see is typically in the first close is that you have a substantial portion of re-ups from existing clients, and that has been the case in EQT X. And as we mentioned in the presentation, we expect that to be the case also for Infrastructure VI. And then, say, the last quarter the fundraising comprises different sources of capital as we were alluding to, including private wealth and to some extent, new clients. And in this environment, as we've said before, we probably had a slightly lower conversion of new clients than we have had in an environment where there is more liquidity on the client side. Thank you. We'll now go to our next question. One moment, please. And your next question comes from the line of Nicholas Herman from Citigroup. Please go ahead, your line is open. Yes, good morning. Thank you for the presentation. I'm a bit cheeky, and also four, if that's okay. So, one on fundraising, one on Asia, and then two just quick -- hopefully quick technical questions. On fundraising, I guess, given the challenging fundraising outlook, are you confident in hitting the hard cap to EQT X? And also more broadly for the industry, LP congestion was a theme we talked about, I guess, early last year. I hear you on why the allocations, but I guess, do you see a risk that LP congestion remains a factor for longer and maybe impact '24 allocations given 2023 allocations have been impacted by market uncertainties, denominator effect and so on? That's the first. On Asia, we are seeing signs of China reopening. Do you see this impacting you from an investment perspective in the near term? But also just curious if there are any triggers your Asia-based LPs are looking for and what they're telling you. And then just the last two. One on the fee rate and one on costs. I heard you before say that there were no material catch-up fees in the second half. But it looks to me like the realized fee margin [Technical Difficulty] an effective fee rate of 148. So how do I reconcile those two, given there were no material catch-up fees? And then the last one, please. I guess, a lower dollar is unhelpful for you overall, but from a cost perspective, after BPEA, could you just remind us please, what percentage of your cost base is dollar-denominated? And, I guess, that might be helpful for keeping your -- weaker dollar will be helpful for keeping your costs lower. Thank you. Okay. I'll start on the first two and then Kim, you could take the rest, and maybe Olof wants to comment also on the first one. And your cheeky question is good. We typically don't talk about whether we're going to reach the hard cap or not. The hard cap is something that we set in negotiations with our clients. We do talk about our targets, we're confident that we're going to meet our targets. And I'm not sending any signals there at all, just stating facts. When it comes to the trends with investors, in general, I don't think we can add much more than we have said. We remain one of the best performers in the industry. We have very thematic investment strategies. We're raising capital in areas which are long term quite resilient and we believe we will deliver strong returns in the future as well. So I think we're in a pretty solid position in this more complex market. Then on the Asia question, I don't think China's reopening necessarily changes how we invest or necessarily where we invest. But for our Asian business, and actually for the global economy, the fact that China is going to be coming back online, I think will help both in terms of demand, but also in terms of supply with supply chains opening up and becoming -- let's say, flow better. And it may be that some more opportunities will arise in our Asian business that as you've seen is performing well and where deal flow is strong and were today 15% to 20% invested. But we're going to remain quite diversified across that region and across the world in the way we invest. No, I think the other question you had was whether congestion in fundraising, as you put it, would continue. And I think I'd go back to what Christian talked about in terms of liquidity for the clients. When we have this period of lower realizations, if that picks up, slowly you will see this improving as well. And on the more technical questions. On fee rates, to start with, there's couple of elements impacting that, which are not one-off, I'd say. One is BPEA, that has a higher fee rate than the legacy EQT has, and that is part of the uptick. And the second part is that there is a slightly larger portion of Exeter there than historically and they also have a somewhat higher fee rate than average in the portfolio. So those are the reasons. In terms of costs, and I'd rather look at it actually on both revenues and costs. And, going forward, if you look at it on a sort of pro forma basis for the combined new EQT, we are very balanced when it comes to dollar exposure, because we also have significant revenues in dollars. Most of the Exeter funds, the BPEA funds, and the large flagship equity and infrastructure funds also have dollar sleeves in there. So it's about 45% -- 40% to 50% dollars in both revenue and costs. Conscious of time, I think we should start to wrap up shortly, but let's take a few last questions, but let's try to keep it short. Thank you. I will now go to the next question. One moment, please. And your next question comes from the line of Jakob Brink from Nordea. Please go ahead, your line is open. Thank you. Most of my questions have been answered, but just one final on the carry recognition. I seem to recall, Kim, that you said in the Q3, I think it was, or it was Q2 conference call that there was still some carry left to be booked from the first half year that wasn't recognized back then. Then given the relatively low carry in the second half, I'm just a bit surprised that there is nothing left there. And also, could you may be just -- as Ermin said, there was quite a few exits towards the end of the quarter and I think especially, one of them was an internal transaction to EQT Future. Why wasn't that one booked now, just so I understand your methodology? And then lastly on the methodology. Looking at the MOIC development in your funds in private capital, they were slightly down or flat, while public markets were up. Could you just explain that sort of lack of correlation, please? Yeah, on carry recognition, I can't recall exactly whether I've said that, it doesn't ring a bell. There was one or so transaction as of H1, which we had not closed. And, obviously, carry recognition is not only a function of closing deals but also of the evaluation performance in that fund over the rest of the period. So it's not a one-to-one exercise. And when it comes to the methodology, it's just prudent to have a closing as the date when we book carry, then you don't need to form a view on whether there is risk to closing or not. Typically, they wouldn't be. We would typically not have that. But that's the way we operate. That's on carry. What was the other question? Well, I think we went through the valuation methodologies in some detail here before. It's not one factor impacting a big portfolio of companies, there's both the public market references, there is the public investments we have, and then there is the performance of the underlying companies and other aspects. So I can't give you more of an answer than that really. Thank you. We have one further question in the queue. One moment, please. And the question comes from the line of Marcus [Lejael] (ph) from SEB. Please go ahead, your line is open. Yes, thank you. Good morning. Just finalizing with some short follow-ups. On the items affecting comparability and also the relatively large delta in amortization and related to intangibles in this fourth quarter here. How much of that should we see as really temporary or how much will remain going forward? Thanks. Well, there is about EUR80 million of one-off items in there, primarily relating to the acquisition related expenses for BPEA. And the rest of the adjustments are more of an accounting technical nature. Happy to go through those in detail with you offline.
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Ladies and gentlemen, thank you for standing by. Welcome to the MarketAxess Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. [Operator Instructions] As a reminder, this conference call is being recorded on January 25, 2023. I'd now like to turn the call over to Steve Davidson, Head of Investor Relations at MarketAxess. Please go ahead, sir. Thank you, Chris. Good morning, and welcome to the MarketAxess fourth quarter and full year 2022 earnings conference call. For the call, Rick McVey, Chairman and Chief Executive Officer, will provide a strategic update for the company. Chris Concannon, President and COO, will review key business trends and then Chris Gerosa, Chief Financial Officer, will walk you through the financial results for the quarter. Before I turn the call over to Rick, let me remind you that today's call may include forward-looking statements. These statements represent the company's belief regarding future events that by their nature are uncertain. The company's actual results and financial condition may differ materially from what is indicated in those forward-looking statements. For a discussion of some of the risks and factors that could affect the company's future results, please see the description of risk factors in our annual report on Form 10-K for the year ended December 31, 2021. I would also direct you to read the forward-looking statement disclaimer in our quarterly earnings release, which was issued earlier this morning, and is now available on our website. Good morning and thank you for joining us to review our fourth quarter and full year results. We continued to execute our growth strategy and delivered the third consecutive quarter of record market share gains across nearly all our product areas. Strong increases in trading volumes and significant price improvement for clients through our unique all-to-all trading protocol, Open Trading. Our underlying revenue growth trends improved materially in the quarter despite near-term bond duration and FX revenue headwinds. We delivered 8% revenue growth, 10% adjusted for currency, EBITDA growth of 10% and EPS growth of 15%. With this strong finish to the year, we delivered our 14 straight year of record annual revenue. Slide 4 highlights the key areas of our growth strategy. Our leadership position in global credit continues to expand beyond just U.S. high-grade with record estimated market share in high-yield in municipals, record share in Eurobonds and accelerating share gains of almost 300 basis points in emerging markets, reflecting our increasing global diversification. The deep pool of liquidity on our platform continues to expand with a record of nearly 2,100 active client firms and a record number of active traders. We have seen especially strong growth in our international business with over 1000 active client firms and nearly 6,000 active traders. As traditional sources of liquidity have become scarce, the importance of our all-to-all liquidity increases and a record 38% of our credit volume was executed through Open Trading. This has been a key driver of our estimated market share gains and a source of valuable price improvement for our clients. For the full year 2022, an astonishing 1,300 client firms provided liquidity on the MarketAxess platform. In summary, the foundation of our business has never been better with accelerating growth in trading volume, new market share records, increasing momentum in new product areas, and a substantial addressable market opportunity. With this strong financial performance as backdrop, earlier this month we announced that Chris Concannon, a proven leader, deeply experienced in electronic markets will assume the CEO role in April and I will take on the new role of Executive Chairman. I would like to congratulate Chris on the promotion as CEO. It is well deserved and given his strengths in automation, e-trading protocols, data, product delivery, and ETFs, Chris is the right person to lead the company. And now is the right time to make this transition because we have never been in a better position. I am excited about my new role as Executive Chairman where I will continue to work with Chris and our Board of Directors on long-term strategy, key client relationships, regulatory affairs, and investor communications. We will continue to invest actively in our business by developing new trading and data capabilities, adding new product areas, and expanding internationally. We believe we have an outstanding opportunity set for the next decade and beyond, and many reasons to believe the fixed income market environment will be favorable for e-trading and data revenue growth. Slide 5 provides an update on market conditions and U.S. credit. In 2022, the Fed raised the Fed funds rate a total of 425 basis points, making it the fastest rate hike cycle since 1980 to 1981. This shock to the fixed income markets, especially with the initial moves in the first half of the year, drove an unprecedented 14% decline in investment grade indices for the year, the largest negative return I have seen in my career. Along with these price declines duration declined approximately 20% from year end 2021 levels to the lows in October, directly impacting high-grade fee capture for institutional client e-trading activity. With some measures of inflation and economic growth trending down, interest rates have moved lower in the recent months increasing bond index duration about 6% from the lows in October. Higher bond yields around the world compared to one year ago create a better fixed income investing environment. We are already seeing the benefits of that with TRACE investment grade bond volumes up 23% in Q4 versus one year ago. Investment grade TRACE ticket count in Q4 grew a remarkable 93% as investors reenter the market and use trading automation to find liquidity. TRACE average trade size is down 38% year-over-year, another trend that is favorable for market MarketAxess. Smaller tickets require greater trading automation and at the margin add to high-grade fee capture. I expect market volumes in high-yield emerging markets in Eurobonds to improve this year as well. We remain optimistic on growth in trading velocity due to the improved fixed income investing environment, increase in trading automation and growth in market participation due to all-to-all trading opportunities. Slide 6 shows the strong multi-year gains in estimated market share from the pre-pandemic period in 2019. This is the third consecutive quarter of top quartile market share gains for the company. In Q4 2022, all but one of our primary products were in the top quartile of historical data for year-over-year quarterly growth versus the past 10 years. Strong market share gains across our global product set combined with improving market volume and bond duration trends positioned the company well for revenue growth in 2023. Thank you, Rick, and thank you for the kind remarks. The last several years have been an incredible experience leveraging your deep fixed income market knowledge and working with you as a trusted partner and executive. The track record that you have established is unparalleled and I am deeply grateful to you and the Board for having their confidence to pass the CEO reins to me for the next phase of the growth trajectory for MarketAxess. This is truly an honor, so thank you for all your support and I'm looking forward to working with our clients, with you and with the Board on our many strategic initiatives that we will continue to unlock shareholder value for years to come. The team that we have assembled here is world-class and we are well positioned to capitalize on the growth opportunities ahead. Slide 8 illustrates some of those tremendous growth opportunities. As we begin 2020, the strength of our franchise in terms of product and geographic breadth has never been stronger. Our leadership in global credit is expanding reflected in the strong market share gains that we achieved over the last several quarters. These gains only serve to reinforce the sizable revenue opportunity that we have ahead of us. We believe the product opportunities that we have are further enhanced by the current market conditions. Higher yields typically lead to higher velocity of trading, which will increase the demand for electronic trading solutions. January month-to-date has seen strong new issue activity, which reduces market share in the short-term, but increases outstanding debt. Our total credit ADV month-to-date is showing solid double digit growth year-over-year and sequentially. Slide 9 provides an update on Open Trading. The diversity of our liquidity pool has made a significant difference in the quality of execution for our clients. We delivered price improvement of $945 million in Open Trading for the full year, well in excess of our annual revenue of $718 million. We believe that the price improvement opportunity we deliver to clients provides us with additional flexibility to fine tune our pricing over time, particularly when we are delivering such high levels of execution quality to the client transactions. Open Trading is able to deliver these levels of price improvement because it increases market participation by bringing a multitude of investment banks, systematic and alternative funds, ETF market makers and institutional investor clients into one unique pool of liquidity. This unique liquidity pool is good for market participants and more recently regulators have become more focused on these types of protocols that support liquidity and market resiliency. This is a particular focus in the rate space where we believe our all-to-all solution in and U.S. treasuries is very well positioned with a record 244 active client firms now on the treasury platform up from 192 in the prior year. Slide 10 highlights the increasing momentum we are seeing with automation and credit trading. Automation tools are critical to solving for the pain points facing our clients. Clients are facing increasing cost constraints and need to find more efficient workflow solutions. Our automation suite of tools will be critical to helping our clients solve for these cost pressures while delivering high quality execution. Automated trading increased to a record $62 billion in volume and a record 383,000 no-touch trades reflecting continued strong adoption. Today, Auto-X represents 20% of total trade count and 8% of our credit trading volume. We also saw increased adoption of our Auto-X Responder solution during the fourth quarter. Additionally, the use of dealer algorithms continues to grow across our platform. Clients are increasingly facing higher ticket counts and smaller trade sizes while trying to manage their technology costs. Our automation tools are increasingly in demand to help address these growing challenges. Lastly, in the first half of this year, we will have an initial launch of our Adaptive Auto-X solution, which will provide algorithmic workflows for clients to systematically access broader liquidity across multiple trading protocols. This new service is expected to unlock additional cost savings for clients while simplifying client workflow. Slide 11 illustrates the growth we are continuing to drive in portfolio trading. The fourth quarter was another record for portfolio trading with total volume of $31 billion up 135% year-over-year. Estimated high-grade and high-yield portfolio trading market volumes have remained relatively flat at around 5% to 6% of secondary TRACE volume over the last several quarters. We believe approximately 65% to 70% of our portfolio trading activity is currently using electronic trading venues. And based on that, we estimate that we had an estimated 31% share of the electronic portfolio trading market, up from 17% in the prior year. Thank you, Chris. On Slide 13, we provide a summary of our quarterly financials. For the quarter, we delivered revenue of $178 million up 8%, which was our best fourth quarter ever driven by record market share gains across most products. Excluding the impact of FX, revenue would have increased approximately 10%. These strong results include the negative impact of a 9% decline in total credit fee capture, driven principally by the lower duration of U.S. high-grade bonds traded over the platform. Record information services revenue was up 9% or 17% excluding the impact of FX. The full year effect of the contract signed in the fourth quarter is a positive driver as we move into 2023. Fourth quarter post-trade revenue included the negative impact of approximately $1.1 million on the strengthening U.S. dollar compared to the prior year quarter. Excluding the impact of FX, the year-over-year growth rate would have been approximately 8%. The increase in [indiscernible] was principally due to a higher interest income of $3.2 million driven by higher rates. The effective tax rate was 25.4%, slightly below the prior year period, which included the negative impact of return to provision adjustments. On Slide 14, we provide more detail on our commission revenue and fee capture. Total commission revenue increased 9%. Our growth in total credit commission revenue was driven by record increases in estimated market share and healthy increases in our trading volume, but was partially offset by lower fee capture across U.S. high-grade. The lower high grade fee capture was driven principally by higher bond yields and slightly lower years to maturity of bonds traded on the platform. All-in-all assuming the same level of trading volume, we estimate that the change in U.S. high-grade duration lowered our fourth quarter commission revenue by approximately $10 million. While the U.S. high-grade fee capture declined year-over-year and was down slightly from 3Q 2022 levels, duration did move higher intra-quarter as reflected in the Corporate Bond Index duration, which is well below those set in October, 2022. On Slide 15, we provide you with our expense detail. Fourth quarter expenses increased 8%, driven principally by invest investments to enhance the trading system and our data product offering. Excluding the impact of FX, expenses would have increased 12%. Employee compensation and benefits increased $3 million on an increase in headcount, mainly in technology and customer facing roles to support revenue growth initiatives. The increase in clearing fees was due to the strong increase in credit open trading volume. On Slide 16, we provide an update on cash flow and capital management. As of December 31, our cash and investments were $515 million and we had no outstanding debt. Our trailing 12-month free cash flow came in at $261 million. During the year, we paid out $106 million in quarterly dividends to our shareholders and for 2022 we repurchased 280,000 shares for a total of $88 million, $100 million remains on the outstanding repurchase authorization. Our Board of Directors declared a regular quarterly cash dividend of $0.72, which was based on the financial performance of the company. On Slide 17, we have our 2023 guidance for expenses, the effective tax rate, and CapEx. We expect that total 2023 expenses will be in a range of $418 million to $446 million. Approximately 65% of the increase is due to our continued investments in trading system and personnel to support our product and geographical expansion. We expect that the effective tax rate for full year 2023 will be in the range of 25% to 26% and 2023 CapEx is expected to range from $52 million to $58 million of which the majority relates to capitalized software development costs, resulting from the investments we are making in new protocols and trading platform enhancements. Our full year expense and CapEx guidance is based on foreign currency exchange rates as of December 31, 2022. Thank you, Chris. In summary, we continue to execute very well against our growth strategy. We delivered record levels of market share and enhanced our competitive position in the institutional client e-trading space, both in the U.S. and on the international front. Our global footprint continues to broaden and deepen as we diversify our product offering and achieve record growth in active clients. The market is increasingly turning to our unique Open Trading solution for liquidity and significant price improvement. Market volumes have improved and we are currently seeing positive trends in fee capture and FX. And lastly, the improved macro backdrop for fixed income markets is creating a very attractive operating environment for MarketAxess in 2023. Yes. Good morning Rick and Chris and Chris. First Rick, congratulations on the transition to the Chairman role. It's very well deserved and we thank you very much for mentoring that proven leader in the new asset class, Mr. Concannon. But no, true, you stuck with it and congrats Rick. So you're very bullish on the outlook for volumes. You know U.S. high-grade I think is already standing at a record level in January and appears that the stars are lining up. I guess my question, Rick, is there anything that we should be, like, how can this get derailed the outlook on volumes? Because we've seen it happen in commodity volumes when you -- people expected energy, oil, but financial products generally have performed as expected I guess, but is there anything that you're watching that could potentially be unexpected and impact volumes? You know what, not probably, but of course it's a full year ahead and markets are full of surprises. I will say it's encouraging to see that the mutual fund outflows that took place most of 2022 have started to turn into inflows, which is opening up the new issue calendar for the high-grade market as we start the year. And who knows that the expectation right now is that we could have a soft landing and the inflation numbers will continue to come down, but nothing is certain and there is the possibility that we get a negative surprise on inflation and the Fed has to continue to move rates higher in the near-term, but that's not the expectation right now. And I will say, while the high-grade market is wide open, we are still not seeing anywhere near normal levels of activity in markets like high-yield and emerging markets in even euros. So it's a good sign that high-grade is leading the way and we're having robust levels of new issue activity this month. But what I would expect to happen is this improving environment will work its way into the high-yield in emerging markets as well. And EM in particular volumes were greatly depressed in 2022 with some of the market challenges and FX challenges throughout the course of last year. So there's a huge opportunity there that is the market environment does continue to improve and we have China reopening that EM market volumes may follow the path of high-grade and improved. They have not done that yet, but that would be something to watch, I think, in the quarters ahead. Got it. Got it. And I was just looking at the, this is for Chris Gerosa, the cash, excuse me, the cash levels seem like they went up substantially like over $150 million quarter-to-quarter cash and cash equivalents. Any explanation or color behind that? Yes, Rich, it's a seasonality effect with our clearing operations. We have to put capital into DTC to support our failed activity. So at the end of September, you have elevated fails, which takes on some of the cash and the seasonality impact as you get into December, there's less trading volume lower fails, which reduces in more cash on the balance sheet that we don't have to hold at DTC. Got it. Got it. And, one last thing, Rick, the seasonality here usually, and you mentioned the higher new issuance, so just so I guess we can, I don't know what is braced, but people won't be, I guess is it fair to expect that the market share numbers in January are likely to come down? They seasonally seem like they do that all the time because low issue -- our issuance is low in December, then higher in January, so that they had to assume that market share is likely to come down, do that, that seasonal effect? That is the norm. That is, you're exactly right, Rich. That is the normal month-to-month seasonal pattern because new issue is at the lowest level in December and often the highest in January. But we're taking a holistic view of our credit market opportunity and the guidance that Chris gave in credit ADV month-to-date in January puts us at or around record credit ADV levels. So we see robust trading activity when we look more broadly across all products that we're involved in, in credit. I wanted to followup a little bit on the high-grade side. One of the -- basically the one pushback we're getting on the stock now is just that the market share of high-grade has been pretty static if you kind of look at it over the last three years, right around 20%, 22%. I was wondering if you could provide any color there, particularly in the context of recent quarters you see in the average trade size coming down, which should be helpful for your market share of high-grade. I'm just wondering if there's any dealer activity in terms of balancing share on high-grade versus high-yield where you're seeing good gains there, or there's some other factors apply? Yes, Chris, I'm happy to take that one. And I think the way to think about high-grade is, we are seeing record levels of activity even in the fourth quarter in our Open Trading all-to-all solution. So we are seeing gains in terms of Open Trading hit 33% of our total volume in Q4, so we are seeing gains there. We are also seeing gains in our portfolio trading solution in high-grade. We had record volume in PT in high-grade of $17 billion up close to over 90%. So we're making gains. Obviously direct dealer RFQ has been running flat for us. We also made gains in our dealer RFQ, sorry, was up 23%. But when I look at high-grade and high-yield full U.S. corporate credit, the overall activity from our clients is still positive and you're obviously seeing those big gains in high-yield. But again the high-yield gains are driven by our Open Trading volume which ADV grew by 43% in the Q4. So, overall credit activity on the platform is showing signs of substantial growth, particularly driven by Open Trading. Got it. And then just wanted to ask, I mean, obviously the environment looks like it's trending positively in a number of different areas and I agree with Rick in terms of the opportunity to get better. But when I think about things under your control, just automation tools have been a key focus for you. Where are we at in the rollout of products and capabilities around automation tools and the new things on the horizon and commerce are more just blocking and tackling around existing products and where are you from the customer penetration, particularly in the buy side there? Sure. Automation continues to be a driver of activity on the platform. It had nothing but records across the Board in Q4, record volume of $62 billion in our Auto-X solution and then overall trades on the platform was automation accounted for 20% of total trades on our platform. So we -- not only did we see heightened growth in Q4, but overall the year of 2022 sort of record volumes of total of $220 billion in automated volumes. As we look forward in 2023, we continue to hear from our largest clients around their cost controls that they are facing, particularly given the AUM performance of 2022. So they are facing bigger and bigger tech challenges and looking to us to help outsource some of those challenges in workflow solutions like our automation tools. As I mentioned in our open remarks, we are launching in the first half of this year what we're calling Adaptive Auto-X, which is a true client algorithm which adapts to market conditions as it trades. So it's a unique solution that's being rolled out for the first time in credit trading in the U.S. Just a couple of comments to add to Chris's points is that, quantitative easing caused significant changes in client asset allocation over the last three or four years, and the net result was underweight fixed income because of the zero interest rate policies around the world that has now changed. So I think what you're seeing is the very beginning stages of people starting to reallocate into fixed income, and you see it with the mutual fund inflows kicking off the year, the retail numbers are way up, the ETF assets are growing and a lot of this is driving small tickets. Some of that retail money is coming into SMA accounts, some of it into ETFs, but all of it with just this massive growth in tickets. So it's not an option to automate, it's a requirement. And I think we're going to continue to invest in tools to help our clients with that. And I would expect a very robust year of automation growth this year. On the institutional side, the other thing I would add, Chris, is that we are still seeing as a result of the massive amount of trading opportunity that's now in our Open Trading order books significant increases in market participants, both in market makers as well as systematic credit funds. So all of this points to the fact that fixed income is a better investing and trading environment now than it was for years due to quantitative easing and that's one of the reasons that we're excited about 2023. Hi, good morning. Chris Concannon, yes. You mentioned a comment about flexibility to fine tune your pricing over time in relation to Open Trading, right now where you're adding the most value to clients. I guess, how much room do you think there might be to fine tune that pricing over time and how do you kind of balance potentially making pricing changes with maintaining pricing and trying to incentivize as much flow as possible to move in that direction? Well, first of all, we're very careful about how we adjust pricing historically and over time. We do want to continue to deliver that high value execution quality that you see in Open Trading. The value of open trading gets sizable across product. We saw the value being delivered in high-yield in particular, which increased the demand for our high-yield Open Trading offering given the growth rates in high-yield and OT of over 40% and the overall growth rate of our high-yield offering. I would say we're very careful about fine tuning pricing, particularly around OT, but we're confident in the flexibility that we have given the sizable savings that we talked about in the opening remarks. We have not announced any pricing plans for 2023. We're quite comfortable with the current dynamic of our capture rate, because as behaviors change, and we saw that the behaviors changed obviously in 2022 to our detriment and capture in high-grade, but as those behaviors change in 2023 we're confident that the pricing opportunity that we have in 2023 is quite positive given the behavioral changes that we're already seeing. Okay. and just for a followup, just taking a step back, if we were going to kind of rewind maybe five years ago and think about the opportunity that you had in high-grade and high-yield from a market share standpoint, I don't think anyone would have guessed that you would have effectively had the same market share in both as we sit here today. So I guess the first part of the question is, just given the different liquidity dynamics in these two markets, do you still think that high-grade total electronic share will ultimately settle at a higher level than high-yield over the long-term? And, just to follow up on Chris Allen's earlier question, is there some level of market share where it just gets harder for a single player to gain incremental share? Is that playing into anything that's happening in high-grade at all, because obviously the high-yield dynamics seem much different right now with the momentum there? So first on electronic share and electronic adoption across the fixed income market, I do see that over, we will see differences in adoption across the various products that we offer. So obviously investment grade has seen the highest adoption of electronic trading, high-yield is growing rapidly, particularly on our platform. If you look at emerging markets, the opportunity is one of the largest opportunities globally. But we're seeing higher adoption rates there, particularly in 2022, where we have record shares, record share in both TRACE and global EM market share, estimated market share. I think munis is probably one of the most interesting product for electronic market share is probably in the most need of electronic adoption, particularly given the size of the average ticket in munis and we've seen -- we had a record year of adoption in munis, both record market share and record ADV. I would say that we look at it holistically across the entire fixed income landscape, not just one product. Our clients don't trade just high-grade. They trade across the entire fixed income landscape. So when they -- we think about electronic adoption, it certainly can achieve in my view, the 90% rate that we see in other asset classes, because at one point in the electronic adoption evolution you get to a point where you have to go all the way, not just part of the way, and your workflows become fully automated and fully electronic. So I predict very much higher levels of electronic adoption across high-grade, high-yield, emerging markets, and in particular munis and obviously we think we will play a key role in that. When our clients are outsourcing trading solutions, they're not studying market share by product like we all do. They're studying that solution and the quality of execution that's being delivered on the other side. Hopefully that answers your question. Just one, add on too, Kyle. I think with high-yield in particular, the liquidity challenges in the U.S. credit markets were most pronounced in high-yield and that plays right to our favor. And what I think it's showing you is that when liquidity is challenging, Open Trading is significantly differentiated from any other way of conducting trades in the high-yield market or elsewhere. And anecdotally, you'll hear stories of challenges in inventory, in the leverage loan market, in the high-yield market that creates constraints around balance sheet for secondary trading and the high-yield market, I just think is another data point that shows that we have a unique solution for liquidity through Open Trading that people are not able to find elsewhere. And I think that just positions us great for market share gains for many years to come because of the investments that we have made there. Good morning, Rick, Chris, and Chris. I had a quick question on RFQ-hub. Can you provide us an update on the build out of that platform and how we should think about incremental future volume contributions from the ETF channel? Sure, happy to take that one. So RFQ-hub, just a reminder, it is owned and operated by Virtu and I don't want to jump ahead of their earnings call on activity levels for RFQ-hub. We are excited about what we've seen thus far from RFQ-hub and our investment in RFQ-hub and the year that it had in 2022 just in terms of client activity, client engagement, and the work we've been doing with the partners in RFQ-hub, both our dealer partners and obviously BlackRock as a key partner as well. We do think the demand for fixed income ETFs by our institutional clients is climbing. It's a wonderful vehicle for dealing with capital flows to get exposure to the overall credit market quickly and through a liquid instrument. So we're seeing heightened levels and heightened demand from our client base on fixed income ETFs and expect that to continue, particularly given the activities in 2023 and the attractiveness of the fixed income market as an investment vehicle going forward. So we're very happy about the overall opportunity that the ETF market provides us through our investment in RFQ-hub. Thank you. And just as a follow up question, I wanted to circle back to the commentary around fee per million. You've said that in the deck it's up Corporate Bond Index duration is up 6% from the lows of October. Have you seen that trend kind of continue into January with some of the new issuance changes in the marketplace and some of the trading dynamics changing? Hey everybody, good morning and thanks for taking the question. I had a bit of a market structure question for you guys. So as you look at the accelerating shift from active bond mutual funds into ETFs which again continues to accelerate here, even year-to-date, I think over 70% flows into fixed income are going ETFs. How do you think that impacts turnover rates for the credit markets? And the reason why I ask is, naturally that creates secondary degree of liquidity in the kind of the ETF wrapper, but I wonder if that also impacts positively or negatively turnover in the underlying bonds, especially when the flows are so concentrated with the handful of players, particularly with BlackRock? Great question Alex and we obviously are well positioned as we think about inflows into the fixed income market, as you point out we're seeing inflows into the ETF fixed income market in particular. We're also seeing inflows into SMA products as well across the fixed income landscape. Both of those inflows, both ETFs and SMA products leave us well positioned for 2023 as we see continued attractiveness in the fixed income products as investment vehicles. In particular around ETF inflows it's a wonderful situation for us, given our position with ETF market makers. Some of the largest ETF market makers are very strong clients of MarketAxess and in particular play a major role in our Open Trading offering. So we feel like we're well positioned to take advantage of inflows into the fixed income ETF market. It also justifies our investment in RFQ-hub that we were talking earlier and the attractiveness of having an ETF execution solution as a part of our overall offering. But again, turning to the SMA opportunity, these are -- SMAs are growing. We saw growth in 2022, despite some of the challenges in the fixed income market and as we go into 2023, we'd expect the SMA account to grow as well. Those deliver very small tickets in terms of the workflow that comes through institutional clients and that heightens the demand for our automation solution. So we're excited about the overall market environment in fixed income as an investment vehicle and the growth in AUM back into fixed income are coming into those two main products, where we think we're well positioned. And Alex, I'll just add onto that too, is that while standalone the turnover of an ETF portfolio is likely to be lower than an actively managed portfolio, that's only really part of the story because the ETF share liquidity is adding to the overall liquidity of the fixed income market and giving dealers and investors another way to transfer risk quickly. So I view it as very positive for overall liquidity and activity because of that tool as a way to quickly transfer risk. And don't forget, there are a whole group of industry participants that are now actively trading the shares versus the underlying bonds, which is additive to velocity. So I think you have to take a holistic view as how that, how the growth in ETFs is adding to the fixed income ecosystem in order to get a valid outlook in terms of what it means for velocity. Yes, that will make sense. My second question was just a quick follow up, I think to the last question around the fee capture, right? So I think I heard you guys say that you continue to see positive trends in fee capture into January. Could you dissect that a bit between IG and the rest of the business? So in other words, like is this a function of a mix where maybe high-yield is quite active and that's what's driving your comments around positive fee capture, or you're actually starting to see an improvement in the underlying IG capture rate as well? Yes, no, I think it's the latter. It's really the high-grade fee capture is directly impacted by the market conditions. And when we talk about the developments were going back to October when Rick pointed out that the Corporate Bond Index duration was a low, and we've seen a strong recovery going through November and December. And I sized up the math of a year-over-year comparison. But when you look at the bond yield movement and years to maturity so far in January that we put on a chart relative to December, the high-grade fee capture was more or less at the same level. We saw the exit rate as of December. Thank you. Good morning. I wanted to followup on just the non-transactional revenue, just thinking about 2023 and what, as you think about info services and post-trade, what are the kind of good growth rates or appropriate growth rates to think about for the next 12 months or beyond? Yes, Dan great question. I'm glad you asked it, because we mentioned in our prepared remarks that some of the data contracts that we signed were towards the back end of Q4. And I mentioned in the last call that our target was to hit an FX adjusted growth rate of 10%. We fell just short of that, and a lot of that was due to the timing of when we signed those contracts. But the good news for the 2023 outlook, we think that the growth rates will be in the 10% to 12% range for information services on a constant currency basis and we hope to do better than that. And with respect to the post-trade, that continues to be a mid-single-digit growth rate. We're not expecting any significant upside, as you've seen in the past due to the acquisition of Reg Reporting Hub. And I'll just add, we'll continue to see demand for our CP+ products particularly across high-grade, high-yield and now EM where CP+ provides a level of transparency that is hard to achieve with any other product out there on the market. We're also excitingly rolling out CP+ for treasuries and my personal favorite CP+ for munis, a market that needs more real-time transparency and we're excited for those two products to be out in the market during 2023, so some exciting new products, where we're seeing a lot of the growth of our market data revenue in the suite of CP+ products. Great, that's helpful. And then just on the expense guidance in the context of what you guys are characterizing as certainly an improving environment from a revenue perspective. So the midpoint at 10% maybe dissect that a little bit in terms of where those incremental dollars are going and if we're going to, if revenues come in, maybe above what your base case is, is that just flow through to compensation or are there other areas where you would spend more if the environment is constructive from a revenue perspective? Yes. So operating expenses, we've always talked about the fixed variable mix being 16% to 17% variable and what contributes to variable expense? It's really three line items. It's our cash incentive bonus pool. We have some treasury licensing fees that are directly pegged to the treasury business, and we have our self-clearing line item. And I'm happy to say that we've employed a very disciplined approach with the challenging operating environment in 2022. We're continuing to manage that disciplined approach in 2023, and we've had some success with lowering some variable fees directly correlated to the clearing business. So I think as you see the Open Trading business grow, we're going to see operating leverage come through on that line item. So just to help size up the math, on 16% to 17% of that total operating expense base is variable with the balance being fixed. And to the question on which line items are that 10% being attributed to compensation is going to be the biggest uplift year-over-year, which is around, mid-teens growth rate then you have your T&E resuming to more normalized levels, which is about a mid-teens growth rate. On the page, we put directly what the depreciation and amortization is 10% of $40 million is $4 million. And in the balance stand across it is 1% to 2% across all the other line items on the income statement, with the exception of clearing that will be pegged to our growth in Open Trading. I hope it helps you dissect, where you need to allocate that $40 million across the income statement. Hey, good morning and thanks for taking the question. So I wanted to ask about the regulatory backdrop late last year SEC put out a bunch of market structure reforms largely geared towards the equity markets, but there were some aspects, I believe, including BestEx that do sort of rope in aspects of fixed income. So just curious your views on that, how that might impact the market in fixed income and the industry at large? And then just more broadly on the regulatory backdrop, what are some of the key regulations, proposals perhaps that are maybe on the horizon that you guys are tracking and that could be impactful for your business? I know in the past we've talked about all-to-all trading and rates as well as potential treasury clearing. Sure, thanks Michael. And I would say nothing meaningful in terms of what has come out from the SEC so far. I think I'm right in saying that a lot of the best execution revisions were focused on dealer obligations as fiduciary and agency trading. So not quite as relevant around the world of fixed income, but we do expect something much more material at some point during 2023, which is what I would view as long overdue revisions to the fixed income electronic trading and ATS rules, and something that I was directly involved in promoting and supporting as part of FIMSAC at the SEC when the industry participants were helping the commission think through that. So what I'm looking forward to is really a level playing field with standardized e-trading rules across the ATS community. The staff continues to do their work on that. So we're not exactly sure what the timing will be but, I would expect that those fixed income ATS rules will be out sometime during calendar year 2023. Great, thanks. And just a followup question, just curious, your latest thoughts on M&A here just given the rising cash balance, where that might be most additive to the platform and how you think about enhancing connectivity to clients including retail clients, now that fixed income and particular retail fixed income is becoming more in vogue. So we obviously look at the coming 2023 as an opportunity given the re-pricing of many financial assets a number of small companies. When we look at the marketplace, there is what I call scarcity of assets. So we're really talking about an M&A strategy that involves much smaller size bolt-on type of product offerings. The FinTech space has clearly been repriced. So there's an opportunity and there are a number of FinTech providers in the market that will start facing capital challenges in the year ahead. So with a very strong balance sheet, we feel well positioned to take advantage of a re-priced market with a number of FinTech players that may be in need of capital. So excited about what's ahead, but again, there's nothing material out there given the scarcity of assets that we look at. Great, thanks. Good morning, folks. Just why don't you to ask about execution quality and the price improvement that you're getting for your clients in particularly regards to portfolio trading versus some of your more, legacy protocols like list trading. I guess first of all, to what extent do you think the price improvement is better in some of the other protocols outside of portfolio trading and that will limit PTs share or is that not really an issue and the clients are more focused on getting the trade execution done? So it's a great question, Brian. I view portfolio trading as really a demand for liquidity and capital because these are very sizable trades that our clients are in need of, so they're demanding higher levels of capital commitment from our dealer partners. And so I do think that portfolio trading done in comp or in dealer competition, which is what our electronic solution offers our clients does result in a better execution quality across the full portfolio. We also rolled out analytics and will continue to roll out analytics that help our clients judge how portfolios are being priced relative to either an individual or a list trade, however you want to call it. So we think clients are being given all the proper tools to evaluate portfolio trading as a large block trade or as an individual or list trade, where they get the participation of additional market participants. So right now, portfolio trading, we see it, it has grown. It has grown over the last couple of years. We do see that growth rate flattening at some point depending on market dynamics. More importantly, what we're seeing in the first quarter is obviously smaller trade sizes. So the demand for more trading activity at smaller size is probably going to be a theme that we see in 2023, and that's where many of the other list trading and other alternative protocols that we offer come into demand. So while we do see strength in portfolio trading as inflows come in, many times our clients are using the portfolio trade as a way to get instant exposure, and they pay for that capital utilization from very large dealers. If I could just add, we're one, we're really pleased with the growth in PT we've seen on MarketAxess and the ability to give clients their choice depending on the, the risk that they're trying to move. I will say, and we previewed this a year ago that as volatility has picked up, don't forget the dealer side, it's become much more difficult to manage the risk of large portfolios from the dealer side and I think there have been two outcomes of that in 2022. One is that the growth rate of portfolio trading volume has slowed dramatically. And if you look at the last 12 months, it's been right around 5.5% of secondary TRACE volume over the last year. And it's been even slower than that in high yield, where the liquidity challenges are more severe. So the growth rates of PT volume are down, but also, we see greater concentration in terms of the dealers that are printing portfolio traits than we did a year ago. And I think that's just it, the level of sophistication that's required to manage that risk is way up because of volatility. So all those factors weigh in terms of the quality of the pricing that comes through in PT, and as a result of client behavior on where they think they're going to get best execution. That's very interesting. Thanks for that color. And then just one follow up on the ETF substitution, a number of questions were asked on that. Obviously definitely improves velocity, but how do you think about the nature of the client base that's using that in terms of, I guess, revenue capture? So the punch line of the question is, does the greater velocity more than offset any diminution of revenue capture or is the revenue capture pretty similar to your overall fixed income trading in investment grid? Well, I'll start by thinking about the velocity first. I mean when you think about ETF activities on the equity markets, fixed income ETF activities on the equity markets, there is a direct correlation to activity in open trading, but across the overall fixed income market. And so, as you mentioned, velocity does increase with the level of inflows into fixed income ETFs. The other important point is, and it goes back to the levels of electronic trading in the fixed income market, as ETFs become a dominant product of choice by investors, the demand for electronic trading goes up because those ETF market makers need to hedge in an electronic capacity. They are executing electronically in the equity market, the transfer of that risk is best done in electronic form in the fixed income or the underlying market. So we do see a very strong connection between velocity and ETFs and velocity in electronic trading in the fixed income market. We also see a number of new participants in the ETF market that are leveraging our open trading solution from systematic hedge funds, alternative hedge funds, and the ETF market makers see huge benefits of leveraging a broader network in the fixed income market, a broader network than they are they typically have access to. So again, Open Trading is certainly a wonderful tool for the average ETF market maker and any systematic hedge fund that's using ETFs as an investment vehicle.
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EarningCall_1294
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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 Organigram Holdings First Quarter 2023 Earnings Conference Call. [Operator Instructions] Thank you. Craig MacPhail, you may begin your conference. Good morning, and thank you for joining us today. As a reminder, this conference call is being recorded, and a replay will be available on our Organigram website. Listeners should be aware that today's call will include estimates and other forward-looking information, which the Company's actual results could differ. Please review the cautionary language in today's press release on various factors, assumptions and risks that could cause our actual results to differ. Further, references will be made to certain non-IFRS measures during this call, including adjusted EBITDA and adjusted gross margin. These measures do not have any standardized meaning under IFRS. Our approach to calculating these measures may differ from other issuers, so these measures may not be directly comparable. Please see today's earnings report for more information about these measures. Listeners should also be aware that the Company relies on reputable third-party providers when making certain statements relating to market share data. Unless otherwise indicated, all references to market data are sourced from high-fire data as of November 30, 2022, pulled on December 21, 2022. Thank you, and good morning, everyone. With me is Derrick West, our Chief Financial Officer. For today's call, we'll discuss the results for the three months ended November 30, 2022, and a general business update. We will then open the call for questions. The first quarter of fiscal 2023 reflected the results of our efforts in fiscal 2022 to enhance scale and efficiency through facility expansion and productivity improvements. These initiatives have had a positive direct impact on our bottom line. In the quarter as well as a 43% year-over-year increase in net revenue, we delivered our fourth consecutive quarter of positive adjusted EBITDA, positive net income and record adjusted gross margin. In Q1, we maintained our number three position among Canadian LPs. We were number two in the flower segment, number three in gummies and hash and again held the number one market position in capsules. SHRED remains a solid and well-recognized brand, embraced by cannabis consumers and we continue to hold the number one position in milled flower by a wide margin. We expect our focus on product innovation, brand revitalization, strong sales execution and advanced plant science will enable us to continue to gain share. Looking at provincial board data. We have leading market share in the maritime and we're number one in flowered gummies and hash. In Ontario, we have the top three selling SKUs. We were number three in gummies, number two in hash and whole flower and number one in milled flower and capsules. In Quebec, our sales have nearly tripled compared to Q1 of fiscal 2022. This is partly from the addition of products from the Laurentian acquisition, but also due to significant increased sales of our overall portfolio. Based on data from Weak Crawler, we had the number one hash SKU, we're number one in milled flower, and SHRED was the third largest brand in the province. This national market strength comes from our focus on creating products that excite consumers. In Q1, we introduced 17 new SKUs, including infused pre-rolls, such as Edison Grape Crescendo and Tremblant Sweet Cherry. In November, we launched Holy Mountain, a new brand in English Canada and Wo La in Quebec. These brands offer unique strengths such as R*NTZ and MAC-1 and 3.5 gram format and pressed hash. They provide us a position in the small pack size value segment that isn't covered by our successful Big Bag O'Buds. In terms of production, with the 4C expansion completed at Moncton in Q4 of fiscal '22, we achieved scale benefits from a record harvest in Q1. After the expansion, Moncton has an annual capacity of 85,000 kilograms, but this will increase as we continue to refine our cultivation technology. This includes LED lighting implemented in fiscal 2022 and fractional watering, which is now in place in all grow rooms. In the quarter, we achieved a yield of 168 grams per plant, a 30% increase over 129 grams in Q1 of fiscal '22. As a consequence of a larger capacity and improved yields, the Company has significantly reduced its cost of cultivation, the lowest cost in our history. In Winnipeg, we have increased our output for gummies in kilograms by 35% from Q4 '22 to Q1 of '23. This was driven by the increase of Monjour units in response to high consumer demand. We continue to have great productivity on our packaging line with 35,000 to 40,000 pouches per day production. At Lac-Superieur, construction is substantially complete. We expect to begin to move into the new building in February, which will help support the launch of several new exciting hash SKUs. The greenhouse expansion is expected to come online in May. This will take us towards expanding the facility's annual capacity to 2,400 kilograms of craft flower and over 2 million packaged units of hash. As well as expanding and increasing automation at Lac-Superieur, we are adding staff to the packaging chip to increase production. Another initiative completed in Q1 was transitioning our medical cannabis business from direct patient fulfillment to having orders completed through medical cannabis by Shoppers Drug Mart. This provides a proven and trusted platform for our patients. We remain committed to our medical cannabis business, ending Q1 have added 26 SKUs to the Shoppers channel. Our center of excellence is now active and focused across various cannabinoids to develop and launch new product technologies. One area of activity is supporting discovery and development efforts on novel vapor ingredients and substrates. This research also creates an industry-leading vapor data set that will serve as a foundation for future development activities, including consumer safety, product quality and performance. The state-of-the-art Biolab facility has been operational since June. The focus is on developing genetic toolboxes to aid the research of key cannabis traits and accelerate R&D activities. This has already supported several plant science discoveries that will benefit our current plant portfolio and long-term growth strategies. So overall, this foundation of increased capacity, high-quality, efficient production and innovation serves us well in addressing markets in Canada and internationally. In Q1, we delivered $5.9 million of dry flower to Israel and Australia. This is a 71% increase over $3.4 million in Q1 of fiscal 2022. On November 17, we signed a new agreement with Canndoc in Israel. This agreement over a three-year term supply allows for the shipment of 10,000 kilograms of dried flower with an option for Canndoc to order an additional 10,000 kilograms. This is a great long-term partnership with Canndoc. The products sold in Israel is dual-branded with Organigram and is identified as indoor growth Canadian flower, which is recognized as premium product by Israeli consumers. We also expect to make further shipments to Australia in fiscal 2023 and are looking at other international opportunities. I will now turn it over to Derrick to present the financial review, and then I will return with some closing comments. Thanks, Beena. As Beena mentioned, in the first quarter of fiscal '23, we benefited from the increased efficiency and scale we created in fiscal '22. Gross revenue grew 37% from Q1 '23 to $60.9 million, and net revenue grew 43% from the same period in fiscal '22 to $43.3 million. These revenue increases were primarily due to higher recreational net revenue, which grew 43% from Q1 of fiscal '22. The cost of sales in Q1 fiscal '23 were $32 million compared to $28 million in Q1 '22, an increase of 13%. The low increase in cost of sales relative to the increase in revenues was due to the lower cost of production that was achieved through higher output from expansion and improved yields. We harvested approximately 22,000 kilos of flower during Q1 '23 compared to about 12,000 kilos in the same prior year period, an increase of 92%. In Q1, the harvest benefited from the increased annual capacity at the Moncton growing facility to 85,000 kilos. We expect to see similar harvest levels in '23, which positions us well to meet our Canadian and international sales demand. On an adjusted basis, gross margin was $12.8 million or 30% of net revenue over the $5.5 million or 18% in Q1 of '22. The significant improvement in adjusted gross margin was primarily due to the higher overall sales volumes, combined with a lower cost of production. SG&A, excluding non-cash share-based compensation, increased to $15.7 million in Q1 '23 from $12.6 million in Q1 '22, while our total spend increased as a percentage of net revenue, SG&A expenses decreased to 36% from 42% in the previous year's quarter. The increase over the prior period was primarily due to the increased employee headcount related to the acquisitions of the Winnipeg and Lac-Superieur facilities, increased professional fees, ERP implementation costs and non-cash amortization of the intangible assets acquired from the acquisitions. In the quarter, we achieved positive adjusted EBITDA of $5.6 million compared to negative $1.9 million in Q1 '22. The primary drivers of this significant improvement in profitability were the higher volume of products sold and the lower unit per unit cost of production, which resulted in a large increase to gross margins. Q1 '23 was our fourth consecutive quarter of positive adjusted EBITDA, based on our outlook for revenue, including international sales and improved efficiencies primarily achieved through scale, we expect this trend to continue. In the quarter, we had net income of $5.3 million compared to a net loss of $1.3 million in Q1 fiscal '22. The transition to positive net income is primarily due to higher gross margins along with a fair value gain in biological assets that occurred as a result of a large number of plants now growing in the multi-facility as a consequence of the 4C expansion. From state in a cash flows perspective, there was cash provided from operations of $3.5 million compared to cash used of $9.3 million in Q1 '22. This improvement was primarily driven by the quarter's positive adjusted EBITDA and a decrease to accounts receivable. Cash used in investment activities in Q1 '23 was $1.7 million compared to cash generated of $54 million in the prior year's comparison period. In Q1 '23, the cash use reflects a net redemption of short-term investments of $5 million, offset by the purchase of property, plant and equipment of $8.4 million. Note that cash generated in Q1 '22 includes proceeds of $60 million from the redemption of short-term investments. In terms of our balance sheet, on November 30, 2022, we had $95 million in cash and short-term investments compared to $99 million at the end of fiscal '22. The small decrease is primarily a result of capital expenditures of $8.4 million, partially offset by the cash provided from operating activities. With Organigram generating positive adjusted EBITDA and the expected completion of the planned CapEx spend during fiscal '23, we expect to generate positive free cash flow by the end of calendar 2023. Thanks, Derrick. Before we open the call to questions, I would like to reiterate that our success in the first quarter of fiscal 2023 resulted from the strategic investments we made in our business in fiscal 2022 that helped improve our margin and enabled us to compete profitably in today's competitive industry. This disciplined approach will continue and will help drive solid progress throughout the rest of the year. Thank you for joining us today. Congrats on the great quarter here. I wanted to talk a little bit about gross margin, please. I think Q1 was the first quarter where you benefited from the expanded production in Moncton, as you mentioned, we saw some great gross margin expansion. And then in the outlook section, you mentioned that it could potentially stabilize from these levels in the rest of fiscal '23. Please correct me if I'm wrong in interpreting that. But assuming that's what your press release indicates, could you talk about what kind of expectations you have for price compression that could offset your yield improvements and scale benefits that you expect to see in the rest of fiscal '23? Maybe you could -- to the extent that you can dive down into your assumptions, price compression on the types of products? And is this primarily on your domestic business here in Canada? Or do you see the potential for price compression on your international sales? Yes. Thanks, Andrew. I think that we're seeing price compression now in the Canadian rec market, particularly around flower. And when we factor that in, notwithstanding, we do believe that we can continue to decrease our cost of production as a consequence of just the continued flow through of the higher yields and in terms of our cost of cultivation that will help our flower margins and as well with the [Indiscernible] CapEx spends around automation, et cetera and the extra margin we should be able to get from Lac-Superieur based on having an improved cost structure there post expansion. I think that while we have room for all things being equal, we have room to improve the gross margin rate in the Canadian rec business, if everything remained equal. But as noted, we do see price compression that could be such that it is equal and offsetting. We're hopeful that it will not be fully equal and offsetting. But in light of that, we do believe that we can achieve the current gross margin rate that we have now being the 30% as we move forward. And if the price compression is not meaningful as we look at this, then we have room to increase the rate. And of course, as we continue to grow, which we would expect, knowing the innovation that we continue to do as sales move up will be more gross margin dollars, But the guidance we've given is specific to the rate of 30%, which we haven't historically provided, but we are comfortable that this is the new normal for us in the climate of the current market and again, with an offset for some price compression. Appreciate that fulsome answer. And if I could switch gears a little bit and talk a little bit about the balance sheet inventories, biological assets. Seeing that you did increase it this quarter, which I think you previously guided to and in line with the production expansion, could you talk a little bit about your internal planning and what you're comfortable with in terms of the level of biological assets and inventory in any way that you're comfortable with talking about a turnover absolute dollars or anything like that? And when do you think that inventory of biological asset could be a source of cash going forward? Yes. I think on the bio asset, it's the increase that we had from the last quarter and also the gain that was on the income statement as we measure the fair value growth of those assets. It was a fairly significant percent increase in the quarter to take it up to approximately $21 million now. We are planting in all our available grow rooms now in the Moncton facility. There will be small fluctuations by quarter. But without another expansion or an acquisition of other facility, this is roughly where the bio assets should reach, give or take a few million dollars. So I think that's a fairly stabilized number. For inventories, we did see an increase as well. But I think in prior calls, Beena has mentioned a few times that we had demand that essentially outstripped our current production. And so as soon as we have the available flower ready, it was shipped out. So we were probably running fairly lean to lean on our inventory level. So we are trying to build in a small reserve there, of flower to ensure that we can meet all sales orders as they come and then to maximize sales and profitability. So I think that inventories are more up to move slightly north from their current number. But again, I think that some of the increases in inventories are now baked into our balance sheet, but I would expect the inventories to move slightly more than what bio assets would as we look forward. Nice to see that the EBITDA improvement there. So quick question for me that I had just around the price compression and market share, specifically more so for Canada, can you just give us a reminder in terms of how you think going forward in terms of how you look to balance profitability of the SKUs you're putting out against share? Obviously, it's been a big momentum in terms of the gross margins that you guys have seen. Shares where you guys were out performer. It seems like they might have softened a bit in the past two months, but would love to get a reminder in terms of your outlook on how you're looking at profit versus share? I know it's a little bit of both, but during sometimes, you might [Indiscernible] more on one versus the other. Thank you. Right. No problem, Aaron. So let me start by saying that it is important for us to continue to see revenue growth, but it's profitable growth, right? And that's important to us. So we are cautious. And I've said many times on these calls that we don't have a problem competing in the value segment because that's where most of the -- that's where the consumers are. However, it is not our desire to lead the race to the bottom. We had a little bit of softness at the end of this quarter on our large format 28-gram flower as a result of some additive activity coming into the Ontario market at the price floor. We did not match that, but we have made adjustments to our pricing in order to ensure we remain competitive. And in the latest four weeks, have seen already a rebound to some of that softness that resulted as a result of that price compression. So further to what Derrick said earlier, we do have price compression. There is a lot of flower out in the marketplace today, more supply across all the other competitors and us than there is demand. We have heard from other competitors, they're looking at moving production capacity to grow [tomato](ph). This is the reality of the market, which is what our projecting some price compression, especially in the large-format products. And as a result, we adjusted our pricing. That being said, we adjusted it to the point where we're comfortable with the profit that we generate from that business. So back to your question of market share over profitability, we will be managing that tightly with certainly our interest to continue to drive our revenue. But again, there will be a continued focus on profitable sales growth. Okay. Great. That was really helpful answer there. Some question for me just want to switch over to international, another really nice quarter there that we saw the last quarter. So just on the go forward, are you guys still confident in being able to maintain or build off that base of about $6 million or so in the go forward or anything that we should think about? I know some competitors had kind of stalled on Israel. You guys were remaining pretty heavy there talking about your indoor premium sale, which I know is in high demand. So just your outlook on international would be very helpful? Thank you. Yes, certainly. Listen, I think we've seen some good growth actually in our shipments to Australia. We've increased customers. We have a long-standing relationship with Cannatrek. But last year, we added Medcan to our customer base and continue to add new cultivars and interest remains strong from both of our Australian customers. And so besides the Canndoc agreement that we have in industry, we have a growing business in Australia. And at the same time, we're looking at other markets. We are in conversations with some customers in Germany. The reality is this is an area of the -- we could not take advantage of last year when we just didn't have the flower capacity and we were operating hand to mouth just the supply of the Canadian market and our existing international customers. So by having this excess flower, we have engaged in several conversations, and we do have confidence that we will grow our international business, and we'll have more to share on that in the upcoming quarters. I've got two here. One is, Beena, follow-up to the comment you made that you saw some softness was at the end of the quarter or just after the quarter on your large format and that you made some adjustments to pricing, is that a meaningful assessment? I wasn't sure how to take that or was it just some modest tweaking on your 28-gram flower. So in answer to that, the competitive activity came into the market in October. We were watching our off-take and seeing the impact. We did make adjustments that announced the market that didn't take effect in the quarter, but after the quarter ended. So, we have some adjustments to pricing. In terms of whether it's a full scale, listen, it's an adjustment on our 28-gram large-format flower, but not to all of our SKUs. So, it depended on the kind of turns we had on our SKUs, so we're being selective to make sure we remain competitive. We are excited about the fact that we will be introducing our Holy Mountain large-format offering in this quarter. And we will come in with what is a brand that has been grounded in consumer insights. We're very excited about the opportunity. But we've also know that we've come in with the kind of pricing that is the right price for that brand relative to the competitive set. So, I'm not sure I've given you a lot more clarity only to say that I wouldn't say it's a tweak, but it wasn't a whole scale adjustment either. Okay. Well, that's still helpful incremental commentary on that. And last follow-up on this whole pricing discussion. This -- you're being a bit cautious in your guidance, which I understand with respect to your calling out the potential for continued price compression. I was wondering, are you able to -- like do you have a sense in what -- in your guidance or expectations, the sort of magnitude of price compression, your sort of expecting over fiscal '23? And within that, I guess, higher level is -- I think a couple of quarters ago, you had thought that maybe we were starting to see some stabilization in price, but it sounds like both from your comments today and your competitor that reported earlier that this price compression across the industry is still continuing. Do you see, at some point, it will stabilize? Like how long do you think it might take to get there? Like what continues to drive this? When do you think we'll be kind of out of this tunnel here? Great. I'd love to know the edge to that. But let me perhaps address your question in this way. If you look at the overall supply of cannabis in the Canadian marketplace and you look at the size of the market and the demand, there is still a significant surplus of production coming out into the market. And while there is a lot of extra capacity with some of our competitors, they have extra flower, people will do what I might call silly things to get product out to try to generate some cash from that inventory. And so you're right, a couple of quarters ago, I thought we had stabilized on flower. We were kind of had a few quarters of it that had stabilized. But we really see the -- especially the large format flower prices are being compressed now. And I think until the supply and demand gets aligned, this could always be a problem. There will always be somebody out there who might make a move that isn't what I would say the best move for the overall industry, but might be the right thing for them. From our perspective, we did add capacity but we were adding capacity because our demand was greater than what we could supply. And so, we have confidence that we have customers for that extra power capacity. But we have some competitors who are producing a lot more flower than they have demand. And that's what's causing the volatility in pricing. Again, when will it stop when some of that capacity is taken out of the Canadian industry. Thanks for taking my question and congrats on a great quarter here. I want to circle back to the balance sheet. Beena, could you talk about how you're thinking about your cash position today? You've got $95 million on hand around $20 million of CapEx commitments remaining this year and you're expecting to get to positive free cash flow by the end of the year. So that does leave quite a big cushion. Should we think of that as mostly dry powder for M&A? Or is there a chance you consider returning some of that to shareholders on cash flow and maybe pricing stabilize a little bit? Yes. I think the answer is, listen, we have still quite a bit of CapEx to spend this year. We've talked about it, as you mentioned, there's $20 million more as we look at opportunities. We have the cash. So, we're able to look at a longer time frame and look at return on investment capital expense that will help our ongoing margin improvements. So, this is around automation and efficiency driving. So while we have identified projects currently, we'll continue to evaluate where we could continue to optimize our business and improve our margins, improve our profit in Canada. But certainly, we do have enough cash on our balance sheet to explore other opportunities. This is going to be an interesting year in 2023. We all know that there -- with the tight capital markets right now, a lot of companies are low on cash, and there might be great opportunities for us to explore. So, we have that optionality in our balance sheet that we will look for the right opportunities and hopefully continue to build what is a great business for us. Okay. Great. I appreciate the color. And maybe ripping off your comments on the opportunity set out there, could you maybe update us on how you're thinking about U.S. opportunities might have changed following some of the recent disappointments in Congress and maybe whether this elevates some overseas investments in the pecking order or maybe even turn attention back to Canada in the near term in terms of potential M&A opportunities? Right. So listen, I think we have mentioned many times on these calls that we wanted to establish a solid foundation in Canada. I think we're there. If there's the right Canadian opportunity that is, what I would say, complementary in terms of addressing some under-indexed segments in the marketplace, we might look at it. But really, we recognize that Canada is now in a good position, and it's time to look outside the Canadian borders. We are watching Germany closely as most people are. While we saw draft regulations in the fourth quarter, we're expecting to see their final regulation report out by the end of March. And so Germany is a market that we're looking at, for sure. As for the U.S., it is disappointing with all the high hopes for safe to pass before the end of the year, and it didn't. But we -- you can't help but look at the U.S. market. It is right next door. And so we continue to look at the U.S. And while in the past, we looked at CBD opportunities as many of our competitors did because they were available to us with our current TSX and NASDAQ listing. What we've evaluated as most companies who invested in CBD have not seen the benefit of that investment, mostly because it is a highly fragmented market in the U.S. and until FDA regulates CBD, we don't really see it as a great opportunity. So, that leaves THC opportunities, which we know we can't do with our listings. But there are some creative ways that people are looking at that market, and we continue to explore opportunities that would be compliant to our listings and we'll -- if we find one, you'll hear about it, obviously, but it's something we're looking at for sure because it is an important next evolution for our business. Congratulations on a terrific quarter. I wonder if you could comment on the result of the capacity expansions that you've completed and are in progress, respectively. How that is filtered into your ability to supply some of your most popular brands domestically. You've mentioned having limited supply relative to demand of the SHRED brand products. Wondering if you have been able to satisfy demand in some jurisdictions where you previously weren't able to? And also how this capacity -- these capacity expansions filter into your ability to supply international markets? Sure. So, my [Technical difficulty] memory. Yes, absolutely. We talked a lot last year about being hand to mouth on our supply and not having the capacity to introduce SHRED to all jurisdictions across Canada. We were able in the fourth quarter to finally get shipments to every province. And so we have now the flower supply to be able to continue to supply those markets. We were lapped into BC. SHRED takes as we've gone into other provinces, it takes a little ramp-up time as people try it, understand it, come back to it. So, we are seeing a ramp in D.C., and we hope to see even greater demand in that market. So, we do have enough flower now for supplying our business across the country. And we also have excess capacity to capitalize on some of the international [Technical difficulty] that we've had inbound requests for but could have [Technical difficulty]. So, our priority last year was supplying our existing Canadian business and our existing international customers. And now, we have a great opportunity to capitalize on some of those opportunities we didn't have the flower for before. All right. Great. That's very helpful. Now shifting gears to your product and brand mix. I wonder if you could touch on how the launch of the Holy Mountain brand has been going, where you see gaps in your current portfolio, and I appreciate if you could touch on your pre-roll offerings in this answer? So, certainly. So first of all, on Holy Mountain, we're very excited about this launch. We did start shipping the 3.5 gram format and press cash format into the market and saw some good response to that. We're very excited about introducing also a larger format flower offering in Holy Mountain. And we have some new SKUs that will add to that portfolio as the year goes on. In terms of distribution, Holy Mountain has just started shipping. We expect that we will be in all of English Canada with [Wola] in Quebec in the next couple of months. So we'll keep pushing that distribution growth. In terms of our overall plan, we do have a stronger innovation pipeline for the back half of our year than we had for the front half. I did talk about some of the infused pre-rolls that we have started to ship. But we have some very exciting new disruptive innovation that we plan to introduce in the back half of this year and we're excited about it. So again, I don't want to tip my hat yet on what they are. But as they come out, I'm sure we will issue a press release -- excited to see the response from consumers. But it really was grounded in as significant consumer insights as we build our plan. And I mentioned this with respect to Holy Mountain and with respect to infused pre-rolls as well. The other thing you asked about was where we might see under development in some of the segments. In the vape segment, it's no surprise to anybody that we have an under index on our vapes. We tested -- we introduced SHRED-X vapes last year, and we introduced three to four SKUs. And when you look at our actual sales per SKU, our actual sales are pretty much in line with some of the key -- other LPs takes SKUs out there. Our actual overall share is lower because we just don't have the same number of SKUs out in the marketplace. So you could expect to see more vape offerings from us in the backbone of the year. Really to address our under development, we are confident we have the quality and the insight on what consumers are looking for. And we've always been probably tighter on our schemic than some of our competitors, and we recognize that in vape category, more is more. So we will add some items to our lineup. Okay. Great. That's very helpful. And if you would entertain one more. I wonder if you could touch on your relationship with British American Tobacco. And any interactions you might have at them beyond the center of excellence, perhaps talks on new jurisdictions, et cetera. We have a very strong partnership with British American Tobacco. They are -- I would call them -- they're a very engaged strategic investor. It's probably the right way of saying it. We have conversations with them regularly. We have meetings as we talk about not only the development in the center of excellence, which is really sort of that long-range research. And we need to talk about what those product -- what the work is that we're going to do in the PDC in order to generate both benefits to today's business as well as long-term business. So, very strong relationship, we -- obviously, they're a large shareholder, we update them on how our business is going. And in the past, they have been very supportive in terms of helping us in terms of getting some equipment if they have a stronger relationship with suppliers. It's a kind of -- it's not day-to-day by any means, but it's an ongoing discussion that we have with them. And we continue to look at ways to work together in the future. Just two questions for me. The first is one of your peers that reported earlier this week was calling for potentially an increase in market share just on the back of less competition as there's a bit of a shakeout for some of the lower-end LPs that aren't as capitalized. I'm just wondering, if you think that's something that's reasonable and sort of 12-month time frame, if you think there'll be some potential tailwinds with respect to the ability to compete for provincial purchase orders? And the second is just your view on the overall total addressable market in Canada, maybe just at the retail level. Do you think that any chance of meaningful upside from where we are today without changes from the federal government at this point? Great question. So let me start with the first one. Everybody has sort of heard there are an increasing number of LPs going into CCAA. There's a need for the shakeout. This industry is highly fragmented. And as people run out of runway, run out of cash, I suspect we'll have more of those that have to exit the market. And as a result, as a company like ours that has now the flower, the capacity, the ability to supply the market, I do think there is opportunity to grow our revenue and our market share. I think it might be closer to the end of the 12-month period, and I think there might be more silly stuff happening in the short term until people really have to throw in the towel. And so as a result, we're being cautious. But certainly, we believe, similar to what you've heard that there will be a consolidation in this industry, and there is opportunity for those who have scale and who have lower cost to be able to capitalize on the opportunity in the short term. Longer term, what do I think in terms of the size of the market opportunity. I mean the market is still growing, right? We're still seeing month-over-month, annual. I think the latest BDSA forecast is, what, 13% growth year-over-year. There's lots of market -- other commodities or other industries that would love to see a 13% year-over-year growth in the market. So, I do think that there is some buoyancy. We had a really strong fourth quarter as everybody knows that the summer is the largest demand period for cannabis. And we still had some restrictions around COVID, and I think you're going to continue to see some opportunities of growth in the marketplace. But I think long term, this is -- I'm happy to be in this space. It's really exciting. I think the consumers are going to continue to come. And will the government regulations change to make it easier to compete. I'd love to see the removal of 10-milligram tap on edibles because we have a very strong and thriving Edibles business that would benefit from that. We know we're not offering consumers ideally what they're looking for with a cap on 10 milligrams. We look at Colorado market that has edible at 15% of the market. And on average, people are buying 100 milligrams at a time. So, there is opportunity, certainly if regulations change to address that. I'd love to see CBD be coupled from THC and the opportunity to sell CBD through pharmacies and natural grocery stores. We have a great brand in Monjour that has pure CBD gummies and with other minor cannabinoids that would be a great opportunity. But again, we all know that regulations take a long time to change. So, we are involved with our industry association. We are at the table at ISED talking about what the industry needs to continue to grow. And I am confident that it will change over time. I just don't believe it will change fast enough for some of the LPs that are struggling today. And there are no further questions at this time. Ms. Beena Goldenberg, I'll turn the call back over to you for some final closing remarks. Well, great. Thank you, everybody, for joining us today. We're excited about the quality of the results we reported, and we look forward to providing further updates throughout the year. So for everyone, have a great day, and we'll speak soon.
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EarningCall_1295
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Good afternoon and welcome to the Netflix Q4 2022 Earnings Interview. I am Spencer Wang, VP of Finance, IR and Corporate Development. Joining me today are Executive Chairman, Reed Hastings; Co-CEOs, Ted Sarandos and Greg Peters; and CFO, Spence Neumann. Our interviewer this quarter is Jessica Reif Erlich from Bank of America. As a reminder, weâll be making forward-looking statements and actual results may vary. Thank you and thank you so much for having me today. So Reed, the big announcement about the management changes, could you give us some more color on the process and how you came to this decision? Jessica, it feels like yesterday was our IPO. We were covered in red envelopes, we IPO-ed at about $1. Hopefully, some of you have held the stock, the full 21 years. And when I think of the evolution, the three of us and so many other incredible Netflix employees to go from DVD service to streaming leader in films and television and emerging player in games and now to have over 230 million members, itâs just â well, Jim Collins probably said it best. He calls it a good start. Weâve had a good start. But honestly, we dream of the whole world finding their favorite entertainment on Netflix and we shorthand that as entertaining the world. And the three of us have been working together for 15 years now trying to figure out how do we get through this issue, that issue, how do we grow. And I couldnât be happier to complete our succession process. It really started about 10 years ago with the Board trying to think through how could this work. They both have such amazing talents and gifts and to find a platform where they have been able to contribute is fantastic. About 2.5 years ago, we took a partial step. Ted as Co-CEO, Greg as COO. We continue to just make a super progress. And frankly, more and more, they have been leading the company and this is acknowledging really in formal terms how we have been operating for at least the last few quarters. Itâs just a great feeling. And when I think about the stock appreciation over the last decade, I know that they want to beat that record and I am all for that. I will be Executive Chairman, helping them everywhere I can, but itâs really theirs to lead and to do that energy and hustle and intensity that we have been doing. They are very ready. Thatâs whatâs driving the timing and so I could not be happier. So back over to you. Thank you. Subjectively, I will just add that this maybe the smoothest transition we have seen in media for quite a while. Now for Ted and Greg, what does this mean for Netflix? Does this signal a change in strategy or approach? Jessica, let me start with, first and foremost, to thank Reed personally and professionally. He has been, and I trust will continue to be a role model, a mentor, friend. And 22 plus years, Reed has positively changed my life in every way imaginable and he leaves some big shoes for Greg and I to fill. Unfortunately, we have four feet to do it with. So thatâs a good thing. In so many ways, the way that Reed has been able to see around corners. Thatâs why he has been thinking about the succession for the last decade. He generously opened up more of a co-leadership model over a decade ago for he and I, and like he said, 2.5 years ago made it a little more formal. And in that time, delegating a lot of the day-to-day to Greg and I. And in that time, in the 2.5 years weâve been working at it. Weâve been working together for 15 years, Greg and I. But in the last 2.5 years, particularly, we have been able to build a really trusting, respectful and complementary partnership. In many ways, the same way I have with Reed over the years. And I really do believe that this kind of shared leadership model is going to help us to move fast and to challenge each other, to challenge the company to raise to new heights. And I am just incredible what we are able to do. And to your point, this is the leadership team. Itâs been pretty stable and thatâs why that this steady transition feels so steady. This ability of this team has helped us build a great foundation and a culture that can absorb complexity and change. And as you saw in this last quarter, it can rise to any occasion. And Greg, I just want to say I am thrilled to be in this with you. And Reed, we canât thank you enough. Thanks Ted. Itâs a real honor to be asked to take on this responsibility and join you as Co-CEO and frankly a pleasure to be able to continue to working with some of the most amazing leaders that I have ever had the pleasure of working with and frankly, in my opinion, the best leadership team that Netflix has ever had. So Iâll just echo Tedâs comments. Itâs been a real fun and rewarding experience to work closely with him over the last couple of years especially and Iâm tremendously proud of the partnership that weâve developed in the shorthand and really how we have been able to take what are sort of a complementary set of skills and perspectives and seeing different angles to different situations. But basically, at the end of the day, we are â I have always found are ultimately motivated by the same things, which is that we want to serve our members and we want to grow our business and that is an incredible and powerful lining process to those different perspectives. So I am proud of the work that we have done over â22 in the latter half, especially to get some more momentum into the business, but I am even more excited about continuing to push that into â23 and follow the model that Reed has always had of continually seeking excellence and always driving to be better. So, looking forward to that. And then to your specific question, Jessica, we â there is no big strategy shift or big culture shifts. Ted, Reed and I have been working and sort of grinding through our individual perspectives on this for a long time. And so really, we look forward to taking things forward as we have been for the last little bit in responding to a dynamic industry and doing the changes that we think are appropriate. But we are not â we donât have a bank of changes that were â that we have been holding for this moment. So mostly, itâs continuity and move forward. Great. So this was originally for Reed, but now given the change in leadership structure, maybe for all three of you, for Reed, Ted and Greg. One of the best quotes recently was from John Malone, who said shareholders should build a monument for Reed Hastings? John and Rupert Murdoch ran the dominant global media companies in prior decades and we are one of the few media executives who have been able to see around corners. Ultimately, they both sold the bulk of their assets. Netflix is now one of the most dominant global media companies, if not the dominant. What is your view of the next 5 plus years? Do you need to get bigger, stay the course? Well, the one thing I would point out is that whatâs happening now and whatâs going to be happening over the next couple of years is that the consumer is moving to streaming. So the way that they watch content at home delivered to them on Internet on demand, free of the linear schedule and all those things, that is a change, a fundamental shift in the business and you have got to be where the consumer is. And thatâs what we have been focused on since we started streaming, doing original content 10 years ago, but being really realizing that we really have benefited from being a customer-first company and meeting the customers where they are. And we have also had this blessing of not having to unwind our traditional media business as we built into this one. So we have always been focused on the future and where the consumers are going. And I think our ability to continue to stay focused on that, because we are â this is really â I know as weâve been talking about it for a long time, Jessica, but this is really in its infancy. I mean you think about as big as weâve become and all these things that are happening. And in the U.S., we are about 8% of TV time still. So, itâs an enormous amount of growth ahead, even in markets where we are very well established. So, thatâs the key for us and I think being able to focus on consumers first and has really been our biggest benefit. And I think itâs what led us to those milestones that you just referred to. Greg? Yes. And Jessica, I would say I think that, that translates into being bigger. And I think that means being bigger in terms of touching more members around the world, delivering them incredible entertainment. We will see that in terms of being bigger, in terms of the amount of engagement that we can drive the amount of hours that we are satisfying them, be bigger in terms of the culture impact is too. I mean you have seen â I mean just incredible cultural impact in terms of Wednesday, Stranger Things, the ramifications that these shows have in terms of the popular culture are significant and thatâs going to get bigger, too. Also it means bigger in terms of revenue and profit stream. So we are looking forward to those as well. Right. So losing subs in 2022 and the market reaction or valuation reset is akin to August 2015 when Bob Iger called out the early decline of pay-TV subs and the impact for Disneyâs ESPN. It will take a while for Disney to build ESPN Plus into a sports streaming giant. And actually, they may never replace the profitability of ESPN at that point in time. Your pivot seems more broad-based by extending genres and going into new areas whether itâs games, fitness, live, etcetera. Do you see any similarities or differences to that momentous inflection point, which has certainly shifted Wall Streetâs view from subs to profits? I will take a shot at that and then Ted, maybe weigh in. But I think itâs a fundamentally different situation. And if you look at where we are at a significant part of what we need to go do is essentially take the core model that we have been operating since we have been starting in streaming and just execute it better in all dimensions. And so whether itâs the incredible content that Bella and Scottâs team are producing constantly, how we are talking about that content to the marketing and conversation that we do, the product experiences and business model innovations that we are doing, but a lot of it really fundamentally is about executing that core model better. We are not â there is not a lot of massive pivots away from a traditional legacy business model that we have to go figure out. We are planting some seeds in terms of games and things like that, that if we execute well and we are excited about the progress we are seeing so far, will represent the future potential for us in terms of growth and more profit opportunities. So thatâs exciting. But essentially, a lot of this is just continue to execute the play that we have got and do it better and better. And then I donât know about what the similarities, but I would say that this business is really completely about engagement, profit and revenue. So â and we have got to grow all of those things and all those things are really are tied to executing on that â on the content. When the content is working, the business is working. We grow engagement, we grow revenue, we grow profit. There is an interesting thing starting in July and you think about from Stranger Things Season 4 from the phenomena that became and what we have been able to offer up to our members from that day forward. So they went from Stranger Things to Extraordinary Attorney Woo, which was a phenomenal success throughout Asia and in South Korea, but also built a big cult fan base in the U.S., straight into Sea Beast, which is our biggest animated film ever; straight into Purple Hearts and Gray Man, two of our most watched films ever on Netflix. And then to August, the Sandman and Never Have I Ever Season 3, September, Copra Kai Season 5, Empress, Cyberpunk is this animated adaptation of a videogame thatâs been hailed as one of the greatest of all time, Narco-Saints, another monster hit from North Korea, the Jeffrey Dahmer Story, Monster, straight into Watcher, back-to-back hits from Ryan Murphy, All Quiet on the Western Front, which just today became the most nominated non-English film in the history of BAFTAs. Only Gandhi has got more nominations in the history of BAFTAs and thatâs from Germany with the great Ed Burger. And then straight out of there into Enola Holmes 2, a big monster success, sequel to â with Millie Bobby Brown. And you look at all of these things that go back and forth and they go all the way into January now, we will end the month with You People, Eddie Murphy and Jonah Hill. Any outlet would kill to have any one of those months as their entire year. And itâs our ability to fire on those cylinders and create hits, but more than that create the expectation that as soon as you are done with this one, there is another one waiting for you. Jessica, may I just â just one thing to add, I know but I just think the analogy is kind of fundamentally different. So with ESPN and the example you gave, that was a fundamental kind of shift in the industry from 100 plus million pay-TV connected homes to cord cutting thatâs on a path down to mid to high single-digit reductions in that distribution platform each year and thatâs moving in that direction. So itâs kind of a shrinking core distribution platform where you see in our earnings letter, the world is shifting from linear to streaming. Even in the largest â there is no country where streaming is more than 40% of share of TV time. And in many big countries, as you saw, itâs less than 5%. So, itâs our 5% â or itâs less than 5%, itâs less than 10%. So there is an incredible runway still in the shift from linear to streaming. And so for us, itâs about growing into that shift and also obviously competing well and continuously innovating and improving. And what you saw or what we saw and felt when we had that decline in subscribers was really near-term limiters in growing into that big market, but the big market is still growing as opposed to fundamentally long-term limiters in that ESPN shift that you described. Right. So letâs move on to some of the drivers of growth, both near and medium-term and start with advertising. So your advertising platform has been open only 2 months and you have amazingly given some money back to advertisers indicating in one way that demand is exceeding supply. The company is - you guys have consistently said you are going to crawl, walk and run. How is the [process] (ph) going relative to your expectations? Yes. Like you say, itâs 2 months. And I think the hardest part is actually that first step when you are crawling, because you donât really know what exactly to expect as you get it going. And now with 2 months, we are ridiculously early, but we have learned a bunch already, I would say. So just ticking through this, I mean, Iâd say, first and foremost is that we were able to launch this very, very quickly. And the tech is all working. The product experience is good. And thatâs really a testament to lots of hard work for both Microsoft and Netflix teams who worked very hard to make that happen and itâs really rewarding to that to see. The other, Iâd say, pretty significantly fundamental thing is around engagement and we see that engagement from ads plans users is comparable to sort of similar users on our non-ads plan. So thatâs really a promising indication. It means we are delivering a solid experience and itâs better than we modeled and thatâs a great sort of fundamental starting point for us to work with. Furthermore, now, we are seeing take rate and growth on that ads plan is solid. Itâs great, because partly that take rate and that growth is due to incremental subscribers coming into the service, because we have a lower price point, thatâs $6.99 in the U.S., â¬4.99 in Germany, just to give you two examples. And so that elasticity is a real â not only a benefit to sort of growing our ad scale and sustainability, but also to the general business. I expect to see that continue to actually grow over the year. That take rate fits sort of within the middle of our other plans, which is another really healthy sign. It means that weâve got a complementary set of offerings that are working to sort of satisfy different needs for different consumers at the right mix of features and price points. So thatâs quite good. Another important one, I think, for the investor community because it came up a lot before we launched was plan switching. We arenât seeing as expected much switching from high arm subscription plans like premium into our ads plan. So the unit economy remain very good as we modeled. So these are all really good initial sort of progress points, but I think itâs important to reiterate that as you mentioned, weâre crawling and weâd like to get to sort of move to the walking phase. Weâve got a lot to do to get there. So there is a bunch of technical improvements in terms of ad delivery validation, measurement. Weâve got progress already on that, more to do in the next quarter or two. Targeting improvements, which will be better for consumers. More relevant advertising, better for advertisers in terms of more value delivered, a better set of offerings on products for advertisers to buy. Weâve got a long list of experience improvements that we know we can deliver that will deliver more value to both subscribers and advertisers. And there is just also some nuts and bolts stuff that we are learning and improving, just things like how do we do a better job with Microsoft at the ad sales and operations processes. There is so much that we need to do both companies need to do to better serve advertisers, serve an increasing number of advertisers and meet that demand. So weâre just getting started. Weâre constantly improving, and we see the trajectory ahead of us. And really, our aspirations are ultimately successively over a period of years to basically build, just like we have essentially in terms of the streaming experience, the best, most effective, highest quality premium connected TV ads experience as a win for consumers and advertisers and for us as a business. Spence and Greg. Sorry, Jessica. Spence, maybe give a little context on Hulu, kind of what we know about Huluâs advertising. They have got a 10-year head start. And sort of how many years will it take us to sort of pass them in all of these key dynamics? Alright. Letâs see. I mean Hulu is â yes, they have had a long start, they started in the ads business. They have â we would estimate, reason we obviously donât know exactly, but roughly half of their membership is on the ad tier. Itâs a multibillion-dollar business for them already, and thatâs a domestic business, U.S. only. So lower reach, lower engagement than us. So I guess the short story there is we have given what weâve seen and what Greg just outlined in terms of the engagement on our ad plan, the strength of the performance in terms of the monetization, kind of the unit economics and our ability to kind of scale in a way that is even better than the kind of comparable ad free plan, plus providing clearly choice that our members or consumers are seeking out because of the sign-up flow that we would expect to be as large or larger over time, certainly in just our U.S. market and more from there. But itâs â I just want to emphasize, itâs a multiyear path. So weâre not going to be larger than Hulu in year 1. But hopefully, over the next several years, we can be at least as large, and we wouldnât be getting into this business obviously, Reed, as you know, if it couldnât be a meaningful portion of our business. So weâre over $30 billion of revenue, almost $32 billion of revenue. in 2022. And we wouldnât get into a business like this if we didnât believe it could be bigger than at least 10% of our revenue and hopefully much more over time in that mix as we grow. So thatâs kind of how I see it without putting a specific guide on it. You committed to an upfront market spot, taking CBSâs prior spot, CBS now Paramount spot, which really indicates your long-term advertising goals of being a major advertising platform. Given this is a prime spot on a critical week for advertisers in premium video. Like itâs just â itâs amazing how quickly you just took that lot away. Whatâs the run stage? And how would you and whatâs the time frame to get there? Well, I think as Spence talked about it, it will be an iterative process. To your point, it does signal that we have big aspirations here, and we think there is a big potential opportunity, and so weâre committed to incrementally execute against that opportunity. But just back to Spenceâs point, we are starting from a zero base essentially. And also, weâre also starting from a history as a non-ads platform, we had a lot of folks to basically join Netflix fully as non-ad subscribers, and so I think that we will be working through that over a period of time. But again, our goal and aspiration is that this is a very meaningful and significant source of revenue and profit for us over many years to come. So I mean when you think about the pool of money that youâre targeting, linear, letâs call it, $50 billion, $60 billion business, seems like the easy money, youâve mentioned already. These are shifting from streaming to streaming from linear, so weâve seen all of the kind of eyeballs move. And so now you have basically more scale or reach, but the digital pool is much larger. But in the past, youâve said youâve made comments, the companies may comment that you canât compete with Google and Meta or it would be incredibly difficult to compete with them. Has this changed? Has your view changed? Not really. I would say that initially, weâre competing mostly with that sort of traditional TV advertising pool. Now I think we can layer into that over time, components of what has made digital advertising so effective. So if you think about the targeting capability, the fact that we signed in fully addressable. If you think about the growing relevance of first-party data and how we do that, those are real big advantages that we can bring relative certainly to the traditional TV world. But again, the form that we have at least for the next couple of years will still be in that sort of lean back â primarily in that lean back experience. And so that lends itself to certain kinds of advertising and certain kind of advertising goal. And a lot of the demand collection component that a Google or a Facebook is really good at. We wonât be well suited to compete with that for at least some time to come. And Jessica, just to add to that, the good news, as you saw in the letter, is that, that branded video ad market that Greg talked about us focusing on is about $180 billion, globally ex China and Russia. So we have plenty to do and a lot of opportunity ahead just in that area alone. Yes. No, itâs an enormous opportunity, but there is also, besides advertising, there is enormous opportunity in incremental subscribers, as you have mentioned. You are the lowest priced service, at least now you are the lowest price, but can you frame the opportunity in terms of sub growth and how youâre thinking about it? Sure. And just to comment on lowest price. I mean, again, we donât really think about the pricing question from a competitive perspective. Again, weâre â think of ourselves as a non-substitute good when you think about Wednesday or you think about Glass Onion, these are titles you can only see on Netflix thatâs extremely powerful. Scott and Bella are delivering more incredible titles that are non-substitutable in that regard. So really, when you think about the pricing question is how do we offer a wide range of options for a wide range of consumer needs? We want to make that spectrum even wider as we seek to serve more members around the world and trying to deliver appropriate value at those different price points, and weâre doing a good job expanding that range. And so then you think about so there is sort of two pools then of incremental subscribers. There is a bunch of people around the world in countries where weâre not deeply penetrated, and we have more opportunities to go attract them. A component of that is weâve got folks that are watching Netflix who arenât paying us as part of basically borrowing somebody elseâs credentials. And our goal is over this year to basically work through that situation and convert many of those folks to be paid accounts or to have the account owner to pay for them to get enough subscription. But either way, weâre seeking to sort of monetize the viewing value that weâre delivering. And then beyond that, itâs back to Spenceâs comment, even our most penetrated market 8% of total TV time, which is potentially a relatively narrow length to think about the broad competitive entertainment offering. So we have huge opportunity to grow the engagement component that several X. We feel like we can get to if we do a great job of executing across all fronts and that represents a tremendous opportunity for more entertainment value delivered and we believe that the revenue flows from that in time. Before we get to password sharing, just one last advertising question. You now have roughly a decade of producing your own IP. Any thoughts on offering a fast service over time, free advertising supported television? Yes. Look, weâre open to all these different models that are out there right now, but weâve got a lot on our plate this year, both with the paid sharing and with our launch of advertising and continuing to this slate of content that weâre trying to drive to our members. So we are keeping an eye on that segment for sure. So on the password sharing, what will drive consumers to pay $3 or $4 per sharing versus becoming a sub with their own profile? Is it affordability? Is there something else? What do you expect? Yes. I think there is a range of motivations for different borrowers. So some of it is economically driven and to a part of what weâre trying to do is that we are being responsive to that and finding the right price points, whether in terms of an individual account or an extra member of forte. And obviously, the ad-supported plans give us the opportunity present a lower consumer face pricing in those countries where we have advertising. Part of it is just what we call casual sharing, which is people could pay, but they donât need to, and so they are borrowing somebodyâs account. And so our job is to give them a little bit of a nudge and to create features that make transitioning to their own account easy and simple. So we have this basically a profile export feature, which allows you to take your viewing history and all the great recommendations with you. So to your point, there is a range of motivations and I think a range of solutions that we will be able to offer to land people in different places. Yes. So weâve been working hard at this and trying to do some sort of thoughtful experimentation to let our members speak to us in terms of what set of solutions work for them. So thatâs the testing that youâve seen us do over the last couple of quarters. We feel like we have gotten to a good set of features. Itâs the profile export that I mentioned, but there is also a bunch of account management features that we think are important to making this experience work for folks. And so weâre ready to roll those out later this quarter. We will staggered that a bit as we sort of work sets of countries, but we will really see that happen over the next couple of quarters. And I think itâs worth noting that this will not be a universally popular move, so there will current members that are unhappy with this move. We will see a bit of a cancel reaction to that. We think of this as similar to what we see when we raise prices. So we get some increased churn associated with that for a period of time. But then generally, what happens is both from the specific changes that we make, we will see folks come on as new subscribers, essentially borrowers creating their accounts or incremental monetization through the extra member that will happen shortly thereafter. And then clearly, our job is to continue to grow value, right, to have more amazing titles that people cannot wait to see and whether thatâs satisfying those members to make those transitions or winning back essentially folks who have turned off the service and bringing them back on service over the months and years to come. Jessica, sorry, I just â maybe just because we touched on it a little bit in the letter, but just to kind of reinforce a little bit of what that looks like in terms of timing and guidance. So those dynamics that Greg just walked through, because of that as we kind of start to roll this out later in Q1, based on the timing, what we talked about is that we will have modest growth we expect in paid net adds in Q1, but kind of atypical seasonality, where typically Q2 would be a softer pay-at-ad quarter. It will probably be a larger paid net add quarter. And most importantly, what weâre most focused on is obviously revenue. That is our primary metric. And what you see is in the guide, these revenue initiatives between paid sharing rolling out and then scaling ads, you donât see much of that in Q1, which is why we are forecasting 8% growth FX neutral in Q1 revenue. But throughout the course of the year, we would expect to see accelerating revenue growth as we roll out page sharing broadly across our business and then obviously, scale adds throughout the year, which is a more gradual build. So I just want to kind of highlight that, and thatâs kind of what youâre seeing in the guidance. And given the revenue drivers of paid sharing and advertising, how are you thinking about price increases in the current year? Is it just too complicated? How are you thinking about it? Well, I would say the two initiatives that you described represent the bulk of our pricing strategy in â23. We anticipate that theyâll both be revenue positive, revenue accretive significantly. So in the â according to the details that Spence just offered. Now having said that, our core sort of pricing approach in theory remains the same, and so weâre going to look at the metrics that our members are giving us and telling us and look for opportunities where weâve â I think weâve done a good job of creating more value for them and for a certain customer segment and a certain tier and a certain country, we think weâve done a good job at delivering more entertainment for them. And then we will go back and opportunistically ask for them to pay a little bit more so that keep this virtuous cycle going and really invest that back into incredible content and stories. And maybe, Ted, I donât know if you want to highlight anything you see comment on that side. No, I would just say that itâs the massiveness of the content that will make the paid sharing initiative work. Itâs â that will make the advertising launch work that will make continuing to grow revenue work. And so itâs across film, across television. Itâs the content that people must see and then itâs on Netflix gives us the ability to do that. And we are super proud of the team and their ability to keep delivering on that month-in and month-out, and quarter-in and quarter-out and continuing to grow in all these different market segments that our consumers really care about. So, that to me, is core to all these initiatives working, and we have got the wind at our back on that right now. But you amazingly continue to expand the genres of content, which, as you guys have mentioned, clearly drives engagement. But the most recent new genre, which you introduced on your platform in â at the end of last â very end of last month is fitness. One class online could be the price of a nevus of subscription. So, while many of the work at our bite size. I mean some along, they are simple, but deceivingly effective. Can you talk about what your plans are in this area? And as you develop more content, it really, as I said, drives value for anyone who would work out anywhere else. So, how do you define success? And is there anything you could take about partner economics with Nike? Yes. We canât comment on the partner economics, but I would tell you that we have historically stayed away from the fitness category because itâs abundantly available online, in many cases, for free, as you know. But we thought if we could partner with a great brand, and Nike is certainly a leading brand in fitness with really well-produced content, which this content is, and then letâs go out to our members and see if itâs something that they value. And we will see that in the engagement and see where we could take it from there. So, I think in that way, working with a great partner and the high quality, to your point, of the content itself, we will put it in a really good test, do people want to use Netflix to get in shape or to get back in shape. And if they do, we would like to keep serving that. And if they donât, we will keep poking around. So, itâs the way we kind of â we are able to test the market at a very high end with a premium brand partner. There is constant speculation that you will experiment with sports, which is an expensive rental business for many. Does having an advertising offering change your views on offering sports? And any thoughts that you â on like WWE, which is for sale, that could be â potentially, I just think that could be owned content like any views on sports. Yes. Look, I would say in sports, our position has been the same, which is we really â we are not anti-sports for pro profits, and we have not been able to figure out how to deliver profits in renting big league sports in our subscription model. Not to say that, that wonât change. We will be open to it, but thatâs where itâs at today. And in WWE, we look at â we have a lot of M&A activity all the time. We look at all of them, but nothing we can comment on. Does this term play a role in your investments into live events? While life comedy specials seems which have a value outside of the live window, other events, like you just announced that you are going to host the SAG Awards, sports, obviously. These have fairly short use for lives. So, how do you balance the investment in live versus the potential to drive advertising dollars? I would look at this as part of just like other crawl/walk/run scenarios, where we are really looking at our content that would benefit creatively for being live. So, the results show for one of our competition series that we have or a reunion show that drives news or like the SAG Awards and opportunity to engage audiences live. And because we have got the shelf space, we can do hours of shoulder programming around the live events and all of those things that our members may enjoy. So, I think â there is nothing particularly novel about live television, as you know. But we are dabbling in it, starting with our Chris Rock live concert to try to create the excitement around live for those things that are uniquely more exciting to be live. The theatrical release of Glass Onion was incredibly successful in its limited release. But â so for some, it looks like you left a lot of money on the table by not continuing beyond the first step one week, do you have any regrets, or can you give us your thoughts on your evolving film strategy? Well, I am thrilled with every aspect of the release of Glass Onion, starting with Ryan Johnson, and his great film and Scott Stuber and the film team for bringing it to the table. And I think what you saw was a lot of excitement. We drove a ton of us with that theatrical release, and we created a bunch of demand. And that demand, we fulfilled on our subscription service. Our core business is making movies for our members to watch on Netflix, and thatâs where we are really focused, and everything else is really a tactic to drive excitement around those films. So, would you like a massive global hit like a Wednesday? There seems to be so many ways you could drive monetization. I know like just staying with margin for a second. Like the Wednesday makeup was sold down in every MAX store in New York City. You could not buy it anywhere. Do you participate in these types of consumer products, or is it just a way to fuel fans, fuel engagement? Itâs a little â mostly the fuel engagement and fuel fandom. We actually â we do participate in it. Our owned content, we do drive a lot of revenue in our consumer products business. But mostly, the motivation is that is to drive fandom. And Greg alluded to this earlier, but this impact on the culture that this content can have on our platform. In our earnings letter, we mentioned the Lady Gaga song came back after 11 years because of Wednesday. But that doesnât mention, the four songs this year that we actually jammed back into the charts, some that never charted and some that were off the charts for 40 years from Metallica, Kate Bush, The Cramps. And that impact on culture, Sofia Carsonâs music career took off because of Purple Hearts. Jenna Ortega picked up 10 million social media followers in the first week Wednesday launched on Netflix. And all of these folks who build these gigantic careers on Netflix then go on to have to own their own companies, sell their own makeup in many cases and become incredibly powerful influencers. And all of that business is drawn because of our â the impact that this distribution platform, and itâs incredible UI that basically can take something like Wednesday, which was not a slam dunk for people to predict that people would love it as much as they do. And the UI could pick up on that activity in the early going of the release and push it out to where itâs going to be one of our most watched shows in our history all over the world. And we do use consumer products as a way to intensify fandom. And it could be anything from makeup, from Wednesdays, as you said, or maybe even a hand on your shoulder. Spence? Yes. You never know where Wednesday is going to show up or at least thing. I did get my chance to kind of talk and at the risk of going back to the management changes and say, I am thrilled with the changes. I am going to miss maybe not seeing Reed as frequently as he is supporting Greg and Ted. So, I just brought in a little bit of reinforcement with thing even though Reed is not going anywhere. But this way, I have got a little daily reinforcement. Sticking with content for a few minutes. The local language hits a building, but tell me on the U.S. hits. How do you think about allocating your $17 billion or so content budget between genres or languages? Like is there any way like you can kind of parse it out? Yes. Itâs a big task. Watching where viewing is growing and where itâs suffering and where we are under-programming and over-programming around the world is a big task of the job. Spence and his team support Bella and her team in making those allocations, figuring out between film and television, between local language and what is â and whatâs really interesting is there isnât â there arenât that many global hits, meaning that everyone in the world watches the same thing. Squid Game was very rare in that way. And Wednesday looks like one of those two, very rare in that way. There are countries like Japan, as an example, or even Mexico that have a real preference for local content, even when we have our big local hits. And every once in a while, something like Squid Game is even a big hit in the U.S. So, think about in Q4, we launched a top 10 non-English series nearly every week of the quarter from South Korea, from Spain, from Colombia, from Japan, from Poland. And so the benefit of that kind of local language investment and the benefit of doing that early was that we become exceptional on the ground in those countries. Those content teams generate not just content people want to see, but content thatâs leading the industry. To have Netflix produce the Academy Award entry film for both Mexico and Germany has never happened in the history of the Oscars. Itâs really phenomenal. And I mentioned earlier the All Quiet on the Western Front and the success of BAFTA. And keep in mind that these investments are important because it actually increases the total addressable audience for Netflix around the world. Because if we were just doing English content for the world, we would be mostly attracting Western-centric viewers, but our addressable audience is anyone who is watching TV anywhere in the world. Jessica, we have time for one or two last questions. I just want to make sure you have a chance to ask about margins or anything else you might want to ask⦠So, letâs move away from content then. So, free cash flow. First of all, like, what an inflection point, $1.6 billion in â22, roughly $3 billion in â23, $4 billion plus probably in â24. Can you just talk about â historically, you have been more build than buy. Is there any change in philosophy as cash starts accelerating? Can you talk about overall capital priorities? And whatâs driving that operating margin increase? Sure. Thanks Jessica. So, as we were in the letter, no change at all to our capital structure policy or allocation guidance, which is to, first and foremost, reinvest in the core business and selective acquisitions after that. Those are the main priorities. Beyond that, if we have cash in excess of our minimum cash levels, which we â which is roughly equates to two months of our revenue, then we will return that to shareholders or to our share buyback program. Yes. And I can pick up with margins, I can start with. Itâs a bit of an explanation. But if you like, in terms of just in the near-ish term, our outlook for â23 and then just generally, whatâs driving our outlook. But what you saw in the letter, it kind of dates back, frankly. If we walk back to where we were in the beginning of 2022, when we saw a slowing revenue growth, we said, âWe are going to manage to the target operating margin of 19% to 20%, FX neutral at those January 2022 rates.â And we ended the year at 20%, so at the high end of that range. And now as we kind of turn the page to â23, first, I should say, with everything we talked about, we have got â we are quite optimistic in terms of our path forward. I also just want to highlight there is also kind of short-term unusual amount of less visibility than typical because these things we are talking about in terms of our revenue initiatives, whether itâs scaling our ad platform, launching page sharing, which hasnât globally rolled out yet, these things are early days. And then also all multinationals have a level of macro uncertainty. So, thatâs a bit of a caveat in terms of the variability in the forecast. But what we see is we see with the â our path to accelerating revenue growth and our high confidence there that as we turn forward to â23, we are guiding to now 21% to 22% FX-neutral operating margins, those same January 2022 rates. We are now into New Year, so we take it forward to January â23 to current rates, and thatâs a range of our operating margin guidance of 18% to 20%. So, now FX neutral for â23, we are going to manage within that band to deliver at least within 18% to 20% operating margin guide. So, that is growing margins, growing absolute profit. And really whatâs reflected in there is that this â we have high confidence in our ability to accelerate revenue throughout the course of the year as we scale ads and we launch paid sharing. We have got high confidence in improving the service and the strength of our content slate with everything that Ted discussed here on the call. And we are also continuing to manage our cost structure with increasing discipline. You saw that in the back half of â22 with our slowing expense growth and we will carry that through similarly in â23. So, that all lends itself to our focus, which is kind of healthy growing double-digit revenue growth and accelerating that revenue growth throughout the year, expanding our â both our absolute profit and profit margin and then growing positive free cash flow. So, thatâs all reflected again with the big caveat that there is a bit less visibility than typical in this near-term. Thatâs something we will continue to work through. We will obviously know a lot more over the next couple of quarters, a few quarters as we roll out paid sharing, and we will update guidance as appropriate. But thatâs what plays through and then also plays through that cash flow generation that you see, where we believe with all those dynamics and managing at about the same level of cash content spend that we will have more than $3 billion, at least $3 billion of free cash flow in the year. Thank you, Spence, for that answer and, Jessica, for the last question on all your questions. And before I turn it over to Reed for closing remarks, I just wanted to say as a longtime Netflix employee, as formerly prior to that as an analyst covering Netflix for many years, Reed, it has been a real privilege to work alongside you. And on behalf of all Netflix employees, we thank you for everything you have done for us and the company over the past 25 years, and we are all super excited for the next chapter with you as our Executive Chairman and Ted and Greg as our co-CEOs. So with that, over to you, Reed, to make... Spencer, I just â because I canât just deal with this thing. I just want to thank Reed as well. This is not a goodbye, I know. But itâs been fantastic. I couldnât have asked for a more incredible experience in the past 4 years with you as our leader, learned so much, across everything from work to humanity. And I am so thrilled with the next chapter with Greg and Ted and you and so super excited. And thanks Reed. Thank you, guys. Itâs certainly not goodbye. I am heavily invested in Netflix success. So, there has been 83 earnings calls now, and I honestly have loved them. I love the interaction. But itâs time for Greg and Ted and the team to lead, and I will be in the prep sessions, but this will be my last earnings call on the screen. Overall, I would say our first 25 years were good, and I am super excited about Netflixâs next 25 years being great under our broadened leadership team. Pleasing, our shareholders and members is so satisfied and I just want to thank all of you for your support and look forward to continued more progress. Thank you everyone.
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EarningCall_1296
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Good day and thank you for standing by. Welcome to the First Merchants Corporation 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 this conference call is being recorded. Before we begin, management would like to remind you that today's call contains forward-looking statements with respect to the future performance and financial condition of First Merchants Corporation that involve risks and uncertainties. Further information is contained within the press release, which we encourage you to review. Additionally, management may refer to non-GAAP measures, which are intended to supplement but not substitute for the most directly comparable GAAP measures. The press release available on the website contains financial and other quantitative information to be discussed today as well as reconciliation of GAAP to non-GAAP measures. Well, good morning, and welcome to the First Merchants' fourth quarter 2022 conference call. Lisa, thanks for the introduction and for covering the forward-looking statement on Page 2. We released earnings today at approximately 8:00 a.m. Eastern time. You can access today's slide by following the link on the second page of our earnings release. On Page 3, you will see today's presenters and our bios to include President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. Page 4 is a snapshot of the First Merchants geographic footprint and some relevant financial highlights for your review. I'm excited to share our results with you today, given our strong performance in 2022 to include a clean fourth quarter that requires no adjustments related to our April 1st acquisition of Level One. Our message should reflect my appreciation towards our clients and our teammates for delivering a very good year. We also hope to establish a baseline through our Q4 results that allows for effective modeling around an optimistic 2023 inclusive of the realism required given the industry headwinds. Now, if you turn to Slide 5, net income totaled $70.3 million for the quarter compared to $47.7 million in the fourth quarter of 2021. Reported EPS for the fourth quarter totaled $1.19 without any required adjustments compared to Q4 2021 of $0.89, a 33% increase. Organic growth in loans of 11.8% for the quarter and another 18 basis points of core margin expansion over Q3 of 2022 by the drivers of our EPS improvements. This performance resulted in a 1.59% return on assets and a 24.2% return on tangible common equity for the quarter. The year-to-date results, our EPS totaled $3.81, which equaled last year's total of $3.81. However, this year's results had $27.7 million less PPP income than last year and $33.3 million more acquisition expense than last year's earnings per share. When adjusted for those two items, which totaled $60 million, our year-to-date 2022 EPS totaled $4.20, which is 24.3% better than 2021's total of $3.38. Fueling the improvements for the full year for once again loan growth, excluding our acquisition totaling 13.9% and core net interest margin expansion of 34 basis points. Mike, Michele, and John will provide some color on the loan portfolio, its makeup, pricing and areas of growth later in the presentation. Yes, thank you, Mark, and good morning to all. As you look at the next two slides, I will provide an update on our line of business results and their contributions within the quarter. Since our business strategy on Page 6 remains unchanged, I want to focus on Page 7 titled business highlights. The top of the page offers a breakdown of the core loan growth by our business units. The fourth quarter represented another excellent quarter of organic growth, nearly 12% in aggregate with the commercial segment growing over 10.5%. The results continue to demonstrate the close working relationship between our team and our markets. As discussed in prior calls, we strive for high single digit growth rates, and as noted on the right hand side of this chart, we achieved those levels for all of 2022, the commercial segment over 8.5%, the consumer segment over 9.5%, the mortgage segment close to 60%. As footnoted, these are organic results adjusted for PPP and the day one balances of the Level One acquisition. But I do want to spend more time on the global loan results, specifically the dollar increases behind the percentages on this page. As noted on Slide 11, the commercial segment represents 75% of our total loan portfolio. The 10.6% fourth quarter growth rate in commercial was approximately $240 million or 70% of the total fourth quarter loan growth of $345 million. While the consumer segment contracted this quarter by 3.1%, that dollar amount is less than $7 million. The mortgage portfolio growth during the quarter was approximately $100 million versus the prior quarter growth of $190 million. My point is the commercial segment continued to be the loan growth engine of the bank. All segments can demonstrate solid growth rates and John Martin is going to talk more about the detail of our portfolio later in the presentation. Let me go into the drivers of commercial loan growth in the fourth quarter. There are threefold. New business activities, first and foremost our teams continue to win new relationships across the geographies and across all segments of focus. Our team alignment puts them in the best position to win. We have alignment with our credit partners and we have alignment on market coverage. I shared several quarters ago we added key staff within certain markets to augment our existing teams. This people investment was within asset-based lending, upper middle market, and syndications, and all are contributing alongside our existing team. The second driver of growth was from our existing clients, capital for expanded plant and equipment, working capital growth and acquisition financing remained active through the end of the year. And the final driver is line utilization specifically within investment real estate, which is construction draws and the C&I line utilization inched up 1%. Overall, we have maintained a consistent and disciplined approach towards underwriting within all these segments and the commercial pipeline ended the quarter consistent to prior quarters. Moving on to the consumer segment, loan balance is contracted by 3%. As the second bullet point notes, the $7 million decline is attributed to the private banking footings. With the rise in interest rate, certain clients reduce balances with excess investments or lower earning deposits. On the contrary, home equity balances continue to increase during the quarter, which is correlated with increasing home values. Average utilization on that portfolio has not changed. And across all of consumer, our underwriting approach remains unchanged. Additionally, the consumer loan pipeline remains consistent with prior quarters. So let me touch on the mortgage segment. The 24.2% growth rate was approximately $100 million. The aggregate mortgage portfolio is now just over $1.8 billion, or 15% of the total $12 billion loan portfolio, again trying to highlight the emphasis on commercial. The driver of the quarter and year-to-date increases in mortgage comes from the continued strength and purchase volumes with more of our clients choosing our five and seven year adjustable rate product offerings. Our underwriting standards remain unchanged here prime borrowers. With how low housing inventory, high home prices and higher mortgage rates, the mortgage pipeline ended lower for the fifth consecutive quarter. I want to speak to the deposit section on the bottom half of this page. We are actively managing the deposit rates to maximize our margin. The quarterly decline of 1.4% continues an improving trend. Last quarter we reported 3.7% deposit contraction, which was less than the 8.2% deposit contraction reported in the second quarter. Consumer deposit balances increased for the quarter at a 4.1% annualized rate. The consumer team continued to gain new accounts through both in branch and digital online activities. Additionally, our consumer relationships have responded favorably to our new money CD and new money market promotions. As noted in the first bullet point, the commercial deposit decline is primarily from the public fund sector. The decline in this segment is simply from municipalities or school corporation looking for the highest marginal deposit rates across the competitive landscape. Additionally, many business clients continue to utilize excess liquidity on their balance sheets for higher returning activities like acquisitions, plant expansions or dividends. Michele has more details to share about our balance sheet, our expanding margin along with greater details of our other key performance metrics. Michele? Thank you, Mike. My comments will begin on Slide 8, covering fourth quarter results. You can see on our balance sheet on lines one through five that we continue our trends towards a more favorable earning asset mix. Total loans on line 2, which Mike covered in his remarks, increased $344.1 million, or 11.8% through organic growth during the quarter, which was offset by PPP loan forgiveness of $6.5 million to arrive at the $337.6 million you see in the variance column. Deposits decreased $52.1 million during the quarter and investments on line 3 decreased $31 million. I will add some additional color on our investment balance later in my comments. Our loan-to-deposit ratio continued to trend up and was approximately 83.5% this quarter compared to 81% on a linked quarter basis, and 72.7% in prior year. Earnings per share for the quarter totaled $1.19, which reflects our bank's strong performance. Pre-tax pre-provision earnings totaled $83.8 million this quarter, a 9% increase over last quarter when excluding acquisition costs. Rising yields on earning assets offset somewhat by higher deposit costs drove higher profitability this quarter, which is reflected in the increase in net interest income on Line 11 of $8.6 million over prior quarter. Non-interest income on Line 14 declined by $5.5 million due to a large BOLI gain recorded in the third quarter. Adding to the quarter-over-quarter profitability was lower non-interest expense, which declined $6.7 million, bringing our net income on Line 17 to $70.8 million, an increase of nearly $7 million over Q3 or 11%. Our stated efficiency ratio was 48.6%, but excluding the lingering acquisition costs of $400,000 that was recorded in the fourth quarter, the efficiency ratio was 48.37%, reflecting excellent operating leverage. The tangible common equity ratio on Line 6 increased 68 basis points. Intangible book value per share on Line 26 increased $2.19 or 11% reflecting the strong earnings from the quarter as well as a meaningful recovery in the unrealized loss valuation of the available for sales securities portfolio. Slide 9 shows our year-to-date results. Line 25 shows year-to-date earnings per share of $3.81, which on a stated basis equals earnings per share for 2021. As Mark mentioned, non-recurring items had a meaningful impact on earnings. So when excluding acquisition costs, Day 1 CECL provision and PPP loan income, EPS for 2022 totaled $4.20 and 2021 totaled $3.38 for an increase of 24% reflecting strong core organic growth and profitability and the contributions of the Level One acquisition. Pre-tax pre-provision income year-to-date was $289 million, an increase of $47.6 million or 20% over prior year. Keep in mind that the prior year pre-tax provision income included $31 million of PPP fee income compared to just $3.2 million in 2022, so year-over-year the core growth in PPP fee was significant. Slide 10 shows highlights from our investment portfolio. On the top right, you can see the yield on the portfolio remains stable given we aren't reinvesting in bonds, although the total portfolio balance only declined $31 million from last quarter, the portfolio actually declined $130 million from pay downs, maturities, and sales of bonds. Bond sales during the quarter totaled $82 million, which netted to a very small gain of less than $100,000. As our portfolio manager continues to find opportunities to sell bonds without realizing any meaningful losses, this $130 million decline was offset by an increase in the valuation of our bond portfolio of $96 million. On the bottom right, you can see we had a net unrealized loss on the mark-to-market of the available for sales securities portfolio of $296.7 million at year-end, which compared to $392.5 million in Q3, which reflected a nice recovery. On the bottom left, you will see the cash flow we expect to receive in 2023 of $360 million, which includes cash from principal and interest payments, maturities and expected bond sales. The bond portfolio will continue to be a strong source of liquidity to fund our loan growth through the year. Slide 11 contains the highlights of our loan portfolio. In the bottom left corner, you will see the stated fourth quarter loan yield, increasing substantially up to 82 basis to 5.58% from last quarter's yield of 4.76%. On the top right, I noted the yield on new and renewed loans, which also increased significantly from 4.96% last quarter, up to 6.10% this quarter, an increase of 114 basis points. On the bottom right, you will see 8 billion of loans or 67% of our portfolio are variable rate with 40% of the portfolio repricing in one month and 50% repricing in three months. So we will continue to see meaningful increases in interest income from the loan portfolio as the Fed continues to increase rates. Slide 12 shows the details related to our allowance for credit losses on loans. We did not record any provision expense during the fourth quarter. As a reminder, the provision expense recorded year-to-date was to establish the Day 1 CECL allowance associated with the acquisition of Level One. During the fourth quarter, we had net charge offs of $3.4 million, which brought the ending allowance for credit losses on loans to $223.3 million. The coverage ratio trend is shown in the graph on the top left. Our coverage ratio at the end of Q4 is 1.86%, down from 1.94% at the end of Q3 due to strong loan growth. This reserve coupled with the remaining fair value accretion of $31 million, which gives us some additional coverage for acquired loans, provides great credit protection given the uncertainty of the economic environment. Now, I will move on to Slide 13. The total cost of deposits in the bottom chart shows costs increased by 46 basis points up to a total cost of 92 basis points reflecting the competitive pricing environment. Our interest-bearing deposit cycle to-date beta at year-end was 29%, which was up from 20% last quarter. Competition for deposits continues to increase and we expect our deposit beta to increase in response. Slide 14 shows the trending of our net interest margin. Line 1 shows net interest income on a fully tax equivalent basis of $155.3 million, when you back out non-core interest income items such as fair value accretion on Line 2 and the impact of PPP loans shown on Line 3. Our core net interest income totaled $152.5 million, which is shown on Line 4. Compared to the prior quarter total of $143.1 million, the increase in core net interest income was $9.4 million, reflecting our higher loan yields. Stated net interest margin on Line 7 totaled 3.72% for the quarter. Adjusting for fair value accretion and the impact of PPP loans brings us to a core net interest margin of 3.65%, which is shown on Line 10, which is an increase of 18 basis points from last quarter's core NIM of 3.47%. The tax equivalent yield on earning assets increased 62 basis points and cost of funding only increased 45 basis points. On Slide 15, non-interest income totaled $24.1 million for the quarter, which was down $5.5 million from last quarter. Recall that we recorded a $5.3 million BOLI gain in the third quarter that elevated our total non-interest income in Q3. Customer-related fees this quarter totaled $21.9 million, which was relatively stable in all categories from prior quarter. Although, gains on the sale of mortgage loans remained at a modest level this quarter, mortgage loan production is still strong despite fourth quarter lower seasonal purchase trends as $217 million in loans were originated this quarter. We retained approximately 80% to 85% of these loans in the portfolio and sold the remainder in the secondary market. Moving to Slide 16, total expenses for the quarter totaled $89.7 million. Q4 included just $400,000 of lingering acquisition costs. So this is our first quarter with a normalized expense run rate and reflects the achievement of our cost savings goals associated with the acquisition of Level One. This was $6.7 million lower than third quarter as third quarter included $4 million of acquisition and severance costs. Core compensation related expenses were a bit lower than last quarter as we refined our incentive accruals and we recorded 700,000 of gains on sales of property, which offset expenses. Our low core efficiency ratio reflected on the top right shows that we continue to achieve strong operating leverage even while we invest in technology and talent to grow the business. Slide 17 shows our capital ratios, although the tangible common equity ratio remains below our target, we saw great improvement this quarter. The declines in tangible common equity that occurred during the year were due to accumulated other comprehensive income changes from the market valuation of the available for sale investment portfolio and the use of cash in the acquisition of Level One. As I mentioned earlier, we recovered $96 million in other comprehensive income from the bond portfolio valuation this quarter. That along with strong organic earnings created nice capital build. Considering these capital levels, along with $223 million in allowance for credit losses, we feel great about the safety and soundness of our balance sheet moving into 2023. Overall, our financial results were exceptionally strong this quarter and for the year 2022, reflecting the hard work and dedication of our First Merchantsâ teammates. That concludes my remarks and I will now turn it over to our Chief Credit Officer, John Martin to discuss asset quality. All right, excuse me. Thanks Michele and good morning. My remarks start on Slide 18 where I highlight the loan portfolio including segmentation, growth and composition. I'll comment on the updated portfolio inside slide then review asset quality and the non-performing asset roll forward before ending with a couple of high level comments on the environment. So turning to Slide 18, in the quarter, we experienced strong commercial loan growth, as Stu mentioned a moment ago, originated by our middle market lending team, which for us, our companies with revenue generally between $10 million and $500 million. Within the space, the greatest growth occurred in the manufacturing and wholesale trade sectors. Investment real estate increased $108 million on Line 5, bringing our balances back closer to where they were in the second quarter. And finally, we moderated the pace of portfolio, residential mortgage growth as we shifted back to a more originate and sell model, adding $89 million after several very strong quarters of portfolio growth. So after a quarter of 11.8% loan growth and combined annual organic loan growth of 13.9% or $1.3 billion for the year, the composition between C&I, non-owner occupied CRE and investment â excuse me, and residential mortgage loans remains in balance and substantially similar to what it was at the beginning of the year. So turning to Slide 19, I've updated the portfolio insight slide here where we slice the portfolio several different ways to provide additional transparency into its composition. Starting with C&I, the classification here includes sponsor finance as well as other â excuse me, as well as other owner-occupied CRE associated with the business. Our C&I portfolio is representative of our markets and thus has a concentration in manufacturing of 18% of the portfolio. Our current line utilization as Stu mentioned a moment ago, remained relatively stable at 41% up from roughly 40.2%, and Iâve provided historical utilization levels for reference. We participate in roughly $700 million of shared national credit balances across various industries with an average exposure of roughly $10 million. We also have $70 million of SBA guaranteed loans which includes $5 million of remaining PPP loans. Diving into the sponsor finance portfolio. There are 65 relationships roughly with 76% of the borrowers having a senior cash flow leverage of less than 3x and 79% having a total debt to cash flow leverage of less than 4x. 76% had a fixed charge coverage ratio of greater than 1.5x, which resulted in a current portfolio classified loan ratio of only 4.2%. We review the individual names in this portfolio quarterly for changes, including leverage, cash flow and borrower condition. Moving to construction finance. We have limited exposure to residential development and are primarily focused on one to four family non-track individual build residential construction loans, too mouthful. For commercial constructions, we continue to have a bias towards multi-family construction with a sub-concentration of student housing. Moving down to consumer and residential mortgage. The portfolio consists of primarily prime originated residential and consumer loans. These include HELOC and HE loans and to a much lesser extent, branch originated auto secured and miscellaneous other consumer loans. In summary, the portfolio is a balanced mix of what one might expect from a Midwest bank with mortgage, consumer sponsored finance and investment real estate businesses. Turning to Slide 20. As in previous quarters, this slide highlights our asset quality trends and current position. We continue to have a favorable asset quality profile with non-performing loans on line six at 42 basis points of loans down from 44 basis points to the prior quarter. Classified loans on line seven or those loans with a well-defined weakness increased roughly $8 million to $215 million or 1.79% of loans, which remains comparable to pre-pandemic levels. Then finally, we had net charge-offs of $3.4 million in the quarter. In the fourth quarter, we had a single borrower charge-off of $2.8 million related to a third quarter 2021 non-accrual loan. While we continued to pursue potential recovery strategies, the account is now fully charged-off. Then finishing up on Slide 21 where we roll forward the migration of non-performing loans, charge-offs, ORE and 90 days past due. For the quarter non-accrual loans were down $1.2 million on line six with the charge-off just mentioned and the resolution of $4.8 million of other non-accruals this quarter. This included the demonstrated performance and consistent payments from a prior year non-accrual account in the amount of $1.2 million and the resolution of various other non-accrual accounts all under $500,000 individually. Given the continued strong environment, weâve been able to balance the migration of new non-performing loans against the resolution of existing non-performing loans making $200,000 of improvement in the quarter on line 13 and only an increase of $5.8 million for the year after we added $9.4 million of Level 1 non-accrual loads. So overall borrow results have continued to remain stable despite higher prices and interest rates. I would say that while higher interest rates have had an impact, interest rate stress is built into our underwriting and the borrowers ability to adopt â excuse me, adjust either or bulk pricing and expenses has thus far buffered much of the impact. As one might expect, it is the financially weakest customers, consumers and commercial borrowers who are being affected most, and as always, we mitigate the environment by making sure we continue to monitor the portfolio for timely issue identification and the implementation of risk mitigation strategies. Well, thanks John. Slide 22, you can see we made some adjustments to the CAGRs. Weâre just looking back 10 years, probably a more relevant post-recession timeframe, which reflects really strong performance as evidenced by a number of the graphs. You can see earnings per share. The CAGR during that period is 10.5%. Adjusted CAGR for the AOCI on tangible book value per share is 9.3% and the return on tangible common equity across the board in the double digits. If you turn to Slide 23, again, we adjusted for 10 year timeframe. In our 10 year asset CAGR, which does include acquisitions as 15.3% inclusive of the eight acquisitions you see over to the right. Shelby County was included in the year end $4.3 billion. So strong growth and the best thing about our growth rate and moving from $4 billion to $18 billion, we love the fact that we have the ability to take care of more customers with a larger balance sheet. I think weâre an even greater attraction point for talent and thereâs opportunity for growth in this company. Weâre a growing organization and we continue to create new and unique ways for people to expand their career. Itâs been fun. If you look on the next Slide 24, itâs just a reminder of the vision, the mission statements, our team statement and our strategic imperatives of which we use to guide our decision making. Lisa, weâre happy to take questions at this time and just thank everyone for their attention. Okay. Thank you. [Operator Instructions] The first question I have is coming from Scott Siefers of Piper. Please go ahead. Your line is open. Good morning, everyone. Thank you for taking the question. Just the first question was on expectations around the margin. Maybe Michele just thoughts on where we go from here. Maybe best to think about it in terms of the 365 core margin, I guess. And then as a follow on more broadly on NII, do you feel like you can continue to grow NII sequentially from here as we look throughout 2023? Yes. Good morning, Scott. I think looking at net interest margin, particularly for Q1, we have assumed that we get two additional 25 basis point increases, one in February and one in March. And so looking for Q1, I think we would expect to see another 6 or so basis points of net interest margin growth. You had mentioned, looking at a 360, the one thing that I do want to remind everybody of is that given there are a couple less days in Q1, thereâs always a seasonal headwind on margin for us given our commercial orientation. And so that always ends up reducing our margin a few basis points. And so we would still expect to see net interest margin increase, even netting that impact out of a few basis points in Q1. Perfect. Thank you. And then your thoughts on the ability â the companyâs ability to continue to grow NII sequentially. I imagine at least with some margin expansion that should give you a little lift, but just overall thoughts would be welcome. Yes, sure. So for our net interest income for Q4, looking at like $149 million stated, $155 million on a fully tax equivalent basis, I would expect Q4 2023 net interest income to be a good run rate on average for 2023. We revisited our deposit beta assumptions and as a reminder, our historical deposit beta was 41%. Our assumption is that we will get up to a 40% deposit beta in Q1 and get up to 50% deposit betas later in the year. And so weâre being fairly conservative, I think in our outlook, but we think that it is going to be competitive and we want to be prepared for it. Okay, perfect. And just to make sure I heard correctly, so it sounds like what you just posted the fourth quarter 2022 NII, we should sort of average that for 2023, and thatâs where you think things will flush out? Yes, thatâs correct. I mean, I do think we will see net interest margin compression later in the year because of the deposit betas increasing, but I think we can offset that with our loan growth. Thank you. One moment while we prepare for the next question. The next question is coming from Daniel Tamayo of â excuse me, Raymond James. Iâm sorry. Thank you. Good morning, everyone. Maybe just following on the net interest income discussion and the expectation that we may get a decline in rates at some point possibly at the end of the year. Have you been making any changes to the sensitivity of the balance sheet to present perhaps mitigate that? Or is the asset sensitivity kind of the same as or similar to what itâs been prior? Yes. Weâre not making any real â any, I guess, meaningful change. We continue to look at protections in the bond portfolio against future falling interest rates, but more of the liquidity to fund loans. Thereâs not a lot of flexibility to make adjustments. If we didnât need that liquidity, you could probably move in and out of some sectors and make some changes. But we feel like we have a model that works in both interest rate environments. And as weâve assessed things like macro hedges, et cetera, the cost just seems prohibitive to us. Understood. Yes. And then I guess just switching gears here to reserves. Obviously youâve been having a provision of zero here for quite a while now. Just interested in your thoughts on when you think you may have to start providing for loan growth or maybe where that reserve ratio stabilizes here? Yeah. We donât expect to have to take provision in the near-term. We are modeling a mild recession in our CECL models currently. But each quarter will continue to evaluate coverage with our loan growth, and particularly if we see any credit events occurred during the quarter, but no plans in the near-term. Thank you. One moment while we prepare for the next question. The next question is coming from Terry McEvoy of Stephens. Your line is open. Hi. Maybe just start with your outlook for expenses as you think about overall wage inflation and then the uptick in FDIC costs as well. Yes, Iâd be happy to. Using the Q4 stated expense level as a base, we would expect probably mid-single digit growth and expenses, say 5% or 6%. I think that would accurately capture the inflation that weâre all experiencing and also some investments in technology and people as well as that FDIC increase that you mentioned. Mike Stewart here. Iâd say overall itâs been pretty stable. Banker stability, thereâs been some moving in, some moving out. Banking stability, weâre starting to see new business activities in some of the portfolios. So I call it overall pretty stable meaning, or Iâll interpret it, Mike Stewartâs way, which is kind of where I would expect to be less than two quarters posting integration with an outlook that I think weâre in a good position to take advantage of. Maybe one more, if I could squeeze it in. Mark, your comment in the press release caught my eye that the earnings power is pretty easy to digest when you look at the quarterly results. And as a former CFO, I can ask you the question, what exactly really stands out to you as being that kind of source of power. Thereâs a lot of things that go into earnings power, and weâd love to just get your view as we kind of think about 2023? Yes, happy to do it. I was really pleased to have â I would look forward to. I guess I should say, and I was pleased by this quarterâs result where we have fully digested our last acquisition. And I think you can see the earnings power in our numbers and really itâs just the fact that historically, I mean, we have guidance of mid to high single digit growth rate. And I feel like we always achieved those objectives. And you can go back a number of years and weâve had good success. I love the team that we have in place. I love how hard they work and the impact they try to make with our customers. I think our balance sheet is well hedged. I didnât mention if rates come down, we end up just with a nice natural hedge with our mortgage portfolio a little bit with our derivatives, the loan level hedges that we sell to our customers. So I look at our income statement and our balance sheet. I think we have a growing balance sheet on the asset side. We have an awesome core deposit base on the consumer side. I feel like our margins are fairly easy to understand and fairly predictable. And I feel like even though weâre investing in the business, which is exciting to everyone here, we continue to add talent. We continue to invest in technology that weâre able to do in a way that still produces a 50, a low 50s efficiency ratio. And this quarter was 48%. So, there are always headwinds in the business or tailwinds, and they migrate back and forth and my view is this is a bank that has consistent performance over time. And some of those things are a little bit like the weather. You wake up and see, is it snowing? Is it raining? Is the sun out? But Iâll tell you what everybody on our team, they get after it regardless of what the day looks like. And so I just feel like we have a team that works hard, produces results, and itâs pretty easy to see I think in our financials, especially in a quarter like Q4. Thank you. One moment while we prepare for the next question. Our next question comes from Damon DelMonte of KBW. Your line is open. Just wanted to â good morning. Just wanted to circle back on the provision outlook commentary, Michele. Obviously, the reserve is quite healthy and you guys have been quite clear on your desire to kind of grow into a normalized reserve level. If you could ballpark that like ultimate level that would â that might be helpful. Is there a way you could kind of quantify that? Well, I think that what I do is probably go back and think about like our Day 1 CECL adjustment that we wouldâve had before the pandemic hit. And that wouldâve been around, I think it was a coverage ratio of maybe 1.5%, if I recall. Okay, got it. And then obviously if you factor in a mild recession, you want to have a little bit more cushion for that? Yes, thatâs an understatement over the last couple years, Mark. And then I guess my next question, just kind of from a modeling standpoint, how should we think about fair value accretion going forward Michele? I think fair value accretion â looking at this quarterâs fair value accretion, which we do try to give you transparency to that. I think thatâs probably a pretty good run rate. Okay. Great. And then just lastly, kind of bigger picture Mark. Now that youâve digested Level One you kind of look at your competitive landscape across the upper Midwest there. How do you guys feel about M&A at this point? Do you feel like itâs something that you would look to engage in again? Or do you feel that the organic opportunities throughout your footprint are so strong that your content with just kind of focusing internally? Yes, weâre really excited about having a year where the focus is all internal. And there are â we will continue to call on the banks that we think might fit First Merchants well and enhance our growth rates in the future. But at least in 2023, it feels like, well, this team is really focused on just an internal year. I have some of our folks, they talk about, hey, is it â itâs hard to get bigger from an M&A perspective and better. And this is and weâd love to be able to do both all the time. But I think the reality is after absorbing a bank, the size of Level One, the focus needs to be on internal enhancements and getting better every day. So weâve got a couple key initiatives. Weâre working on including an upgrade in our online banking and mobile platform and a number of other things. I wonât get into them all, but we just think it makes the bank better and prepares us for the next acquisition. Thank you. One moment while we prepare for our next question. Our next question will come from Brian Martin of Janney. Your line is open. Yes, Iâm sorry. Thanks, Mark. I apologize. Good morning, everyone. So just wanted to touch base on the funding side just is funding loan growth this year. Just wondering what your thought is there? It sounds like thereâs still some utilization from the bond books and just kind of as it pertains to deposits in the loan-to-deposit ratio as you kind of go through the year? Yes, I mean, but I think weâre going to see some deposit growth. As I said, we had revisited our deposit betas and weâll get competitive, even more competitive to help fund that loan growth. And I think that coupled with the cash flow from our bond portfolio, I think that â those two funding sources we think will cover us. Okay. And as far as what youâre kind of targeting on the loan-to-deposit ratio, where do you kind of see that as you work through the year? I donât recall where that budget number is. Yes, itâs moving up. We kind of have long-term targets. Weâd like to see it around 93% or 94%. We donât get there this year. I think it â I think maybe we were at 88%, if I recall. Thatâs fine. Just a general trend if I can always follow back up, but in generally, you expected to move up from where we are here, just through that combination? Yes. Okay. Perfect. And then just the other two for me was Michele, it sounds like the margin just from your commentary, probably peaks maybe second quarter and then given kind of what youâre talking about, maybe the margin maybe slips a little bit, there are certain third quarters that in general fair how to think about it? I actually think weâll peak in the first quarter, and then I do think that we could see some progression [ph] in the quarters thereafter. That is helpful. And then just the run rate or just kind of the level of fee income today seems like pretty good level and it just builds off of this, is that, I know thereâs ins and outs every quarter. But just in general, how are you feeling about where thatâs at today or just how we should think about that? Yes, we have a couple of positive tailwinds in that space. Our private wealth business continues to grow around 10%, and thatâs the target we have for the year. And then the mortgage business, we expect to originate over $1 billion in mortgages this year. And I think the numbers are, portfolio at about 85% of that in 2022. And weâd like to get back to our more traditional model which would be, call it, 60:40 or even 70:30. And that 60% and 70% weâre talking about is sold into the secondary market. So I felt like in 2022, we took advantage of an opportunity to use our balance sheet. We had the liquidity to do it. The customers were kind of, I think, in shock by how high the 30-year rate went and it allowed us to use our balance sheet. But now thatâs moderated from as high as 7% to slightly under 6%. And I think it gives us the ability to move back into a fee-for-service model. And that should give us a little positive push on our non-interest income. Got you. Okay. Thatâs helpful. Okay, perfect. Well, thank you for taking the questions and congrats on a nice quarter and a nice year. Thank you. That concludes the Q&A session for today. I would like to turn the call over to Mark Hardwick, CEO for closing remarks. Go ahead, please. Thank you, Lisa. Just wanted to say thanks to everyone for tuning into the call, our employees, customers, our shareholders, our analysts. And we appreciate your interest in your investment. And we will â I guess you can count on this team to continue to work hard to deliver results for all of those critical stakeholders. Thank you.
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EarningCall_1297
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Hello, everyone. And welcome to TCBI Q4 2022 Earnings Call. My name is Nadia and I'll be coordinating the call today. [Operator Instructions] I would now hand over to your host, Jocelyn Kukulka, Head of Investor Relations to begin. Jocelyn , please go ahead. Good morning and thank you for joining us for TCBI's fourth quarter 2022 earnings conference call. I'm Jocelyn Kukulka, Head of Investor Relations. Before we begin, please be aware that this call will include forward-looking statements that are based on our current expectations of future results or events. Forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from these statements. Our forward-looking statements are as of the date of this call and we do not assume any obligation to update or revise them. Statements made on this call should be considered together with the cautionary statements and other information contained in today's earnings release, our most recent Annual Report on Form 10-K and subsequent filings with the SEC. We will refer to slides during today's presentation, which can be found along with the press release in the Investor Relations section of our website. Our speakers for the call today are Rob Holmes, President and CEO; and Matt Scurlock, CFO. At the conclusion of our prepared remarks, our operator will open up a Q&A session. Thank you for joining us today. This month marks my two-year anniversary at Texas Capital and the fifth completed quarter since we announced our new strategy on September 1, 2021. Upon arrival to the firm, and through the first several quarters of learning the company, we systematically identified the previously unacknowledged depth of issues in each client facing department and operational function, which were significant. We were quick to return to the office Memorial Day of 2021 and immediately began facing reality and addressing problems. As we dissected the company in its early days, it became quickly apparent that 2021 would be spent defining, communicating and mobilizing to enable the strategy and that we would need all of 2022 to deliver the wholesale transformation required before we can begin to make meaningful progress towards acceptable financial outcomes. The many identified challenges of the prior operating model and outlines for their planned remediation were described in detail in the strategic plan presented on September 1, of â21. Consistent with our multiyear roadmaps, we acted to address each item in a rigorous and methodical manner. And I would like to spend the first portion of this call detailing the pace and magnitude of these actions to both provide context for where we are on the journey and share perspective on the opportunity that is in front of us. As of today, we have addressed every single rebuild, reorganization and restructuring that we said we would do at the outset of our plan, plus much, much more. When I arrived, fee income was limited and loan growth unfocused and represented an uncoordinated series of transactions without a comprehensive strategy and the only products available to serve our clients were basic credit solutions, and very simplistic payment rails. Achieving client relevance and earning our cost of capital was impossible under the prior model, and our inability to serve clients in multiple ways led to an overemphasis of the loan product, rather than active consideration of the solution best fit for the client's current or prospective need. In contrast, today, we have the tools and resources with a more durable and valued offering for our clients with over 20 new investment banking, treasury management, and private wealth related services supporting our stated focus of being relevant to our clients throughout their lifecycles. Fees across these areas of focus are up $32 million, or 68% since full year 2020. And loan portfolio concentrations have been right sized through proactive risk reduction and focus calling efforts on the best-in-class Texas based clients. In early 2021, we made the first of many difficult decisions. We exited correspondent lending and sacrificed revenue to de-risk the balance sheet. Then, in â22, we sold a disconnected National Insurance Premium finance business, sacrificing loan growth in order to refocus our business. In aggregate, these two portfolios dispositions represented 10% of our starting loan portfolio composition. C&I loans now comprise 52% of the total portfolio, an increase of $3.3 billion, or 48% since yearend 2020. The implementation of the balance sheet committee into our routines has been an instrumental tool to ensure our capital is increasingly allocated to our target clients. 75% of commitments reviewed by the balance sheet committee during the last three quarters included treasury or ancillary product opportunities in addition to credit extension, evidencing our desired strategy is becoming increasingly ingrained in our daily client facing interactions. We said we would fix revenue contributions and build a client focused payments bank and we did. Sustainably earning a return greater than your cost of capital requires a stable and reliable funding base tied to the core clients that the firm exists to serve. However, the legacy funding strategy was also broken and characterized by an over reliance on disconnected, high cost, high beta national deposit verticals that created headwinds to earnings growth and volatility as interest rates change. We knew at the outset that transitioning our funding base would be hard and take time. With that sustained emphasis on earning the right to be our clients primary treasury bank would ultimately be a foundational element of our future success. Repositioning the deposit base consistent with our long-term strategy began in early â21, and the many subsequent actions have been directly aligned with this effort. Our first step was to rationalize a series of national deposit verticals, resulting in a $15 million reduction to annualized noninterest expense, which was reinvested in our focus strategy of supporting core Texas based clients. The proceeds contributed to doubling the number of clients facing treasury management professionals, and a wholesale tech enabled improvement in the treasury products platform. Overall, in â22, a significant portion of total technology projects spend was allocated to an improved treasury solutions platform. Projects both delivered and currently in flight are on time, on budget, and meeting the expectations originally established. To further enhance the funding structure of the firm, the highest cost, highest beta and shortest duration institutional index deposits were deliberately reduced from 32% to 13% of total deposits from the year-end 2020 to year-end â22. Coupled with a 15% growth of full year average operating deposits in â22 this is a critical input into our stated plans to transition the model to one with structurally less rate sensitivity and improved balance sheet efficiency, both of which are required to deliver against our desired return targets. By addressing the loan concentrations and the funding base, we're building a balanced company while establishing and now reinforcing cultural expectations that our success will not be marked by balance sheet growth, but instead by the relevance of our offerings and the quality of our advice. We said we'd fix the funding base. And as people in financial services well know, this is not easy. However, the foundation is established, and the transformation is well underway. To round out the balance sheet challenges, capital levels were also lower than peers, which both negatively impacted market perception, and raised concerns with regulators and rating agencies, anathema to this team's foundational commitment to financial resilience. This excess leverage also created an inability to proactively manage capital to take advantage of market opportunities in a manner consistent with long term value creation. During my first 15 weeks as CEO, we secured an improved outlook from one of our two rating agencies. Then recapitalize the firm, another decisive action. The recapitalization added approximately 250 basis points of total risk-based capital to a $300 million preferred offering, $375 million of subordinated debt and a first of its kind mortgage warehouse credit risk transfer. This demonstrated clear action against our stated commitment to building a business model, not reliant on excess leverage for short term returns, but instead operates from a through cycle position of strength, a core component of how we believe you create sustained, long-term value. Building upon these actions during 2022, the firm developed, implemented and began executing within a fully rebuilt internal capital planning and allocation framework. Delivering this analytic framework required addressing weaknesses, and the cumbersome and outdated legacy data infrastructure that impacted everything from call centers to expense allocations, limiting the usefulness of legacy modeling tools. These are now rebuilt. As a result of a disciplined approach and the resulting capital framework further proactive measures during the year led to a higher and increasingly more focused capital position. Well in excess of both our internally assessed risk profile and our externally communicated medium term targets. Our capital considerations extend beyond our regulatory ratios, and as we stated, are also focused on high quality tangible book value growth through cycle. In Q1, â22, we took another crucial action, we transferred $1 billion of our lowest coupon longest duration securities to held to maturity. To appropriately hedge the balance sheet should rates rise. As of yearend, this reclassification allowed us to avoid additional unrealized loss positions by approximately $120 million or 4% of TCE, contributing to our success and improving TCE ratios and supporting tangible book value during this volatile market period. Tangible book value per share has grown over 5% since yearend 2020, compared to a decline of nearly 8% amongst the peer set. This outperformance further confirms our commitment to steadily improving the value of the franchise even during a two-year period, where our focus was weighted more heavily towards building a bank than optimizing for short term financial returns. In addition to increasing both our absolute and relative capital levels, the firm both implemented and acted upon a wider range of previously unavailable tools to proactively manage the capital base. In Q2 of this year, we put in place our first ever share repurchase program, and over the course of the year, executed $115.3 million of repurchases, reducing total shares by 4% and a weighted average price equal to approximately 100% of the prior month's tangible book value. As of today, we have nearly completed the program and repurchased 5% of the shares since it began in Q2. Finally, in November, we've closed the well-received and highly financially accretive divestiture of our national insurance premium finance business BankDirect Capital. The 8% asset premium pull forward four years of earnings for this business generated approximately $165 million of capital, reduced 100% risk weighted assets by over $3 billion which resulted in approximately 220 basis points of CET 1. And importantly, it was accretive to earnings day one. We have worked tirelessly to be in this position of strength with solid conservative capital ratios to investment grade ratings, the first time since 2015, and a balanced business model. We have proven we prioritize a disciplined and professional approach to managing the firm's capital. During â23, we expect to hold north of 12% CET 1 with amounts in excess continue to be dynamically reallocated consistent with our well-defined strategy and observed risk appetite. We said we would fix the capital base and we did. Before the transformation high leverage was paired with a misallocated expense base not tied to a strategy or long-term scale. The legacy investment agenda lacked a sustained focus. Prioritize incompatible infrastructure, and expensive build outs for non-core businesses. Now we successfully re-underwrote all of our expenses in over the last year steadily reposition the cost base to support consistent advancements in the businesses where we know we can compete and win. During 2021, we undertook a series of actions to release unproductive expense to invest against the strategy stated. The corresponding lending businesses wound down and MSR portfolio sold in the second quarter to both improve through cycle earnings, variability and to unlock $70 million of expenses that were directly reinvested into the strategy. Underused, inefficient and redundant software technology assets were written off for a total of $12 million in the third quarter, coupled with additional $15 million of deposit vertical rationalization and $40 million of other realized internal opportunities. In the first year, we reposition approximately $140 million of run rate expenses, enabling the transformational activities delivered in 2022. Additional savings through the divestiture of bank direct in late 2022 allows for $36 million of annual expense to directly contribute to improve profitability. The go forward run rate is a clean expense base directly matched to our strategic goals as we move to a period of more normal investment and improving performance. Expense alignment is a foundational tenet of future scale, and we expect the proportion of noninterest expense directly attributable to our people, technology and operational infrastructure to remain a priority. We said we would fix the expense space and we did. Since the previous operating model offered limited or a poorly functioning products, we and relied on excess leverage to deliver returns. The historical loan portfolio concentrations were cyclical and overweight. This outsized risk profile, coupled with poor client selection in energy, and leverage lending led to substantial charge-offs, $273 million during 2019 and 2020. While large holds led to overexposure in the wrong sectors, and sub optimal risk adjusted returns. We are now providing capital discipline via the balance sheet committee, coupled with a new CEO led Enterprise Risk culture ensures resources are more prudently directed towards achieving our goal of earning deep, long term relationships. Our entire credit risk management team and platform has rebuilt, aligning sector specific credit expertise, with a new set of business leaders focused on client selection and adherence to appropriately established concentration and hold limits. Loan portfolio diversification has materially improved, as a balance sheet is now a vehicle to support our clients broad financial needs, rather than an over emphasize internal growth metric providing a false sense or short-lived success. New credit disciplines are supported by a complete overhaul of our underlying processes, systems and technologies. After $7 million of legacy spend associated with unsuccessful attempts to implement a credit onboarding process, the firm on the other hand delivered its first integrated loan management system named Lscape, a significant contributor to reducing operational risk. This loan management system enables one time data capture, standardized workflows for more efficient processing, and improve client and stakeholder visibility, including foundational capabilities for future automation. Finally, we continue to thoughtfully resolve legacy credit issues while building a reserve consistent with our objective of being appropriately conservative. Current reserve levels are now 49 basis points greater than CECL day one in the top 20% of peers as a percent of total loans, and over 5.2X nonperforming loans. We have said before that being appropriately reserved is both a metric and a mindset. And we've coupled with our strong capital position, a competitive advantage heading into this year. We said we'd fixed loan concentrations and focus on client selection. And we did. Finally, the historical organizational structure on the bank, managed with a siloed mindset did not allow for the ability to scale or provide adequate transparency. During my first year at the firm, we established organizational routines to ensure resources are effectively allocated against strategic priorities, and that decision making and execution is not hindered by inefficient processes with limited information. All necessary parties are at the table to achieve our goals. Executive leadership also implemented an expectation of clear communication, execution, transparency and accountability throughout the enterprise. This was further emphasized firmwide as functions were centralized, and the operating committee restructured to directly align accountability against strategic and financial initiatives. During 2022, we further reorganized operating model around client delivery to emphasize client experience. Firmwide every process flow across credit delivery, onboarding, treasury services, and deposits and payments was reconstructed to meet this objective, and is now further grounded in solidified risk controls through our risk control self-assessments. Detailed procedures are also now in place, serving to automate manual and error prone processes. While operational reporting dashboards now systematically measure and highlight opportunities, driving continuous improvement and reduce operational risk. The organization is now structured within a more efficient, higher quality operating model driving both client and employee satisfaction while supporting feature scale. We said we would reimagine the client journey by improving the organization structure and operational infrastructure. And we did. By addressing the legacy challenges of the previous operating model, we built the coverage, product and technology required to serve our target clients and are now poised to deliver the next phase of our multiyear transformation. Our business banking, middle market and corporate coverage areas are well established and match each client set with a talent, products and offerings they need to succeed. Since I arrived, we have grown the number of clients facing professionals by 1.9x across our defined industry and geographic coverage. By combining this coverage model, with expanded treasury solutions, a holistic private wealth offering and unique investment banking capabilities. This construct allows us to serve clients through the entirety of their lifecycle with a delivery model and solution set tailored to support them at each step of their journey. As we seek to be relevant to our clients each day, assisting them in addressing their day to day working capital needs in an efficient and secure manner. We meaningfully improved our treasury and payments platforms, completely transforming operations, technology and product to build a real payments bank. In 2022, the Treasury Solutions Group implemented a new enterprise payments platform and launched API connectivity, significantly improving the quality and ease of digital banking for our clients. Said simply, our cash management offering from basic wires on an antiquated platform to a best-in-class Treasury solutions platform. Our investment banking division Texas Capital Securities in a Texas based institution offering a full suite of investment banking products and services focused on delivering exceptional outcomes for our clients launched in mid-2022, well ahead of schedule. We are now leveraging our deep knowledge of industry dynamics complemented by our extensive network of capital sources to deliver results that are aligned to our client's definition of success. The sales and trading group now offers significant experience in mortgage securities, and corporate fixed income, convertible and equity markets. Leveraging our considerable network of domestic and international institutional relationships, our team is now providing clients with actionable insight and access to global markets. In the years since we receive FINRA approval, Texas Capital Securities have delivered the following first. Our first swap trade, first FX spot trade, first TBA trade, first specified MBS pool trade. First whole loan trade, first corporate bond trade, first corporate loan trade, first equity trade, first buy- side advisory mandate and close its first sell side advisory success fee. We on boarded 150 new clients and traded over $9 billion of mortgage and corporate debt and equity securities. And finally, Texas Capital Securities partnership with mortgage finance has been critical in evolving the business from a warehouse only platform into a differentiated industry vertical, characterized by multiple new products and services to meet clientsâ needs in real time, resulting in incremental treasury and deposit relationships with top tier national mortgage lenders. The full lifecycle of the client extends beyond their corporate profile and includes their personal financial wellbeing. We are rebuilding and significantly enhancing our successful but subscale private wealth business and our halfway through our project plan, which includes updating our go-to-market strategy, expanding our products, improving our back-office operations, investing in our front-end client experience and adding additional quality talent. Completion of this wholesale improvement is targeted by the middle of this year. In total, we have launched over 20 new products and services in the last two years and have detailed an achievable roadmap to deliver the over 25 new offerings targeted by 2025. The improvements of our technology and operating platform are also significant. We are beginning to see our investments generate efficiencies in operations, while uplifting the client experience through vastly improved onboarding times. Straight through processing, and reduced meantime, to resolve client issues and incidents. We internally developed and delivered a market leading cloud native software named Initio, our proprietary account opening and onboarding solution, which has received praise from our beta clients. And we expect that over 50% of all treasury onboarding requests will be completed digitally by March. This means that existing and new commercial clients will be able to self-serve account opening products and services will be attached automatically, and they can use the account same day. This puts us at or above parity, we will compare to the most digitally forward banks in the country. Other transformational technology infrastructure builds include CorTex, our completely modern API-driven services platform, C360, a cross LOB operations management system, and a completely modernized cloud-based data platform. Underneath these new platforms and applications, we increase transparency and efficiency of operations from front end to back office through a CRM overhaul. Another legacy challenge relating to $20 million of legacy expense spent on something that simply did not work when I arrived. The implementation of corporate management information system for cascading metrics, automation of infrastructure, network improvements, deployment of new hardware, and the implementation of a new cloud-based call center platform. I have often said the biggest risk to our strategy was a need to build each pillar of the platform simultaneously, which was an acknowledgment of both our opportunity and of the limited infrastructure in place. Through five quarters of dedication and focused execution by people across the firm, this execution risk has been further mitigated as the businesses were built, and the needed capabilities landed on a more scalable platform. The accomplishments over the last two years result in a firm that is poised to begin delivering structurally higher and more stable financial returns for our shareholders over time. We are heading into 2023 operating from a position of strength, the expense and capital base are aligned directly to our strategic priorities. We are recycling capital into new and profitable relationships, and improving relevance with both existing and new clients. Our balance sheet is the best since the bank's founding, portfolio concentrations increasingly match our desired composition. Liquidity and funding are higher quality. And our institutional financial reliance is a true strategic advantage, positioning us well for the potentially challenging operating environment ahead. The significant investments and efforts to rebuild the firm are largely in the ground, and we are transitioning our focus towards leveraging the full breadth of a new platform to achieving first call status with the best clients and prospects in our markets. This thoughtfully and deliberately rebuilt client focused business model is designed to earn above our cost of capital through cycle and drive structurally higher, more sustainable earnings. It is very important to appreciate that this transformation is the result of the tireless work of each of our 2,200 people across the entirety of the firm, who truly bought into the strategy accepted that the rebuild is harder than the status quo, but believed it was worth it as we work together to build a new company. Collectively, we make up the new Texas Capital. I'd like to express my sincere appreciation for the continued efforts and dedication to our strategy, vision, goals and our core values. We have so much to look forward to in 2023 as we execute upon what we have established this year. I'll now turn the call over to Matt, who will provide the financial details for the fourth quarter. Thanks, Rob. And good morning. As Rob described, we're increasingly transitioning the firm's focus from a period of concentrated build to a state of purposeful execution as we begin to mature uniquely broad and client centric offering into scaling platform that delivers against our long-term objectives. Today with quiet coverage build out largely complete and targeted capabilities now in place, we are positioned to accelerate delivery against our defined financial goals. Our value proposition continues to resonate, and C&I loans increased again this quarter finishing the year up $2.3 billion, or 29%, relative to the fourth quarter of 2021. We also deliver notable progress in our fee generating businesses in the quarter, which will over time grow in contribution as we improve our relevance with a now consistently expanding client base. Treasury product fees are up 27% year-over-year, reflecting increased adoption of our newly built cash management and payment capabilities. Wealth Management income also rose materially year-over-year as AUM growth of 11% outpaced broad market declines, resulting a 14% increase in wealth management and trust fee income during 2022. Rounding out our noninterest income areas of focus, investment banking and trading income grew 43% this year, with a $11.9 million realized in the fourth quarter, setting the high watermark since we launched the business earlier this year. Taken together, fee income from our areas of focus increased by approximately $19 million or 31% year-over-year, representing steadily improving client receptivity to the completely refreshed operating model and capability set Rob described in his comments. Turning to slide 11, total adjusted revenue was up $12.3 million or 19% annualized linked quarter, and increased $51.2 million or 23% when compared to fourth quarter of 2021. Quarterly results benefited from an $8.5 million increase in net interest income, mainly attributable to the continued realized benefits for assets instead of balance sheet, modest improvements in the composition of our asset mix and continued reduction in our highest cost shortest duration deposit sources. Additionally, investment banking fee income was up by $4.1 million on a linked quarter basis. A syndicated loan fees doubled quarter-over-quarter and increased 56% year-over-year, a result of improved capabilities and stated client focus. The divestiture of our insurance payment finance business closed in November resulting in the recognition of a nonrecurring $248.5 million pretax gain. We stated clearly that while our long-term plans do account for continued investment much of the initial lift to deliver the foundational talent, technology, products and capabilities was incurred over the past two years. And we do expect slowing expense growth in 2023. Q4 expenses include several nonrecurring items related to both the divestiture and restructuring reserves associated with the continued implementation of our Target Operating Model. These items include $13 million in legal and professional expense related to the divestiture, $9.8 million in restructuring expenses, and $8 million to fund the newly created Texas Capital Bank Foundation. Taken together, PPNR excluding nonrecurring items increased 13% linked quarter to $94.4 million, which is a 20% increase relative to the fourth quarter of last year. As we indicated during our Q3 quarterly call after achieving this important milestone in the last quarter, we do expect to maintain year-over-year quarterly PPNRR growth moving forward, including throughout 2023. Of note, the domestic business unit contributed $8.3 million of revenue and $2.8 million of expense during the month of October resulting at $5.9 million, PPNR contribution during Q4 when applying our observed cost of funds for the month of October. As Rob mentioned with the proceeds invested into cash, we recognized immediate PPNR accretion. Adjusted net income to common was $44.3 million for the quarter down 11% compared to the third quarter as a result of the $22 million increase in quarter-over-quarter provision expense. Overall credit quality remains historically strong. Although, we continue to prepare for inevitable normalization, which based on external factors appears increasingly likely this year. We recognize $15 million in net charge offs during the quarter as expected losses on certain legacy credits move closer to resolution compared to net charge offs of %2.7 million in Q3. We've previously indicated that we closely monitor and identify list of legacy credits. In the weighted average origination date, the charge off recognized during the quarter was mid-2013. Criticized loans increased $29 million quarter-over-quarter to 2.66% of LHI, primarily a result of continued migration and a small number of consumer dependent C&I credits. This quarterâs provision expense was impacted by both realized charge offs and observed and expected portfolio trends. Finally, on capital, we repurchased $65.3 million or 1.1 million of common shares during the quarter equal to 2.3% of prior quarter shares outstanding at a weighted average price of $57.20. The modest decline in interest rate outlook as of yearend resulted in slight improvement in AOCI of $16.5 million. Considering the realized gain on divestiture we ended the year with CET 1 of 13% and tangible book value per share of $56.45. Quarter-to-date, we have repurchased approximate 450,000 shares of common stock and have nearly completed our inaugural share repurchase program. Turning to slide 12, C&I loan growth moderated this quarter as a more cautious client sentiment described on the third quarter call resulted in period end C&I loan growth of $143 million. Even with the reduction in recent volumes, sustained loan growth over the past four quarters has driven C&I balances excluding PPP and insurance premium finance loans $2.3 billion or 29% higher year-over-year, consistently delivering our improving value proposition to core Texas based businesses resulting in a balance sheet increasingly comprised of a client base, who benefits from our broadening platform of available products solutions delivered within a rebuilt and enhance client journey. Growth continues to come primarily from new and expanded relationships. As utilization rates move down slightly in the quarter to 51% and remain in line with our pre-COVID average of low-50s. Moving to real estate, period end real estate balances increased to $183 million, up 4% in the quarter, as pay off slowed, supported by modest mix shift toward term over the last 12 months. This is one of the most mature businesses at the firm and we take it through cycle view grounded in client selection and managed portfolio using established and well tested concentration limits. New origination volumes slowed in the back half of 2022 and remained focused on multifamily. Reflecting both our deep experience in the space and observed performance through credit and interest rates cycles. Average mortgage finance loans declined by 19% in the quarter compared favorably to the estimated 25% or greater levels of broader market contraction as our industry specific product offerings are increasingly compelling in what is and is expected to continue to be a historically challenged market environment. Full year industry originations declined by approximately 50% in 2022, compared to our full year average decrease of 34%. As a reminder, while distorted by the rising rate environment experienced over the last 12 months, outstanding balances in this business reflect the typical seasonality associated with home buying activity, rising in the second and third quarter then falling in the fourth and the first. Assuming the current rate outlook remains intact, expectations are for total market origination to decline by 15% to 20% in the first quarter. We expect the same dynamic in Q1 as seasonality is paired with continued rate and industry specific pressures. Near term pipelines remain reflective of a more cautious client outlook, and are comparable to the levels we saw at the beginning of Q4. Moving to slide 13. As Rob discussed through a series of actions over the last two years, we are thoughtfully shifting our balance sheet to businesses where we believe multiple client touch points will over time, result in a higher quality funding day, increasingly comprised of our clients primary operating accounts. While pleased with the observed progress and associated benefits relative to the last tightening cycle, we are realistic in our expectations for achieving target state. We remain in the early stages of our funding transformation and do anticipate deposit costs and betas to continue increasing as market pricing responds to the rapid pace of Fed tightening. Total ending period deposits declined 7% quarter-over-quarter with changes in the underlying mix reflective of both a continued funding transition and a tightening rate environment and predictable seasonality exacerbated by market driven trends. Noninterest bearing deposits represent a 42% total deposit at period end and we're down 16% linked quarter as mortgage finance deposits experienced seasonal fluctuations associated with tax payments from escrow accounts, coupled with moderate impacts from select client repositioning. Tax related escrow deposits will begin to rebuild in Q1 as it does every year. And if market conditions hold, we would expect average quarterly mortgage finance deposits to remain between 100% to 120% of average total mortgage finance loans throughout next year. Average full year commercial operating deposits increased 15% reflecting our focus strategy to generate and sustain operating account growth. Our highest cost and most rate sensitive deposit sources continue to be deemphasized and favor more granular and modestly less rate sensitive options including Bask. Q4 ending period balances and high beta index deposits contracted $788 million and now represent just 13% of total deposits. These balances are down $3.7 billion or 55% year-over-year. Due to our sound current and prospective liquidity position, this quarter we also had $170 million of brokered CDs mature without replacement. Ending period brokered CD balances of $1.1 billion are expected to continue mature throughout the year, with $228 million of 1.2% coupon CDs rolling off in the first quarter. The remaining weighted average portfolio coupon is 2.5%. Supported by the proceeds and accompanying flexibility created by the BDCF transaction, we will continue to use our balance sheet to onboard clients who we believe there are or will be meaningful treasury opportunities. Continued reduction in our highest cost deposit sources is likely to persist as improving the quality of our liquidity is a prerequisite to establishing a more efficient balance sheet. Despite this focus, our current outlook anticipates sustained pricing pressure. And we do expect continued upward trajectory for interest bearing deposit betas alongside planned Fed rate increases. Turning to NII sensitivity on page 14, as expected after decreasing materially in Q3, our asset sensitivity increased this quarter, up modestly to 8% or $77 million and a plus 100 basis points shock scenarios on a static balance sheet as the underlying composition changed quarter-over-quarter. Proceeds from the 61% Fixed Rate BDCF portfolio were invested in cash and the reduction in our most rate sensitive deposits increased overall exposure to changing rates. Model based net interest income depicted on the slide assumes the balance sheet remains constant in terms of size and composition, meaning the expected seasonality of various businesses is not captured. Nor is the anticipated evolution of our business over the defined time period. This is a potentially useful view for comparing point time earnings at risk across firms, but should not be viewed as a forecast. Following a brief pause in early Q4, subsequent to the closing of the BDCF transaction, actions resumed to reduce the amount of future earnings exposed to changes in forward interest rates with the addition of $255 million of securities to the investment portfolio. The core component of our asset sensitivity profile is a large portion of our earning asset index that reprices, with changes in short term rates, exiting the year 93% of total LHI portfolio excluding MFL is a variable rate with 86% of these ones tied out of prime or one month index. Net interest income produced by mortgage finance business is not as sensitive as the rest of the portfolio to changes in index rates due to the pricing dynamic of the associated escrow deposits held in noninterest-bearing accounts, which in some cases receive compensation in the form of interest rate credit. The asset sensitivity figures depicted on the slide account for the behavior pricing relative to both mortgage finance loans and deposits. Moving to slide 15, net interest margin increased by 21 basis points this quarter while net interest income rose $8.5 million, predominantly as a function of higher loan yields and increased income from significantly larger cash balances from the divestiture proceeds partially offset by an expected increase in funding costs. Similar to the last several quarters timing associated with the late quarter Fed move coupled with quarter and spot rates suggests the full impact of the 125-basis point Q4 rate increase will be more fully realized in Q1. The investment portfolio grew this quarter as we reinvested $65 million of cash flows and began the multi quarter process of remixing excess cash balances by purchasing $255 million in Agency MBS and US Treasury securities. The purchases came on the book yet 4.7% yield versus those rolling off around 1.5%. As the characteristics of our deposit base continue to improve, we will be actively looking to prudently bring our excess liquidity levels closer to our published targets, while also taking advantage of market opportunity to more efficiently balance our liquid asset composition with additional securities purchases. Noninterest expense adjusted for nonrecurring items benefited in Q4 from two months of cost savings associated with the insurance premium finance divestiture. In addition to the previously discussed nonrecurring expenses, legal and professional expenses rose in part due to noninterest expenses associated with deposit compensation. This expense is expected to increase in 2023. And is included in our full year noninterest expense guidance. Year-over-year adjusted noninterest expense grew 16% or 13%when compared to the $600 million starting point referenced in our 2022 full year guidance. Expense priority established over the last year remains intact. And we continue the disciplined process of systematically aligning our expense base with our published strategic priorities. Turning to page 16, criticized loans increased $29.2 million or 6% in the quarter to $513.2 million or 2.66% LHI, as early grade migration in these categories continues to be primarily driven by commercial clients reliant specifically on consumer discretionary income, while criticized loans are down 12% since yearend 2021, we do expect the breadth of industries and client types experiencing great migration to expand in the coming quarters as the economy slows and are pleased to be entering the year with reserve levels at 1.31% of total LHI and 5.2x nonaccrual loans, both at or near cyclical highs. Capital levels are also strong and we remain committed to managing the hard-earned capital base in a disciplined and analytically rigorous manner focused on driving long term shareholder value. As Rob mentioned, the gain on the insurance premium finance that's a sure bolstered our already strong capital position and we, end of the year in the best capital position in firm history. CET 1 in total risk based capital finish the quarter at 13% and 17.7% respectively, in the top 10% of peers and well in excess of both short and longer term targets. Finally, as we near completion of our inaugural share repurchase program, the board has authorized a new $150 million program. As we did in 2022, we will consider the array of capital uses as we make capital allocation decisions to enhance long term shareholder value. Consistent with our previously disclosed framework, our preference remains reinvesting capital into the value accretive growth of our Texas based franchise, and we are pleased to be operating with a strong hand heading into a potentially more challenged operating environment. Looking ahead at 2023, consistent with methodology disclosed last year to better highlight the impact of our potential financial performance, our guidance accounts for the forward rate curve, and assumes a peak Fed funds rate of 5.25% in mid-2023, for the year end exit rate of 4.75%. We expect total revenue to increase year-over-year in the mid-teens percent range. As full year impacts of the balance sheet transitions are paired with increasing contribution from recently added coverage and capabilities. As Rob and I both indicated earlier, a large majority of the expense growth related to the wholesale transformation and infrastructure bill is behind us. We, of course have additional investments already in flight but we expect to begin realizing operating efficiencies as we enter the year executing within our target model. As a result, we expect full year noninterest expense growth of low double digits. Together, these expectations should result in the maintenance of operating leverage as defined as year-over-year quarterly PPNR growth. This metric is important given that aforementioned seasonality associated with our business, we expect a predictable decline in linked quarter performance moving into the traditionally slower first quarter, which is why measuring the PPNR relative to the same quarter in the prior year is a more appropriate metric by which to assess progress. Moving to the balance sheet. Market expectations call for further decline in mortgage originations during 2023, with full year volumes anticipated to be down by more than 25% for 2022 levels. Given our market positioning and expanded products, we do expect to maintain modest outperformance. We remain cautious given the wide range of potential rate and market outcomes. As we continue to deploy cash proceeds from the divestiture, we will prioritize actions that reduce our assets sensitivity and help stabilize the earnings power of the banks through cycle. Over the course of the year, we will look to bring our published sensitivity down to a mid-single digit level as measured in UP 100 Shock scenario, with the pace and leverage used ultimately dictated by our strategic progress and market conditions. At this point in our transformation, we remain committed to holding greater than 20% of our total assets in cash and securities. But do expect the absolute level to come down through the year and the composition to change consistent with our goals to reduce interest rate sensitivity. When we set forth the strategic plan, we counted for an economic downturn over our planning horizon in the path to reach our 2025 goals does account for more normalized level of provision. Lastly, we are committed to conservative capital levels. And As Rob mentioned, we'll maintain a CET 1 capital ratio of 12% throughout 2023 as we earn the right to operate at a lower level in the future. With that, I hand the call back over to Rob. Hey, good morning. Thanks for taking the questions. Wanted to first ask, Rob, I'm curious about how you view the environment where in the past, it was really hard to hire talent or it was a competitive landscape. And it seems like that's eased. And so I was curious and thinking about the expense growth this year. If you're expecting maybe the acceleration of hires, just given the environment with a pull back from some competitors on that front. Sure, thanks. It's good question. Just the broader Texas economy Iâd say manufacturing output today declined as did in the fourth quarter. Other firms are not hiring as aggressively in the past for the summer months, the year-over-year employment growth in Texas fell but not as much as the national average. So that's just kind of the macro, if you will, we as a firm as we stated in our comments, the majority of the spend is behind us in the transformation. That includes wholesale hiring as well. We built the businesses, they're largely in place and they'll grow as they grow organically. We do have different opportunities to add select talent on a select basis as we move forward. But we feel really, really good where we are. The good news is, as you said, the hiring across the board has slowed the competition for talent, I think has peaked, but that's just a coincidence of where we are on the transformation. So I think we're going to slow hiring, but it's not because of the environment necessarily. It's because of where we are in the journey. Okay, that's helpful. And then, Matt, a question for you, want to make sure I understood the balance sheet management going forward, you mentioned buying securities, want to make sure or maybe get a little better color on the magnitude of securities purchases, managing cash position, and then just thinking about the overall balance sheet management into â23 in terms of thinking about the liquidity on the balance sheet, maybe you can keep the balance sheet fairly flattish. Or if you intend to grow it if the deposits are successful and growing from here. Yes, happy to take that, Brett, surely complex calculus as you would expect, but like everything else we're doing around here really taken about our aggregate ability to steer the place to a point where we can sustainably earn a return in excess of the cost of capital. So we look at the impact of changing rates on the balance sheet and business model, we generally let that guide our positioning, just stated in the comments that we would like to take the earnings at risk and up 100 scenario down into the mid-single digits this year, while keeping liquidity assets above that 20% threshold, you will see the mix likely shift from heavier weighting toward cash into securities as we do that, but of course, it will balance the securities and swap portfolio depending on where we see forward rates going. And just to be clear, Matt, what, is there a targeted cash position you think you would want to get to or might end up at? Yes, I think it gets pretty dependent on the rate environment. But if you look at the portion of our total liquidity assets today that sitting cash versus securities, there's certainly a scenario where that could flip and be heavier weighted to securities. Hey, thanks. Good morning. I want to drill down on deposits and specifically on the DDAs. Matt, you provide a disclosure around mortgage financed DDAs, I think as a percent of mortgage finance loans. Can you just kind of clarify what that disclosure was for the year? Yes, you bet Matt. So in general, mortgage finance DDAs are going to equal about 120% mortgage financed loans. And that's going to depend on where you are seasonally. There's obviously in any year outflows as people pay their taxes, and then you start to see that build back up into the first quarter but generally can think about is about 100% to 120% deposits relative to loans that are mortgage financed. Got it, okay, that's helpful. I appreciate that disclosure. And then, I guess, kind of looking at DDAs from non-mortgage finance clients, I think there were $6 billion year end. And I know the bank is adding new, commercial operating accounts assuming itâs higher, but on the other hand, with higher rates, we're seeing borrowers move deposits into interest bearing accounts. So we'd love to hear any kind of commentary about expectations of the non-Mortgage Financed DDA balances from here. Thanks. Yes, Matt. So we've been really pleased with success in adding commercial operating accounts over the last 2 years. We noted that average deposits in that space up 15% year-over-year. We expect candidly, an acceleration in our ability to add clients. Some of the balance sheet and income statement impact could be muted by changes in earnings credit rate as rates rise, but both our ability to attract those clients and their deposits along with continued penetration for the new treasury products and services to Robâs comment are right on track. We expect continuation of that trend for the duration of this year. Okay, appreciate that, Matt. And then just lastly around the strategy, good to see you reiterate the guidance around the positive operating leverage. And I guess from our perspective, it's clear the bank has a good tailwind right now from higher rates and the bank sensitivity to higher rates, but assuming the Fed takes a pause here the near term, it feels like there could be some pressure as you move in the back half of next year or this year on the margin. So just looking for any kind of commentary that you can get us more comfortable with maintaining that positive operating leverage to back half this year and into next year with rates maybe not as cooperative. Thanks. Yes, thanks, Matt, for calling out the importance of that year-over-year quarterly PPNR. So we just want to reemphasize is that as we did in the comments, the seasonality associated with the balance sheet and ability to generate earnings. So we said all along that trying to build a business model that is less dependent on rates. And as we continue to accelerate progress across the new capability build in particular TS, private wealth, and notably the investment bank, our ability to generate earnings from sources other than margins is going to improve, which does give us confidence that despite the rate outlook, we'll be able to achieve guidance this year. Thank you. Good morning. Hi, curious on asset quality, your higher level of debt charge-off this quarter as you take some losses on some legacy loans. How much more loss contain do you see in this legacy portfolio that maybe you could be realizing in â23 or â24. The legacy issues that we've talked about in the past, Jennifer, that I think it was pretty vocal for a while about the amount that we saw have worked -- has worked its way down to about $130 million left in the portfolio. And that's -- that -- those are loans and clients that we would like to work off the balance sheet over time, but it's down to a very manageable number. Okay, that's not too much left. And is that $130 million concentrated in any one industry or type of loan or? No, it's, what, itâs price, you know what, I'll let Matt correct me, for what I understand is itâs the majority of it is, is four sponsors across the country, without a sponsor relationship, some of the same sponsors that the firm had trouble with in the past, and we're working our way through those, the rest is pretty distributed. Yes. I think that's entirely accurate, Jennifer, there are legacy credits wholly inconsistent with how we underwrite today. And we comment in the script that the weighted average origination date of those charge offs was 2013. So we'll continue to work our way through those as we get opportunity for resolution, but wholly inconsistent with underwriting since Robâs arrival. And what are you seeing in terms of credit trends in the rest of the portfolio other than what you noted in terms of non-accruals being up from businesses, more dependent on discretionary on consumer discretionary? Yes, Jennifer, I mean the Fed has been on the path now for nearly a year to try to increase unemployment and lower consumer spending. Over that same period, we've been consistently conservative in our view and our approach to how we manage the reserve adding nearly 40 basis points over the last 12 months. So while all the later stage indicators of credit health have actually improved year-over-year, so criticize down 12% and LHI down 33%. We are seeing some downgrades in the past rated book, which we would honestly expect. So when coupled with our conservative outlook, that's what drove the provision expense. Thereâre no real trends to highlight there, other than just we're going to continue to take a conservative approach and be timely in our changes and underlying credit grades. Thank you. Good morning, guys. So I want to start with the share buyback, if you look at, yes, thank you. I wanted to start with the share buyback, if you look at last year, so 2022, you repurchase about $115 million of stocks about 4% of the company. And despite doing that your common equity Tier 1 increase from 11% to 13%. So it feels like the buyback could be a lot larger in size this year versus last year. I mean is that correct? Is there any way to help us size how big the share buyback could be this year? As you, yes, thanks, Brady. I thought you'd be happy with our first share repurchase program, but you want more. I'm kidding. I thought on a serious note, we talked about before we have a highly disciplined framework that we go through on share repurchase, as you know, much to your frustration, and some others. We look at organic growth, other opportunities, there's a whole metric of framework that we work our way through, before we decide on capital actions. Before two years ago, we weren't in a position to do any capital actions whatsoever. Now, as you know, we're still balancing that against business opportunities. And as you know, my preference is to invest in the business, in organic growth and progress across the firm. But the fact of the matter is, when you can buy back $150 million of shares at tangible book, that's pretty good. And you can't ignore that. And we could afford to do both at this period in time, with very conservative capital liquidity levels, and still reinvest in the business. So we felt good about it. And we will continue to be disciplined and opportunistic in the buybacks as opportunity presents himself. So to project how much this year, I canât do that. But Iâll tell you weâll, sorry. Sorry, Brady, go ahead. Yes, I just got my follow up question is just kind of a bigger picture question on the ROA. Now we have the 1.1% target out there for 2025. As I look at the core ROA for last year it was about 50 basis points. That's down from 65 basis points in 2021. I know you guys are investing a lot in a revenue producing activities. So when should we expect to start to see the ROA really inflect higher? And do you guys still feel good about the 1.1% in 2025? We definitely feel good about our ability to achieve the longer-term targets, Brady. And you'll see material progress throughout the course of the year. So seasonal step back in the first quarter, which will include most performance metrics, as you have seasonally slow warehouse but then for the duration of the year, you'll see a steady build, as we continue make progress against those targets. And if you look at the guidance, we have given you a lot of components to assess what that progress looks like this year, including how we're thinking about capital and liquidity levels so in one of the slides checks as a comment we've made quite often we fully realize that this is the year to transition from capability build to financial performance, and the company is oriented to do so. Hey, good morning. Thanks for taking my question. Matt, I joined a few minutes late, but I think I heard you mention that the increase in professional fees after making the adjustments in the last couple of quarters, primarily related to maybe ECR costs. I was wondering if, in fact, that is correct. And then can you give us a sense of as we see further rate increases, how much more that could go up. It would almost seem that if you have a roughly $80 million year-over-year increase in expenses, maybe half of it is coming from that if professional fees sort of hold here, but just wants to make sure I'm understanding that relationship correctly as you kind of move forward? Yes. Thanks, Brad. So just a couple of points to call out. So there's a lot going on with noninterest expense this quarter and this year. The $680 million adjusted noninterest expense is what we're building full year guidance off of. And then if you're thinking about run rate for those who may have interest in building models, that $182.3 million is a pretty good fourth quarter number, although the underlying composition is going to shift a bit. There's some -- somewhat unusual or exotic items that inflated what we'd call sort of other noninterest expense and then decrease some of the salary benefits expense as we reset accruals. So if you look through that legal and professional line, I think you could keep about $2 million of that increase. And then there will be some sensitivity in that line on the income statement as we see or don't see rates move up. So disclosing individual or incremental move is probably not what we're willing to do at this point, given some of the competitive nature of how we compensate folks. But you're right that, that will be an area that's going to be sensitive to interest rate changes. Got it, Matt. And if I look at it bigger picture, although you guided to low double digit, if I sort of annualize the fourth quarter really only represents maybe 4% or 5% growth over the fourth quarter. Is that a level that you guys kind of hope to aspire to you going forward? I know you've got a lot of investments, a lot of things going on. But looking at it through that lens, it seems a little better than what double-digit might first appear to people. I appreciate the question, Brad. I mean, we then, I think, pretty clear that the volume of investment is absolutely slowing. But the number of people, the amount of infrastructure build and the capabilities that come along with it that we incurred over 2022 is going to bleed into 2023. So we're highly focused on sustaining expense discipline, which as you know, we view as just matching expense directly against the strategy and do feel good about the implied operating leverage, but it's certainly way too early to call if we're going to be able to come in inside of our published expense guidance. Highly appreciative of the interest by everybody. And I'm sure Jocelyn and Bob will make themselves available as well as I as necessary. Have a great day. Thanks for your time.
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EarningCall_1298
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Hello everyone, and welcome to the OceanFirst Financial Corp. Earnings Conference Call. My name is Daisy, and I will be coordinating your call today. [Operator Instructions] I would now like to hand over to your host, Jill Hewitt, Investor Relations Officer to begin. So Joe please come ahead. Thank you, Daisy. Good morning, and thank you all for joining us today. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp. We will begin this morning's call with our forward-looking statement disclosure. Please remember that many of our remarks today contain forward-looking statements based on current expectations. We refer to our press release and other public filings including the risk factors in our 10-K, where you will find factors that could cause actual results to differ materially from these forward-looking statements. Thank you. Thank you, Jill. Good morning and happy New Year to all been able to join our fourth quarter 2022 earnings conference call. This morning, I'm joined by our President, Joe Lebel; and our Chief Financial Officer, Pat Barrett. We appreciate your interest in our performance and this opportunity to discuss our results with you. This morning, we will provide brief remarks about the financial and operating performance for the quarter and some color regarding the outlook for our business. As a reminder, in addition to the earnings release issued last night, an investor presentation is also available on our company's Website. We may refer to these slides during the call. After our discussion, we look forward to taking your questions. Our financial results for the fourth quarter included GAAP diluted earnings per share of $0.89. Our record earnings reflect expanding margins, disciplined expense management and strong loan growth with benign credit conditions. Core earnings were $0.67 per share and reflect noncore items primarily related to a $17.5 million unrealized mark-to-market valuation gain on our equity investment position and Auxiliary Capital Partners. The details related to the auxiliary investment were shared in an 8-K filed on November 30, 2022. While provision expense was $3.6 million for the quarter, an increase of $2.6 million from the prior linked quarter. We couldn't be more pleased with the credit experience in our loan portfolio. Nonperforming loans represent just 19 basis points of total loans and remain at pristine levels. With the potential for a recession ahead, the increase in provision for the quarter represents general macroeconomic factors and risks external to our portfolio's asset quality and loss experience. Turning to capital management. The Board approved a quarterly cash dividend of $0.20 per common share. This is the company's 104th consecutive quarterly cash dividend and represents 30% of core earnings. Tangible common equity per share increased to $17.08, reflecting earnings momentum and stable AOCI marks related to our investment portfolio. Over the past eight quarters, tangible common equity per share has increased 14%. The company did not repurchase any shares in the fourth quarter. At this point, I'll turn the call over to Joe to provide some more details regarding our progress during the quarter. Thanks, Chris. Loan growth for the quarter totaled $199 million, capping off a record year of net loan growth of $1.3 billion. Loan originations of over $3 billion for the year were primarily driven by the commercial bank, with growth across the bank's footprint. Originations were also bolstered by our conservatively underwritten construction vertical, which we expect to drive additional loan growth in 2023. We remain unwavering on the preservation of asset quality, credit standards and pricing disciplines. Regarding credit risk metrics, we ended the year with net credit recoveries, decreased delinquencies, sharply lower criticized and classified assets and improving portfolio risk ratings. At just 15 basis points, nonperforming assets, excluding PCD loans, are among the lowest level the bank has ever recorded. Our credit discipline will allow for responsible growth in certain segments. The soften pipeline provides relief of pressure on funding needs in the short-term as we shift to managed credit risk and focus on continued margin improvements. That said, we expect loan growth to continue in the mid single-digit ranges with less noise from prepayments. Turning to deposits. We continue to emphasize effective management of deposit costs. Total deposit costs of 53basis points for Q4 have increased 33 basis points over the past year for a deposit beta of just 8%. The deposits of $9.7 billion decreased just $57.6 million, less than 1% as compared to the prior year. The loan-to-deposit ratio ended the year at 102.5%, up from 97.6% in the prior quarter and slightly above our target of 95% to 100%. We expect modest deposit growth in the coming quarters, but we will exercise price discipline and pace deposit growth to approximate the growth in well-priced credit facilities. We will be methodically focused on deposit gathering through our seasoned relationship bankers, treasury management teams and competitively priced consumer deposits. Thanks, Joe. Turning to net interest income and margin. Net loan growth of $199 million in our historically asset-sensitive balance sheet drove another quarter of margin improvement, which expanded by 28 basis points to3.64%. Our strengthening margin benefited from 8 basis points of purchase accounting accretion and 5 basis points of accelerated loan payoff activity. While our margin was clearly impacted by higher funding costs, it's important to expand or reiterate Joe's remarks and highlight that our deposit betas to date have proven to be lower than we would have expected, and we believe will ultimately outperform others in this respect through the current rate cycle. Two factors should provide further modest tailwinds for our overall margin. First, the quarter end loan portfolio of nearly $10 billion was $100 million higher than the fourth quarter average. Second, nearly a quarter of our earning assets are floating rate, providing further opportunity for margin expansion, although likely at a more modest rate. Also of note, although not material to the fourth quarter's performance is that we resumed securities purchases during the quarter as part of an overall effort to lock in longer-term investment yields and in conjunction with other efforts, move our asset sensitivity towards a more neutral position. Core noninterest expense remained relatively flat in the fourth quarter compared to the prior quarter, with almost equal and offsetting increases and decreases in professional fees and data processing expense, respectively. The elevated level of professional fees are expected to continue and through the first half of '23 should level up by year-end '23. It's also worth noting that our effective tax rate for the quarter was 24.6%, and we expect that to remain in the range through the rest of this year. Overall, we continue to remain very disciplined around expense management. This, combined with our steady growth puts us in a position to highlight that we've already outperformed both the 2022 and 2023 quarterly efficiency and profitability targets that we announced at our last Investor Day in third quarter of 2021. We couldn't be more pleased with the company's financial performance. As a reminder, the 2023 core target metrics set at that time were to earn $0.65 per share, meter exceed 1.1% ROA and achieve an efficiency ratio of around 50%. Having largely achieved that performance a year earlier than originally anticipated, we continue to work through how we should be thinking about financial targets going forward. Not only are we considering the external economic and interest rate environment, we're also reviewing how our efficiency and productivity across all of our operating businesses and processes compared to industry benchmarks. More to come on this topic during the second quarter, but expect that over the near to medium term, our targets may be framed more in terms of relative performance rather than absolute goals. [Operator Instructions] Our first question today comes from Frank Schiraldi from Piper Sandler. Frank, please go ahead. Your line is open. Just wanted to talk about the -- Joe, you mentioned the pipeline, but still, I think, talked about mid single-digit loan growth from here. And it sounds like you're thinking maybe more modest deposit growth. Just wondering where you guys sort of see or target that loan-to-deposit ratio moving over time? And also, if there's any specific niches you're looking at to note to drive the funding side of the balance sheet? Sure, Frank, it's Chris. I will take that. In terms of the strategy over the loan-to-deposit ratio, we love being like 95%to 100%. That's a great operating range for us. So it was a little bit higher. I mean, frankly, the last couple of days of the year, we had just a couple of variations in deposits that were a timing thing. We'd like to try and manage to stay around 100, there's really no issue going to 102 or 103, but we are not going to become a bank that's going to go to 120. We don't think that's a highly valuable franchise strategy. So I would expect, as we go into this year, we think we're going to have mid single-digit loan growth based on as much as we can see now, right, which is really early in the year. We want to try and match fund that with deposits for the most part. So in terms of where we're going to get those deposits, we have a terrific group of commercial bankers that have had a little bit of a luxury in the last couple of years not to have to focus as much on that. Obviously, their goals and objectives this year will be heavily focused on deposits. We have a great treasury team. We have a very mature product set there. So you're going to see our commercial bankers and our treasury team are probably doing the heaviest lift. But we also have the opportunity in our consumer franchise to be able to drive some deposit growth in consumer. So I would think about deposit growth coming in as a blend, some of which may be noninterest-bearing, but a lot of it may be either less price-sensitive interest-bearing accounts and some of it will be just be market-sensitive rates. I think it's a blend. So when we blend on that and we look at the loan opportunities in the pipeline, I think we can maintain margins. As Pat said, there's an opportunity potentially for additional margin improvement, as long as rates continue to increase and then maybe flattening out after the increase is top. Okay, great. And then, Pat, you also -- Pat also mentioned the securities purchases. I'm just kind of curious if you could talk about the size maybe of additional adds to the securities book. I assume as you're reducing asset sensitivities, you fund that with shorter-term FHLB borrowings. I guessing you don't get much spread there. So just kind of curious about how to think about the progression there as we move through the year. Yes. Well, it's kind of the trade you make for future asset-sensitivity versus future log-in future returns. We bought roughly $250 million towards the middle and later part of the quarter of agency paper CMOs constructs. The yields on those were in the kind of low to mid 5s. So net-net, we are -- if you consider incrementally, we are funding it at wholesale costs, we probably clear about 1% on those increases. Now the combination of that and some other efforts that we are looking at, we are hoping to get to where our downside sensitivity is reduced from what we had last year. And frankly, as we move through this year, we kind of like to try to position ourselves relatively neutral. So that we can hopefully lock in a margin at a higher level than certainly what we saw during the zero interest rate environment. I would underscore that, Frank. This is an opportunity for us to try and minimize the risk to future margin compression, should rates begin to change in the back half of the year and going into 2024. So in the period of zero interest rates, we were comfortable letting the bank get pretty asset sensitive. We've seen that positively affect our margin in the last year. Now as -- who knows where terminal rates will go. But as we start to get closer to terminal rates, we want to make sure that we've got kind of reduce some of that volatility that you might see in spreads. This is very much about how we are going to look in 2024 and on '23. Got you. Just -- but thinking about maybe additional purchases, is just for modeling purposes, is there any sort of securities to assets, maybe ratio we should think about? Or is it not expected to change much from what you did in the first quarter? I don't think you're going to see a material change in that kind of outlook. And this is a very tailored approach. So we are dollar averaging into a few positions, we are going to watch the market, watch what rates do, watch what our own interest rate sensitivity evolves to be, and also look at the peer group and make sure that we kind of stay in the band of folks that we want to be in with. So I don't think you're going to see a very different structure to our balance sheet. It's just kind of around the margins. [Indiscernible] starting on the expense base. Just wanted to see if that fourth quarter seemed to be about in line with what you were thinking if that remains a good jumping off point. And then as we see the increase in the FDIC assessments to take place in the quarter, just wondering what you guys were thinking, how that impacts that line item? Right. Hey, Danny, it's Pat. So, yes, I think fourth quarter is a pretty good jumping off point. First quarter will always have the impact of merits and related staff costs comp costs that come towards the tail end of that. So it will insight a little bit. And in this environment, that might be a more permanent inflation. So we might see it tick up just a little bit with merit increases, but the run rate on most of our line items is pretty solid right now. We are -- you should assume looking across all of our expense base as well as our revenue productivity. That will take a little bit of time working to make sure that we are kind of optimizing for the businesses that we do. So that will be a theme throughout the year for us. So that -- thatâs kind of underpins the professional -- some of the professional fees and other costs will remain kind of elevated at least for the near-term. The FDIC assessment will hit us like everybody else to the tune for us, it will be about $2 million on the new rate scale. Okay, terrific. Thanks, Pat. And then maybe on the fee income side, a little bit below what we're all looking for. The swap fees certainly impacted that. So maybe your thoughts on the swap fees from here and how the rates play into that? And then on Trident as well, a little bit below the range, if there was some seasonality there? Or how are you thinking about that going forward? Yes, I'd say a couple of things just on swaps and the outlook there and then Joe may chime in on both loan volume and Trident. Look, our clients are smart. That's a good thing. So they are resistant to buying swaps in a market where they think that rates may be going down over the next couple of years. So it's a combination of the appetite for our customers to want to be in swaps as well as the aggregate amount of loan volume. So while loan growth has been pretty good, the origination volume has come down quite a bit. So we're seeing kind of slower prepayments, and that's what's affecting growth. So if you looked at the swap income that's going to vary with your new originations, not with your portfolio growth. So Joe, any comments on swaps or Trident or ⦠I think you hit right on the head. Relative to swaps, relative to Trident, I'd say that there's always a little seasonality in the fourth quarter, but I think there's also a mechanism that rates have gone up substantially in the residential market. While we're still doing the commercial business and we are doing more and more of penetration there of our own book into Trident, that we expect that run rate may be a little bit muted over the next year until we get a little bit more normalized, less volatile rate environment in the residential space. Okay, perfect. Thank you. And then lastly, just on the -- I guess, on CRE loan growth, in particular, just curious, the interest cap renewals, I mean, there was an article in Wall Street Journal recently about how that may impact values of real estate in the industry and that potentially loan demand there. But just curious what you're thinking about that dynamic in the current environment? So a couple of things I would just point out. We've always been very disciplined about stress testing every credit we put on. So at the very beginning, we are looking at how interest rate changes over time will affect that borrower's ability to kind of roll that loan. I think that the article you're referencing focused in on central business district office and the ability for those kind of the cap rates and vacancies, how could you roll that? We have very low exposure in that segment. So we have less than 1% of our assets, in central business district office underwritten CRE. So we don't feel we've got a significant exposure to that. Most of the exposures we have been well stressed tested at the beginning and have enough room that we don't think rollover risk is going to be material, at least if rates kind of top out where the market expects now. Any thoughts you have about other segments, Joe, you've seen outside the office segment and kind of continuing strength. Yes. I mean if you look at the balance sheet and the way we've reported the credit metrics are very strong. We are not seeing any noise in any one segment. I think one of the things we do well is, and especially in the CRE book is we have diversified not only within asset classes. So office and industrial, retail, multifamily and a bunch of other stuff. We've also diversified by geographic region. So in the last few years, with the advent of our [indiscernible] New York offices, which are now already 4 years old and more recently, Boston, Baltimore, we've really diversified the portfolio. Good morning. Two -- a couple of things I want to hit. Number one, on the kind of one of the opening slides here, you guys talk about the balance of efficiencies and technology investments you guys are making. So Pat, maybe asking the expense question a little differently. I mean you guys kind of hit the efficiency targets ahead of schedule. But I mean, as we think about some of the pressures both ways next year and kind of the bare minimum level of investment you guys still want to kind of maintain, I mean is it fair to be thinking about an efficiency ratio in kind of the low 50% range, give or take? Or do you think that there's still room for leverage in this environment? Yes and yes, I guess to that. So I think [indiscernible] is not a bad thing to ballpark as a proxy for right now. I think -- we think that we can do better for what we do. And certainly, we can do better in preparing for further scale in growth across the business lines that we are in over time. So weâve made a lot of technology investments over the years. Weâve still got a lot of disparate processes and people. And so in this environment -- in any environment, we would be focused on that, but particularly in this environment, we know that our revenues over time are likely to fall, and we want to try to protect the efficiency or the operating leverage that we've achieved even in the face of the falling revenue environment as rates come down over time. So I guess more to come on that. But again, it's an important focus for us this year. Got it. That's helpful. And then just secondly, Chris, you mentioned the I forgot how you clarified it, but I think it was the central business district office. Can you just recall -- remind us what the total kind of office exposure is in the loan book? And -- and as you think about growth opportunities for next year on the commercial side, Joe, as a follow-up to that, I mean, -- can you maybe just give a little bit more color both kind of by product and geographically, where maybe the pipeline could rebound faster? Just curious how you guys are -- what kind of activity you're seeing? Sure. So the figure I was referring to is we would define that as office exposure in central urban markets. So for us, that would be New York, Philadelphia and Boston. So -- but to get a little broader, I don't know, Joe, what would you add to that? Yes. So as I mentioned earlier, we have about $1.1 billion in office in the portfolio. Central business [indiscernible] office is only about $125 million, which as Chris mentioned, 2% of the CRE book, 1% of the total loan book. And if you strip out, as Chris mentioned, if you strip out life sciences or credit tenants, that's -- it's down to $50 million in central business district. So there's not much exposure there. We haven't really ever played in that space too much. We look, but we have a fairly narrow credit band, which I think has served us pretty well. In terms of growth in CRE and growth in the book, I'd say this, we -- I think I mentioned last quarter, end of period pipeline is just a day and time things rotate back and forth at a fairly rapid pace. I think we are pretty comfortable in mid single-digit growth. It could be a little bit more -- it could be a little bit of choppiness in markets goes back and forth. We've seen already -- we saw some pullback in Q4 with some of our clients, yet already in Q1,we've had people out looking for opportunities. So there's still a lot of liquidity in the investor market, and people want to put money to work. There's a bunch of funds out there that we've been fortunate the bank over the years that have money available for opportunities. So I do think there'll still be opportunities for us to continue to grow rapidly or responsibly if you better actually said responsibly. I would just to kind of complement Joe and his team, weâve assembled a group of commercial bankers that specialize in a lot of different things, which gives us the opportunity to really diversify not only the portfolio, but the growth we're putting on in any one period and the geographic diversity. So we have the opportunity markets they come and go and they're hot and cold. And our opportunity to have seasoned bankers in some of the largest markets in the country is really proving to be an advantage. It allows us to be very selective about kind of how we choose to grow and which types of risks we take on. Great. And then just lastly for me, it was great to see the ROE of the business. You guys talked a lot about the inputs being ahead of schedule, but like the 15% level, high-level for you guys over the last handful of years. There's a narrative that banks are kind of at peak earnings and there's pressures on OpEx, NIM, all those things. Just curious, I know you guys aren't willing to necessarily provide targets, but -- any comments on kind of how that -- this ROE level kind of compares to your internal expectations? And are you guys expecting? I mean it sounds like you are, but is it fair to say that you guys expect to be able to kind of maintain that level for the majority of next year, give or take? I'd start with some humility and just say that it's a cloud a year. It's hard for any of us, I think, to have a lot of certainty around what's coming. But there are a few things that have panned out in the last year that have kind of confirmed our opinions on our business. So first, you see the deposit beta. Yes, we are going to be a little more competitive around deposits in the first half of the year. But our existing deposit base has been rock solid, and that's going to continue to serve us well. So while we may have to pay up for deposits, we are not paying up on the portfolio. We are paying up on the amount of deposits we have to kind of grow to fund loan growth. So I think that's a great opportunity. In terms of loan yields, you saw the loan yield pickup, the investment yield pickup this quarter. That should continue as rates continue to rise. So Pat mentioned the level of floating rate assets we have. So -- so without growth, I think you've got some margin expansion. We may trade some of that off. We run a business every day. We want to bring new clients in. You bring clients in on sunny days and rainy days and everything in between because they're good clients. So I think our outlook is generally that margin should continue to improve for a while. I don't think we're at peak margin. In terms of operating efficiency, I think we've done a good job to date. But as Pat mentioned, we are thinking hard about long-term kind of structural expenses, how can you be even more efficient as you grow? I'd kind of look back, absent the pandemic, which I know is a giant shock to the system, that happened to be the point in time where we crossed $10 billion, and we had to work through a whole variety of things, including the scale to overcome the -- amendment changes and things like that. We kind of feel like that's behind us. And we are just going to now continue down the path of growing the customer base. But realistically, with our price discipline and our credit cut, we are not going to be growing at double digits this year. That will be closer to single digits. So I don't know if that helps, but that's a general outlook for us. Thank you. Our next question today comes from David Bishop from Hovde Group. David, please go ahead. Your line is open. Chris, or Joe, Slide 6, you break out the loan geographic distribution by region. As you look out in terms of the newer markets, the Boston and Baltimore, just curious maybe where you see that potentially growing as a percent of the pie over the next maybe 2 to 3 years or so? Do you think that gets to double digits here in the next 2 years? I don't know where the end game is because of the cloudiness as Chris referred to it, at least for '23. But we are pretty happy with what they've done so far. I think Boston has got a little bit of a head start. They have a little bit of a larger team as we tend to do, we are always outlooking for seasoned successful bankers will continue to do that. And the Baltimore group is largely focused on the C&I space, whereas Boston has been largely focused in CRE. So it's not easy to compare them. But if you look at the trajectory of what we did in Philadelphia and New York, I do think we have an opportunity to grow those meaningfully down the road. Some of that will be incumbent upon us to continue to fund them appropriately in this environment. So I do see really, they call it blue skies ahead, David. But I don't know if it will be as rapid as the growth we've enjoyed infilling in New York in a really good environment. Got it. And then I think maybe, Joe, during the [indiscernible] you mentioned some opportunities on the construction segment. Maybe just to dive into that particular where you're seeing some growth opportunities? Sure. Well, you guys may recall that we started a construction vertical just a few years ago with the acquisition of a very talented banker has been in the space for 30 years, and we built out that team a bit. We really saw some significant activity in 2022. We actually did about triple the volume that we did in 2021. A lot of that, as you would expect, is undrawn because these are projects that are being built out. And so we do see that even if we were to slow activity in that space because of the uncertainty, these projects are going to fund and help us support some loan growth in that segment regardless. So we are pretty bullish there. And we are reinvesting there. We are again, we are very thoughtful, but we know the markets that we serve pretty well. And as you all know, especially, we will use New Jersey as an example. It's very difficult to get things approved. It takes 18 to 36 months to get things approved. When projects get approved, they get built and they get filled. So we are pretty bullish. Also kind of talk a little bit about the risk characteristics of that. If you think about our construction book, a significant chunk of it, approximating 40% is non-speculative, another 40% of that spec is apartment-based. So --and those are underwritten to a very modest rental expectations. So there really shouldn't be an issue as those kind of mature and only 20% of it would relate to a single-family home. And as Joe noted, in the Northeast, we tend to have a much more stable level of inventory and prices. In fact, the home prices in New Jersey despite all the slowdown in unit sales or continue to be up about 6% year-over-year. So it's very prudently underwritten, very conservative a very thoughtful portfolio that we feel very good about. Got it. That's great color. And then I noticed in the slide deck, pretty substantial improvement in the substandard loan bucket. Maybe just some commentary what drove that decline? I think it's a combination of factors, David. We've had improving economic conditions post-COVID. And we were, as we tend to be typically very conservative in looking at the client base that was adversely affected by COVID during that period, we were quick to downgrade credit into classified or criticized because we had concerns, the vast majority of those folks were paying, but it made sense for us to do what was prudent for the company. As they've rebounded post-COVID, it's allowed us to upgrade those. And we've had some payoffs from that bucket as well and some recoveries, which we anticipated that we would. So I think it's just a foundational aspect of the way we approach things when we have uncertainty, we will downgrade when we need to. And when we see some more certainty, we are not afraid to upgrade. We made two important decisions during COVID, which may not have been super popular at the time. The first was in the third quarter of 2020, we derisked the portfolio by pushing out the stuff we thought would have a higher likelihood of having a post-COVID issue and sold that off. The second thing that we did is we did not care no long-term Cares Act deferrals in our commercial base. So we took a position that we gave a lot of short-term deferrals, worked with our borrowers, really made sure that we kind of got them through a difficult time, but we did not restructure the facilities, and enter into these kind of longer-term IO periods or payment plans that would have allowed weakness to continue. So we were able to move through that, I think, pretty effectively. When you think about last 8 quarters, 2 years in a row, having net recoveries on a balance sheet our size. I think that kind of proves out our thesis back in the third quarter of '20, which was not very popular, I think, held true. Thank you. Our next question today comes from Christopher Marinac from Janney Montgomery Scott. Christopher, please go ahead. Your line is open. Hey, thanks. Good morning, Chris and team, youâve all mentioned 2024 as part of your thought process for managing the bank now. As we possibly have a different rate then, are there any lessons learned from the 2019 era when rates kind of peaked the last time with the Fed that you can implement now? I know the portfolio is a lot different. But just curious kind of if loan floors and other tactics can work or if there's any particular way you think through the structure from the past? I think it's an excellent point. That's exactly what we're trying to do to learn from the experience we went through in 2020, in particular. So kind of coming through that COVID cycle, we had a strongly asset-sensitive position at the time. That resulted in our margins decreasing going down into the 270s -- and what we've been doing, and this began in the fourth quarter will continue over the next couple of quarters is doing what we can, and you can only do so much around the edges, but doing what you can to make sure that we have a more neutral interest rate risk position. So we are not trying to kind of game and environment, make money one way or another. What weâre trying to do is ensure to the degree we can relative to stability around the margin. So we are willing to give up some of our net interest income today to protect that margin for the longer term. And Pat walked you through the securities purchases. We have a very modest hedge position that we began in the fourth quarter as well. And again, it's not to protect against additional Fed increases. It's actually to protect against what could be Fed decreases at some point. We have no idea when they may show on. Great. That's helpful. And Pat, can you remind us two things, how far out are you going on the hedge position? And then what's the amount of cash flow that comes off the securities portfolio each quarter? So the hedge position, I guess the effective durations that we are putting on are probably in the 7, 8 year range for the cash balance sheet purchases Chris talked about swap. We only have one. It's just a 3-year SOFR. So that going to dramatically change things other than have a marginal improvement around sort of the downside interest rate risk exposure that you'll see in our Qs and Ks, right? So -- that's kind of the general flavor of that. And our securities book is pretty short dated as is. So I think 3.5 years in aggregate. So every little bit helps for stretching that out. With respect to the cash flows that come off the book, it's around $25 million a month. A lot of my questions have been answered. But on the construction line that, that might come in and help with growth going forward. Is that -- does that not show up in the pipeline? Is that the right way to think about it with the pipeline being a little bit lower in this construction? These are undrawn facilities that have like a 2-year life as they're kind of drawing down and building and then kind of convert after that. So we can kind of project that there'll be some draws coming in the first half of the year that are expected in natural. And they would not be in the [technical difficulty] is that commitments. The loan pipeline has some really nice higher loan yields. What would be the construction lines coming in as well? And they kind of have a similar, like, I think, like 6.5% yield roughly? Well, I think the average construction transactions are higher anywhere between half and 1 over prime. You want to get paid for the risk you take in the environment that you're in. I'm sure some of our borrowers are disappointed that the rates have continued to rise, but they look at it from the long-term. And it's a little disintermediation as you would expect. If you build a multifamily project today and it may cost you prime plus one to build it, you can still, at the end, when you fill it up and stabilize it to get an end loan at 200 over a 7 or 10 year treasury, which is 5.5 today. So they look at that as we do. It's a window to pay for the risk of the construction. And then when you get to the end game, you're going to stabilize it and get much better cash flows. Thatâs helpful. How much of your view on loan growth includes the probability of a slowdown. Are you -- you did suggest that there's some slower activity. But if you were as positive on the economy, could you have probably more loan growth? Or is it kind of you're purposely being more selective, you're seeing better yields, you're price conscious. How are you kind of balancing that today versus maybe a year ago? I think that you're going to start with the market has fewer opportunities, right? As you can see in some of the things that have been growing those quickly in the last few years, I'll take kind of warehouse as an example, right? There are very few people going out to build net new giant warehouses. So you see a little bit less economic activity, so that does pull down the opportunity for all of us. And then as rates go up, borrowers are a little discriminating over which projects they want to take on. So if they're going to pay and if you're paying over prime, you could be paying something with an eight handle, right? So you're going to be judicious about using that capital when you can make it work for you, but you're not entering into that lightly. So I think there's a little lower demand. I think there's -- our traditional discipline kind of filters out a lot of what's in the market anyway. And go back to my comments about participating in multiple markets and having a great group of bankers. We can kind of trade off if New York side or Philly side or Boston side of New Jersey's hot kind of look for the deals you need and the places you need them. So -- but the overall tone is slower. To your point about a recession, very hard to understand whether the recession is coming or how severe. The other thing I think that's greatly overlooked is the geographic impact of a recession. So historically, and I have no reason to believe differently the Northeast has been less impacted by business cycle risk around things kind of boom and bust cycles. So even in mild recessions, there seems to be a fair amount that goes on in the Northeast. That's our market. So we don't we have not observed in our markets, kind of the significant over capacity or overbuild or vacancy rates with some selective submarkets like the central business district office is certainly an area that we've got an eye on. That's really helpful. If the probability of a recession grows, where do you think the loan loss reserve heads to? I know you have about 57 basis points now it's about 65 with marks. We are -- like if that -- you have to head more to the severely adverse scenario, where would that kind of push up to? As you can imagine, like everyone, right, we've had our trials and tribulations with CECL and the kind of high class problem to have is when you have no charge-offs, it's really hard to come up with a quantitative allowance. That said, the majority of our allowance is qualitative and it assumes that there is some risk of a recession coming in the near-term. So I think if there were a recession, we'd have to evaluate where is that hitting geographically, which product segments, what are our exposures in those segments? So I wouldn't want to hazard a guess about where that number would go. What I would say is that I'm very comfortable that the composition of our loan portfolio and the underwriting and credit risk management would leave us better than the peer group, which is why you tend to see our reserve being a lower coverage ratio. Our net charge-offs are about 80% lower than the $10 billion to $50 billion bank peer group. So we have a lower loss reserve. It doesn't -- those two things are correlated. So yes, it could go up. Yes, I don't know which segments would be hurt and to what degree. But I think the relative performance point that Pat made earlier I think we are going to show that our credit discipline will hold. And just as a long data point, we use the Moody's SQ as kind of our foundation for our quantitative models, and still have to layer in a whole bunch of qualitative to get to the point where we are today. I was hoping for a little bit more color around the near-term NIM outlook. And I know there's some questions around what the Fed is going to do -- so maybe ask you an age-old question, which is per 25 basis point hike, what is the expectation for NIM expansion at this point? Well, the one comment I can make is the expectation is expansion. So that's an important note, right, not contraction. We -- I think the last time we spoke with all of you, we were thinking that it might be single high single-digit NIM expansion and the deposits outperformed in the fourth quarter, and we did much better than that. So a lot of it is going to be determined ultimately by how much deposit pressure we see, we haven't seen a lot to date. So we still see some modest expansion as long as the Fed is raising rates, and we think that will continue for about a quarter after they stop raising rates, and then you should start to see us flat now. So it could be 10 basis points, but I would hesitate to give you a number. Okay. And maybe to get a little bit more specific on the components, could you just re-quantify for us how much of the loan portfolio, I think, is the majority is fixed rate? And then what is the roll-off yield versus the roll-on yields? So we have about 68% or so of the book is fixed and the -- and the rest, obviously, is float. And then the roll-off yields will probably have like a high 3 to 4 handle the payoffs. And the new facilities coming on is a high 5s, 6 and change. Okay. And then what was the -- if you can provide at the end of the quarter all in cost of deposits? I don't think we published that. So I would hesitate to introduce a new number, Matt. I appreciate where the question is coming from. But I hesitate -- but I think that when you think about deposit betas, I think you're still going to see us on the low end of the pack going forward. Okay. If we do see a slowdown in loan growth, obviously, the balance sheet has been a bit more protected from AOCI, so your tangible equity ratio is pretty solid. I know there's some regulatory bank level capital ratios that area little bit thinner, but I just wanted to get your thought on capital management and where the stock is thoughts around buyback? It's a great question. And obviously, we've not been doing buybacks. So the question would be what is our appetite. I think kind of starts with a fundamental view on our business. We really feel good not just about the year we had in terms of financial metrics, but about where we are in customer relationships and the build-out of the commercial banking teams our core markets because we've been adding bankers in New Jersey, right? It's not just about the expansion markets. So we feel really good about that. Obviously, we see growth slowing a little bit as we kind of go through what could be the -- maybe at the beginning of a recession this year. But we don't --we're in the camp with many others that the recession will not be deep, will not be particularly distracting to us and there'll be another side to it. So -- we think we have a great opportunity to continue to grow over the next couple of years. So we are allowing that equity position to build up. And we have no doubt that we will find a good opportunity to use it for our shareholders in the coming year or two, and we'll be patient about it. So -- if it's a little slower growth this year, a little faster growth next year or that may be the case. But at this point, we are building up our capital levels because I'm confident we will find a good use for it. Okay. Understood. My last one, just odd ball question, but there's been some undulations in unrealized gains in investments, there's a $100 million equity portfolio. Just curious how granular is it? What is it? Are there anything outside of the investment this quarter that you kind of point out a note highlight. I don't think in the equity portfolio, you're likely to see much movement, positive or negative absent a giant move in interest rates. So the $100 million you're referring to is preferred instruments that carry a good yield, but they're -- it's mostly banks. -- it's pretty granular. There's no giant positions in there. We've got kind of limits about how much of any one instrument we are going to take. And it has a decent cash flow coming off. And so as rates were to continue to go up a lot, maybe you would have a little bit, but I don't think there's much risk of that in either direction. It shouldn't be a material number for us. Okay. I appreciate that. Yes. We are really pleased to have had the opportunities in the second half of the year with [indiscernible] and with [indiscernible]. Those were very unusual and there's nothing about them that I would expect to recur in the short-term. Thank you. This is all the questions we have today. So I will hand back over to Chris for any closing remarks. All right. Thank you very much. Our fourth quarter results were consistent with our strong performance throughout 2022, and they leave us well-positioned for what may be an economically challenging year in 2023.As always, we appreciate your time and interest in OceanFirst, and we look forward to speaking with you after our first quarter results are published in April. Thank you very much.
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Thank you for standing by, and welcome to the Sandfire Resources December 2022 Quarterly Results Call. All participants are in a listen-only-mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] Good morning, good afternoon, everyone. Thank you for joining us today for our call to discuss the December '22 quarter. With us today, we have Jason Grace, our acting CEO, Jason will be taking us through the bulk of the presentation today. We also have Matt Fitzgerald here, CFO; and Dave Wilson, our Head of Technical Services, a fair bit to get through today. So I'll hand straight over to Jason, and we'll get cracking. Thanks, Ben, and good morning to all, and welcome to the Sandfire Resources December quarterly results webcast. As we move to strategy and value, so I draw your attention to the disclaimers. Over the last year, Sandfire's execution of our strategy has delivered an excellent portfolio of high-quality operating mines, development and exploration projects. And we have transitioned from being a single operation WA miner to being a genuine international copper producer. Our values of honesty, respect, collaboration, accountability and performance are key to Sandfire's culture, and they guide our activities across every part of the business. When we consider that Sandfire is one of the largest copper-focused miners listed on the ASX, that there is an inevitable increase in demand for copper in the future, driven by the global energy transition that we have a dominant presence in four mineral provinces that have excellent organic and inorganic growth opportunities that Sandfire has proven capability as an explorer, developer and operator of copper mines and importantly, on the back of the MATSA acquisition and development of the Motheo Copper Mine to a 5.2 million tonne per annum capacity. Sandfire is one of the few copper miners that has a firm production growth pathway over the next 3 years, growing to around about 110,000 tonnes of copper, over 80,000 of zinc production per annum. If we look to the December quarter highlights at a company level, consolidated copper production totaled just over 20,000 tonnes with zinc at over 19,700 tonnes for the period. The Motheo Copper Mine development continues to be on track and construction is now nearing completion. The investment that Sandfire is making in resource extension drilling and improving geological knowledge at MATSA is yielding early success with the identification of the San Pedro ore [ph] Zone at Aguas Teñidas I will cover this in more detail later. But in summary, it is a new zone of copper zinc mineralization that is within 100 meters of existing underground workings and has been defined over initial 400-meter strike length. More importantly, as part of this work, a prospective horizon, which is hosting the Aguas Teñidas mineralization has been newly identified and is interpreted to be around 2 kilometers in extent. Looking now at other key company results for the quarter. Sales revenue totaled $217 million, with operations EBITDA at $87.7 million, a group EBITDA of $71.3 million and an EBITDA margin of 40%. As mentioned in the last slide, consolidated copper production totaled just over 20,000 tonnes with zinc at just over 19,700 tonnes for the period. C1 costs for the group were lower quarter-on-quarter at $1.77 per pound of payable copper and cash holdings for the company were just under $264 million, with a net debt of $378 million after repayment of the corporate debt facility and $110 million of Motheo debt drawdown. Looking in more detail at group metal production for Q2. Overall performance was in line with the company's expectations, noting that copper was a balance of lower-than-expected production from MATSA, specifically as a result of mine plan changes at Magdalena. This was offset by higher production from DeGrussa, and I'll cover this in more detail later in the presentation. Zinc production was on plan due to the benefit of continued reduction in stope dilution, partly offset by changes to the mine plan at MATSA and gold, silver and lead production were generally in line with plan. As a result of this, Sandfire is maintaining the previously stated group metal production guidance noting that due to mine plan changes at Magdalena and the deferral of copper tonnes for the second half, we expect massive production for financial year 2023 to be at the lower end of the 60,000 to 65,000 tonnes guidance range for copper. Moving across to the cash flow waterfall for the quarter, and I'll just cover it from left to right. So, opening with $190 million of cash at the beginning of the December quarter. We can see some cash flows there from DeGrussa and MATSA, which are largely, of course, EBITDA driven. But just to touch on a couple of points, which are in the notes around DeGrussa, particularly, and we did have some sales on either end of that quarter moving to the previous quarter being September one sale and one fall into the January quarter as well. The reason that the cash flow from DeGrussa operating activities looks low and how it would reconcile back say to EBITDA, for example. Moving to the right, the equity raising was completed during the quarter funding growth debt reduction and strengthening our balance sheet. As Jason noted, two drawdowns during the quarter with the Motheo debt as we continue towards completing construction and towards commissioning of the production facility in Botswana. The ANZ corporate facility was repaid from the proceeds of the equity raising and the funding growth, as we know, largely around the Motheo copper mine in terms of capital construction, as I said, getting ready towards production, but also the normal quarterly MATSA mine development, just under $20 million and a small portion around DeGrussa and Black Butte. Income tax is a little higher in this quarter at just under $39 million. $30 million of that was the clearance of the financial '22 tax numbers, and we've talked about that consistently over the last number of quarters about the - really part of the wind down of DeGrussa and it's also covered in what's in the next bar being other, which has a $16 million impact of also the once-off wind down of DeGrussa. So that's a transitioning of the balance sheet that we've talked about consistently, as I say, over the last couple of quarters to end the quarter with US$263 million. Moving to the update on debt facilities and hedging. The MATSA facility has $532 million outstanding as at the end of December. The next scheduled repayment is $80 million, which we are positioned to repay at the end of January, and that will take the facility from 650 originally in January 2022, down to $452 million at the end of January 2023 within the first 12 months of ownership at MATSA. And as we've previously signaled, we will be looking to produce our updated Sandfire picture of a base case model around MATSA and look for a potential re-sculpting of some of the repayment profile. So, we will be updating the market through over the next few months with progress towards looking about and making sure that we match that debt facility to our operating plan. The corporate facility, as I said, repaid from the equity raising funds, AU$50 million, US$33 million. The Motheo facility, the drawdowns, as I noted previously, and also just recapping around a targeted $180 million to $200 million total facility, including the 140, which will bring us into the A4 development and also into any working capital facilities towards that product - that commissioning and production time. And that - those facilities are very much - have commenced in terms of discussions that are very much progressing in line with a4 - expected A4 approvals as well and obviously, engineering studies and assessments. The hedge book we update as we - each quarter, as we - as you know, for the rest of the year, 33,000 tonnes of copper and just under 23,000 tonnes of zinc. And that includes some QP hedging towards the back end of the quarter and also into January, as we know, we're also seeing copper increase in recent times, and we plan to QP hedge that as we produce over the next couple of months as well. Moving on to the operations review and outlook and starting with our health and safety snapshot. The Sandfire Group TRIFR closed out the quarter at 2.1, which is significantly lower than 3.0 at the end of the September quarter. This was mainly a result of strong safety leadership and a focus on positive safe behaviors at all of our operations during the lead up to the Christmas season. As a highlight, our Motheo team commemorated World AIDS Day with the Ghanzi community in support of Botswana's approach to ending inequalities against AIDS. Activities and information focused on health advice, counseling sessions, free voluntary confidential screening for members of the community. Looking now at group sustainability. During the quarter, there was a strong focus on engagement and planning to put substance around our long-term plans for our ESG pillars of communities, our people, water, climate change, biodiversity and business integrity. This included an assessment of critical habitats at Motheo to ensure the protection and conservation of biodiversity, maintaining ecosystem services and managing living natural resources in the region. As a further highlight for the quarter, Sandfire in conjunction with the Ghanzi District Council commissioned a solar streetlight project at the Kuke village in Botswana. These solar streetlights will improve safety for the village community, which is located beside our main highway. If we now look out to the full year, as mentioned before, at a group level, we are providing group guidance that includes metal production guidance for copper, zinc, gold-led silver guidance is maintained for the full year. Forecast for - full year C1 costs are $1.74 per pound of payable copper for the year. For capital, we are refining the mine development forecast to $82 million to $92 million and maintaining sustaining exploration and studies capital guidance. Motheo development capital is in line with the previously announced approval of the 5.2 million tonne per annum Motheo expansion project. And MATSA and DeGrussa D+A are forecast to be $250 million and $16 million, respectively. Looking now at group production throughout the full year. We are also providing a quarter-by-quarter outlook for metal production. You will note from this slide that copper and gold production peaked in the first quarter. This trend is driven predominantly by run of mine production at DeGrussa only occurring during the first 4.5 months of the year, followed by processing of lower grade and transitional ore stockpiles through to February 2023. Gold production throughout the year follows the same path and also for the same reasons. Following the completion of processing of lower grade and transitional stockpiles at DeGrussa in February, processing of oxide stockpiles will commence and will be subject to ongoing reviews of technical and economic outcomes. Due to the technical uncertainty of processing of this ore, no further formal production guidance is provided for DeGrussa. Copper production also shows an increase into the June quarter. This is a result of higher copper grades coming into the mine plan at MATSA as well as first production from Matheo. Zinc production has a different trend to copper with lower production expected from Q1 to Q3, then stepping up in the June quarter. The main reason for this is the progression of the mine plan at MATSA. And I'll also cover all of these points in more detail later in the presentation. Moving now to MATSA operations. With the first anniversary of Sandfire's ownership of MATSA now very close. We are firmly committed to getting the best out of MATSA and ultimately establish a solid base for a multi-decade operation. To deliver this, we will continue our improved safety performance through development of the right culture and fit-for-purpose systems. We will continue the recent improvements made in mine productivity and stabilize and reliably deliver a 4.7 million tonne per annum production rate. We will use our technical knowledge and skills to extend mine life through execution of an expanded in and near-mine resource expection [ph] drilling program and undertake technical studies to confer mineral resources or reserves and also establish a pipeline of new ore sources through investment in regional exploration. Looking now at the December quarter. MATSA production for the period was challenged by lower mine production from the Magdalena underground mine. This was a result of localized poor ground conditions in the main production areas scheduled for this period. The resulting changes to the mine plan restricted the supply of Cupriferous [ph] delivered an increased supply of poly ore at a lower zinc grade and deferred mining of higher-value Cupriferous and poly ore to the second half of the financial year. This in turn restricted processed tonnes for the December quarter due to lower supply of Cupriferous ore to the plant. As a result, opportune maintenance was undertaken on Processing Line 1, which is a dedicated Cupriferous processing line - during December to bring forward planned maintenance scheduled for the June quarter and to ensure plant availability is maximized for the second half of the year. As a result of this situation, copper production closed out the quarter below plan with close to 12,700 tonnes of production and zinc production was in line with expectations at 19,755 tonnes for the period. Payable metal sales were in line with production for the period, and this delivered an operations EBITDA of $55 million with a very good EBITDA margin of 40%. If we now look forward to the full year and in particular, the impact of changes to the mine plan at Magdalena on guidance, I would like to draw your attention to the graph displayed on this side. As I mentioned previously, one of the key impacts of the localized poor ground conditions at Magdalena is the deferral of higher-grade Cupriferous and poly ore to the second half of the financial year. The waterfall chart shown illustrates a comparison between financial year 2023 first half and second half copper production variance by ore source. This clearly shows the impact of changes to the mine plan at Magdalena, with copper production from both Cupriferous ore and poly ore increasing by 33% and 51%, respectively. This change is driven predominantly by the changes to the mine sequence at Magdalena to mine higher value or high-grade ore originally planned for the first half to now be mined in the second half of the year. And looking now at MATSA production on a quarter-by-quarter basis for the year. This again illustrates the deferral of higher copper grade ore at Magdalena from half 1 to half 2 through increased production copper - sorry, increased copper production for the period, which is again driven predominantly by higher mine grades. Zinc is a similar story where we started the year at a lower production rate and will step up in the final quarter. This trend in zinc production is driven by mine grade and in particular mine production at Aguas Teñidas, transitioning from a high to low tonnage rate from the stope [ph] work ore body early in the year, which is a low zinc grade part of the ore body. This ramp down in stope work [ph] ore production is now well advanced and is being progressively replaced by increasing production from massive sulphide ore from the down plunge western extension of the main Aguas Teñidas ore body. Now looking at the full year production and guidance at MATSA remains unchanged at 60,000 to 65,000 tonnes of copper, 78,000 to 83,000 tonnes of zinc, 6,000 to 10,000 tonnes lead and 2 million to 3 million ounces of silver. However, and as mentioned before, in light of the changes to the mine plan at Magdalena and the deferral of high-grade copper ore production to the second half, we expect MATSA production for FY '23 to be at the lower end of the 60,000 to 65,000 tonne guidance range for copper. Thanks, Jason. On this slide, we're looking at the net operating costs in 6 [ph] quarters of actuals and 2 quarters of forecast to see through to the end of FY '23. And just draw your attention to the total column on the right, you'll see that this quarter, we saw a significant decrease in absolute cost in euro terms. And that if you look at the processing column, you'll see that's largely in the processing area, hence that has to do with power cost, which I'll cover a little more on the next slide. Just to cover one other area, this offtake agreement, the treatment refining charges and freight rollback reset to benchmark every calendar year. So this month, this quarter. We note that the topics at least the TCRC [ph] has been reports of agreements between miners and smelters. As of today, that benchmark has been reported by Wood Mack. Once it is that will flow through to our cost per our agreement. But what we have factored in going forward is our view of what that will be [ph] On the freight side, what we're seeing at the moment is the sea freight market conditions that were improved compared to when we last negotiated the freight rollback. So you'll see in our transport costs going forward, we see an improvement in that - in the coming quarters. Moving to power. Once again, we've shown the Spanish daily power prices. You'll note that there's been a significant moderation on the power price in this last quarter, which has been welcome. And in fact, our average stock price for the 3 months at December was â¬140 megawatt hour comparing to 270 for the previous quarter, slightly through to milder winter conditions and much higher renewable generation through this period, which is a welcome change. Current forecast going forward for the next quarter is the â¬150 to â¬170 megawatt hour, including the forecast of the compensation agreement - compensation charge under the Spanish gas price cap arrangement. What this change in power costs have done - price has done for Motheo [ph] the electricity costs have reduced from being just over 20% of our C1 unit cost to about 12% in this quarter. In terms of our future plans for power, we have the Sotiel Solar farm is in progress by the third party in the study for construction of the second solar facility to be built near Aguas We're in the final stages of negotiating the ongoing power supply agreement. While that is concluded, our ongoing supply will be a spot to give a little more color to that. Our aim in this power agreement is obviously to secure our long-term power and derisk the business to the type of price spikes we've seen over the last 12 months. So that looks like really from the current peak, we lead to a proportion of the power locked in under a fixed price, a PPA style agreement and making sure we leave capacity for renewable PV power to get long-term low carbon power into a power mix. And that, as I said, most negotiations are drawing to a close and we hope to be able to update the market in due course. Moving to MASTA unit costs for the quarter. So as Dave was mentioning, lower energy costs clearly have brought C1 down. We've also had some pleasingly higher byproduct credits predominantly from the production and value of zinc. That is offset, of course, by a lower production quarter in terms of quarter-on-quarter copper production. So that would ordinarily have dragged the C1 up. Pleasingly, we see margins increasing, particularly in recent times, through December, January and with increasing copper prices. So we look forward to those continuing and being able to report on some increasing margins, hopefully, for the March and June quarters and ahead. And then across to the right, as you can see that reduction in unit cost between the first quarter and second quarter and full year guidance has been set at $1.82 per pound of payable copper for MATSA. Finally, for MATSA. Sandfire was very pleased to announce this morning that a new zone of copper zinc mineralization called San Pedro has been identified at Aguas Teñidas Mine. We have always held the view that MATSA is a world-class VMS system, and we have always had a high degree of confidence in the potential to find both extensions of existing deposits and to make new discoveries near mine and further afield. This potential was one of the several key drivers for Sandfire's decision to acquire the asset. Our investment in resource extension drilling and the excellent work being undertaken by the MATSA geology team on the reinterpretation of existing geological models has delivered an early success at San Pedro. Drilling to date has defined copper zinc mineralization over an initial 400-meter strike length within approximately 100 meters of existing underground workings at the Aguas Teñidas Mine. More importantly, the geological and reinterpretation has identified a prospective horizon, which is hosting the Aguas Teñidas ore body, and this is interpreted to be around 2 kilometers in extent. Step-out drilling at San Pedro is currently underway. Moving now to DeGrussa operations. And if we start by looking at the December quarter, following the completion of mining at Monty underground late in the first quarter and underground mining at DeGrussa was completed on schedule early in the December quarter. Processing of run-of-mine stockpiles continued until November, after which processing of low-grade sulphide stockpiles and transitional ore stockpiles commenced. This operating strategy has advanced well and processing of low grade and transitional ore stockpiles is expected to be completed by mid-February. Following this, Sandfire will take a further transition to processing of oxide stockpiles that date back to the original Open [ph] Pit mining phase at DeGrussa. Laboratory test work and a full plant scale trial completed in the December quarter has confirmed a potential opportunity to process up to approximately 600,000 tonnes of ore at approximately 2% copper. However, due to uncertainty on stockpile homogeneity of mineralogy and grade and metallurgical recovery, processing of oxide stockpiles will be subject to ongoing reviews of technical and economic outcomes. In light of this, no further formal production guidance is provided for DeGrussa. Before I move on to the next slide, Sandfire also announced to the market on the 9th of December that a formal sale process for the DeGrussa Copper Operations and related exploration tenure in Western Australia had been initiated. This process is ongoing and is likely to continue throughout the current financial year. Looking now at DeGrussa production for the December quarter. Copper production was above plan at 7,343 tonnes and gold production was 4,562 ounces for the period. Metal sales volumes were higher than production as a result of timing of shipments, and this delivered an operations EBITDA of $32.7 million, with a very good EBITDA margin of 41%. Looking now at the second production - DeGrussa production for the second half. Copper production was again above plan and exceeded guidance at 21,652 tonnes. Gold production was just under 12,800 tonnes for the period. Metal sales volumes were lower than production as a result of timing of shipments, and this delivered again an operations EBITDA of $80 million with a strong EBITDA margin of 46%. I would like to reiterate that given our transition to processing of oxide stockpiles in the March quarter, no further formal guidance is provided for DeGrussa. I'm going to unit cost for DeGrussa. So Q2 at $1.41 per pound of payable production versus $1.34 in the first quarter. Clearly, two different operating stories across the two, as Jason mentioned, around the predominantly sulphide in the first quarter and then moving into the lower grade in the second quarter. So as much as there's lower copper production, there's, of course, lower costs in terms of not having those upfront mining costs in their existing stockpiles. So into the second half, as we've mentioned, we're not guiding in terms of oxide stockpiles and any production impacts from those. But fair to say that into the second half, we would expect C1 to be significantly higher than these numbers based on processing upside as we go. But we'll report those as we deliver costs in those areas. Moving now to the Matheo copper mine in Botswana. Firstly, as a quick update on development of the Matheo 3.2 million tonne per annum project. Construction is nearing completion and continues to proceed on schedule with first production expected early in the June quarter of 2023. In addition to this, Sandfire has also progressed the 5.2 million tonne per annum Matheo expansion project with the environmental and social impact assessment being submitted to the Botswana Department of Environmental Affairs during the quarter. The Ball Mill was delivered to site late in the quarter. The engineering design for the 5.2 million tonne Matheo power [ph] expansion is now 70% complete. The balance of minor additional equipment orders have been placed during the quarter and the Ball Mill civil contract has been awarded with work commencing in January 2023. And finally, as Matt mentioned earlier, during the quarter, the first two tranches of the $140 million Matheo project finance facility have been received with the balance to be drawn in the March quarter of this year. The development of the 5.2 million tonne per annum Matheo expansion project approved by the Sandfire Board in the September quarter, will transform the Matheo mine into a significant copper producer. With a full ore production rate of 5.2 million tonnes per annum, supported by mining of both the T3 and the A4 open pits, peak annual copper production will reach approximately 55,000 tonnes and will be maintained around 50,000 tonnes per annum production rate over a 6-year period. Subject to the approval of the environmental and social impact assessment and granting of the mining license for A4 by the Botswana government, pre-strip mining at A4 is anticipated to commence by the March quarter of financial year 2024. Looking now at the Matheo development timeline. Work throughout the December quarter has continued to proceed according to the project plan with some of the key development areas being, process plant structural, mechanical and piping works are now approximately 90% complete. The process part electrical and instrumentation contractor is now approximately 75% complete. The tailing storage facility lining work has progressed well during the quarter with 90% of the lining completed, and the tailings pipeline installation is now underway. The high-voltage switching station has been commissioned and connected to the Botswana Power Corporation grid in late December 2022. The primary crusher structure has been fully completed and all crusher mechanicals are now nearing completion. The SAG mill has been fully assembled, alignments completed and mill lining to be completed in January 2023. And finally, the commissioning team has now mobilized and commenced commissioning activities in early January. Looking now at construction development and capital. The total development capital for Matheo is estimated at $397.4 million. This includes $47.9 million for the future development costs for the A4 infrastructure and the 5.2 million tonne per annum plant expansion. Please note that the $71.9 million shown here includes $24 million of preapproved capital. Life of Mine capital is estimated at $499 million. And as at the 31st of December 2022, the company had invested approximately $280 million of the total on development capital. And finally, looking at Kalahari Copper Belt exploration. Drilling continued to focus on the Matheo hub with several prospects tested. At A1 drilling has outlined copper mineralization over a strike length of almost 2 kilometers and the team has now moved on from drilling to data [ph] interpretation and geological modeling. At the T1 prospect, where MOD Resources previously published a small resource estimate, two holes were completed and assays are yet to be received. Preparations also continued during the quarter for large-scale airborne gravity survey and collaboration with neighboring exploration and mining companies will result in almost complete geophysical - coverage of the Kalahari Copper Belt and enabling our team to build a comprehensive structural and basin model to aid exploration targeting. Finally, in closing, I won't go through all of these points, but I would like to reinforce my points again from the start, which is to again remind everyone that on the back of the MATSA acquisition and the development of Matheo to a 5.2 million tonne per annum capacity, Sandfire is one of the few copper miners that has a firm production growth pathway over the next 3 years, growing to over 110,000 tonnes of copper and over 80,000 tonnes of zinc production per annum. Hi, Jason, Matt and team. Just a quick couple of questions. The first one on MATSA. Pre-timed [ph] last quarter, you flagged lower backfill rates at Magdalena and this quarter, ground condition issues. Just wondering if they were related? Look, partly related. If you look at particularly stope availability around that, this has been the impact of ground conditions on that. Now it does not only slows down our production rate, it's also meant that we've had to alter our mine sequence to bring in additional ore. And it also impacts on our ability to actually backfill stopes in a logical manner to support ongoing production there as well. So some of these ground conditions that we've seen have particularly come to a head [ph] there, probably early December, but we were starting to see the impact of those late in Q1 as well. Yeah. So the team has done a lot of work about basically implementing a new mine sequence and stabilizing that sequence. There is an adjustment period as we go through that because obviously, we needed to change, particularly development priorities and where we deploy resources throughout the mine. The team has done a lot of that work, particularly during the last quarter, and we have developed to the levels below the areas that were implied by poor ground conditions, and we've seen a significant improvement in those ground conditions in those areas. Sure. Thanks. And maybe a second one. We've talked about the trial processing of stockpile oxide ore at DeGrussa. Can you just share some of the recoveries that you achieved during that trial process? Yeah. So look, recoveries are significantly lower than what we've seen previously with sulphide ores. So obviously, our plan is geared towards processing of sulphide ore in particular. The new reagent regime that we've got and based on the plant scale trials, we're seeing recoveries around and just above that 50% mark. So generally, we work on around about 50% to 60%. Now one of the issues with us is, given the age of these stockpiles and not so much from an oxidation point of view because it's already oxide mineralogy. It's more to the tune that these stockpiles were mined right back at the beginning of mine life at DeGrussa. And there is some uncertainty around particularly on grade distribution through the stockpiles and particularly you know, potential variations in metallurgy that may impact on recoveries. So given that uncertainty, that's largely why we've decided not to provide any further guidance for DeGrussa. So we'll process this material opportunely. We'll monitor it very closely and make sure that it's making money. And we'll react either way given the results that we start to see coming out of the plant. Thanks. And then just squeeze one last one in. I mean, Sandfire's owned MATSA for some time now. Has there been any improvements of learnings that you can share with us with processing poly metallic ore, specifically around recoveries? Thanks. Yeah. Look, thanks, Kaan. And look, I'll start and then I'll throw it to Dave. Look, Dave's team and particularly with the MATSA team have been doing a lot of work, particularly on recovery improvement. So there's two key projects that are currently underway at the moment, which is firstly around control of the blend and getting a more stable blend going to the plant. And the second one is we've been doing a lot of work, particularly on optimizing our reagent regime and control of metallurgical parameters like PH which we now expect will deliver a significant recovery improvement with copper, but certainly to a higher extent there for zinc. Now we've got plant trials, particularly on those new reagent regimes starting later this month and going out throughout this quarter. So we expect to get some positive results of that in the near future. Dave, did you want to add anything? Yeah. Let maybe just to add. Look, it's really on the back of a [indiscernible] coming up on anniversary on the MATSA. What we've done through that period is really a back to basics and really that's understanding the liberation characteristics in the feed [ph] which is very important in flotation and how the mineral - what's the efficiency being within that flotation circuit in terms of misreporting of game in - into concentrate and lots of variable minerals. We've got - we're starting to get a lot of that data back now, which is really indicating some opportunities to improve. And as Jason said, next month, we will be kicking off on some trials, and we're quite hopeful we'll see some improvement. Hi, good afternoon, Jason and team. First question is on MATSA. So you still look to be targeting a process of some - 0.6 million tonnes. I know that you've only done 2.1 in the first half. So that looks like a bit of a stretch. So maybe could you give us some more color on how you can make back these tonnes. It does look to be a reasonable step up of volumes, you've achieved since you run the mine? Look, that's - you make a valid point there, David, and you're 100% correct. So we've taken two opportunities during the first half of the year to take planned maintenance shutdowns as well for items that were planned originally for the second half. So firstly, that does give us a higher availability and by default, a high utilizations of that plant going into the second half. The other area there as well is that I've mentioned before, we are looking at some blended stockpiles going into the plant, which we believe once we control that blend and get more of a consistent feed, there's benefits there in recovery, but potential benefits in throughput. Okay. Thanks. And - then maybe just following up on the new discoveries, San Pedro. Obviously, it looks really prospective and now highlights that for a respective horizon, which I think you see sort of requirement [ph] long. How do you think about testing that horizon now going forward? Have you seen enough here to push outs in development? And I guess, within that, is this - physically a blind discovery or are you now seeing things that could help you target further success? Yeah. So firstly, we are currently undertaking step-out drilling on this at the moment. So we're able to do that from existing underground workings. So we are pushing this out and seeing how far we believe it extends. We are at this stage as well where we are starting to look at planning of drilling to test further that prospective horizon. The thing you need to understand, this is literally hot off the press and particularly the geological reinterpretation work that the team's been doing has really given some really important insights to control on mineralization, particularly at Aguas Teñidas, but also that give us some insights there at Magdalena and also beyond further along the belt. So we are particularly excited about this initial success. We're very excited about potential on that prospective horizon. And yes, we'll be moving very quickly to try and test as much of that as we can. Now on the geophysics. So we are doing some geophysics from underground drilling. And the team has already identified some off-hole EM conductors that require further follow-up drilling as well. Morning, Jason, Matt and Dave. First question is on MATSA again. And sorry to harp on about, I guess, digging into the performance of Magdalena in particular. But if you look at the last four quarters in production from Magdalena has been coming down each quarter now grades improve and the expected improvement in the June half. But from a multiyear perspective at Magdalena, how do you - and you alluded to a little bit on the development of the lower parts of the mine, but how do you actually lift the volumes at Magdalena sustainably in a multiyear view? Just keen to understand the turnaround, I guess, strategy for Magdalena on a multiyear view? Yes. So there's two key areas of focus, particularly at Magdalena, but also for Aguas Teñidas. So our mine development rates are still not what we would expect to achieve here in Western Australia or in Australia in general. So that is a constraint given the overall morphology of the ore body. So we've got quite a flatly dipping, flatly plunging ore body that does particularly opening up new areas does require significant amounts of development rates. And we are seeing that, that is an overall constraint there, both at Magdalena and Aguas Teñidas. So we're doing a lot of work at the moment to lift our basically development rates that we're able to achieve and particularly working with our Spanish contractors to get some insights in terms of how say, Australian contractors approach and get much higher rates in there as well. So that will unlock further tonnes and unlock better production potential. The other area that we've been working around is particularly around stope turnaround times. So the stope turnaround, and we've got some valuable insights from the work that we've done at DeGrussa historically to basically minimize that without incurring additional dilution and without delivering on ore body or loss during the period as well. So we've done a lot of work on that sequence. Now that delivered improvements that we reported back in Q4 of FY '22. So if you remember back to that rate, we're actually mining, I think, for over a month there. So it was almost two months of that quarter on a combined basis of around about - I think it was about 4.8 million, 4.9 million tonnes per annum. So that's what we believe we can achieve out of Magdalena and Aguas Teñidas longer term. Once we get beyond some of these localized poor ground conditions, and start to see some more inroads into some of these improvements, we do expect that those production rates will sort of sustain the plant at a 4.7 million tonne per annum rate. Yes. Okay. Thanks, Jason. And then just on the CapEx year-to-date at MATSA of around $50 million versus the full year guidance of 120 to 140. Is that under spend, or I guess, on an annualized basis versus guidance, just a reflection of the lower development rates we've seen in the first half? Look, partly, it's more around, if you like, sustaining CapEx around equipment, things like that as well. So lead times on that. And obviously, we don't have to pay for some of those equipment and services until that's incurred. So a lot of it is simply timing. Yes. Okay. Great. And then moving south to Botswana, really good outcome guys on executing this project on time and on budget and actually appears to be a little bit early. So congratulations. That's a huge effort considering the challenge in the last couple of years. The one question I did have is around the commentary around the expansion of 5.2 million tonnes per annum. And I know construction crews [ph] on like commissioning crews and vice versa, but you've obviously got a few times involved with that expansion. But is there any possibility of actually bringing the 5.2 million tonne expansion forward a little bit? Look, critical path. Look, we could actually have the Ball Mill and the plant done earlier than we've guided. The critical path here for development or for that expansion is really around mining and pre-stripped A4. So particularly if you look at it, we've got first production there forecast from the A4 open pit in FY '25. So - and even during that period of time, it doesn't fully meet the expanded plant requirements. So we actually make up, if you like, that shortfall from T3 ore and changes to that schedule as well as drawdown of T3 stockpiles. So if we work back from that, that critical path in terms of that pre-strip on A4 is the time limiting factor, which is almost in sequence with the permitting of the ESIA and the granting of the mining license. So if that can be brought forward, there is an opportunity to potentially bring forward some of that expansion and some of that production earlier. But at this stage, what we have seen with Botswana is permitting time lines can be quite variable, and we're certainly not counting on that at this point in time. And I just wanted to follow up on the last question from Paul. When is a date at which you could get the permit that could unlock this potential benefit that you were talking about? Like when is the drop - that date when a permit becomes a problem and - or when could it happen forward benefits? Yes. If we look at this, and I'll just refer you to the time line slide in the pack there as well. So particularly, we are looking to commence mining around the middle of... Yes. So commencement of mining there around about the end of Q3 FY '24. So if you look at that and particularly there as well, we've got the A4 environmental approvals and mining license. At this stage, we've assumed that, that continues for three quarters and is available early in FY '24. If that can be compressed, there is potential opportunity. But we've also given ourselves around about a quarter fee [ph] wave for overruns on that permitting process before it hurts the overall project time line. Okay. Thank you very much. And just could you expand a little bit on your strategy â so this is MATSA sorry, this question is MATSA. Can you explain your strategy with regards to power purchase agreement at MATSA, how long a contract are you targeting? And for how much of your needs? And then also the pricing outcome longer term versus what's in your existing guidance? Thank you. Yes. Thanks, Daniel. Look, obviously, this is still under negotiation, so that's very limited to what we can say. But I guess, just reiterating the comments we have, what we're aiming to do is to get some relief from this current period of high power price. So to do that, we expect to have a proportion of our power lock at a fixed price. And as we work through that, we'll disclose the market what we can. But at the same time, we're cost [ph] of the risk of locking in too much for too long. So look, all the points you raised are what's in the balance through this negotiation in this process. But right now, I guess, we're not in a position to say much more. In terms of your comment on longer-term power prices. I guess if you look at the - I mean this year, we've truncated that chart a bit. If you look at the historical power prices in Spain, they've historically been in the â¬50 to â¬80 megawatt hour. That's certainly one of the key markets we're looking at going forward that we don't preclude us from being able to achieve that. Where power prices reversed to a time all way things are in the mix. So that will - that's from the market operator, we find on the â our MI or MIP page. But added to what you'll find on the test our current providers given an estimate of the gas cap compensation price, which is part of the Spanish arrangement at the moment, which is not permeably [ph] found. So we've put that into [indiscernible] if you won't find that on the line. Thanks. Just wanted to touch on the MATSA costs. It looks like your unit mining cost has hovered around that $40 a tonne mark for the last four quarters, which is a great outcome. Just wondering if you're able to talk to that, there doesn't seem to be any inflation coming through? Yes. Thanks, Lyndon. Look, I'm not sure what I'll call - there the actuals. Obviously, one of the things we found in MATSA and probably in Europe, more generally, that we experienced quite inflation very early on in our period of ownership and things have settled down, particularly with power starting to revert. There is a proportion of our power cost. I think it's something in the order of 30% to 40% goes into mining as well. So I guess, yes, I guess the data speaks for itself, our costs have trended pretty flat. And I think in rate-wise, Lyndon probably affected also by programs that Jason and his team are working on with things like dilution and that sort of stuff, you'll get an impact through in unit costs. But you'll also get an impact in terms of contractor efficiency and some of the improvements we're making there. So a bit two factor. But yes, you're right, it's actually fairly stable after that initial kick. You'll notice that a number of areas, some of our costs have really stabilized over the last two or three quarters. Great. Yes. No, good outcome. And then the other question I had was I'm wondering if you can touch on all-in sustaining costs at all, whether you've got any thoughts on reporting that and what they would be, whether it's around that $3 type mark? It's not something we report on, and we tend to separate it out between C1 and CapEx. So we do see one on a unit basis, and then we refer to CapEx on a dollar hold dollar basis, something that can, of course, be back calculated and put together, not as we report at the moment, so I won't quote a number, but certainly a consideration we can have into the future about how we wish to put those two together. But the story is complete in any event in the way we do it in whole dollars in terms of CapEx. Thank you, everyone. Maybe just bringing together a couple of those prior questions on MATSA. As you approach the close of this PPA negotiating period, is it fair to say that you'd expect a material step down on that C1 operating cost? The current guidance is fiscal '23, $1.82 per pound of copper payable, I think it is? Thank you. Yes. So I mean, my understanding is that you currently have guidance in the market for fiscal '23, which includes the March and June quarters. And if you get this PPA out in the next days, weeks, whatever, that it should have an impact on the remainder of fiscal '23. So can we expect a step down in that US$1.82 per pound of copper payable? Sure. Without giving any future guidance, we'll give that midyear, of course, but you're right. So any impacts in power, of course, any particularly any long-term locked-in impacts on power will assist long-term C1 versus this year, assuming other things equal, of course, around state [ph] copper production. There will also be an impact as Jason talked about, the mine plan looks at increasing zinc production over the 3 years. So that all things being equal in terms of zinc price, if we've got high zinc production, we'll clearly have a larger by-product credit as well. So I'd say on balance, there's pressure downward in terms of C1, all things being equal over the next couple of years. Hey. Morning, guys. Just a couple of things just on approvals, I guess, just about noticing that mine approval in Botswana. I mean is that taking longer than the original approval? Are they starting to stretch out a bit like they are in every other part of the world? No. Look, thanks, Hayden. Look, from our point of view, we went through this process with T3 and the 3.2 million tonne per annum project. If you look at it publicly stated time lines for approvals from the Botswana government, they state seven weeks. Now if you look at it, the T3 approvals took pretty much seven months. So as I've said before, we've basically allowed about nine months for approval, and we put about another three months or a quarter in their float [ph] before it starts to improve impact on the mine plan. Okay. And I guess a similar sort of question to MATSA, I mean how there is some reasonable targets and some other stuff. I mean how long do you think that process would be from if you could drill the sand [ph] into some sort of resource in the next six months? Do you actually get approval [indiscernible] mine and San Pedro and then obviously more regionally/ Yes. If we look at Magdalena, from discovery through to resource and reserve, it was around about 2 to 3 years. So it was actually a 2-year period. So there's a real recent, if you like, case study where we can actually move these things through the process and get them into production quite quickly in Southern Spain. Okay. And just one final one, just on the power of the forward power hedging sort of potential. I mean, how much of your power would you think you'd look to lock in? And how much would you be on spot? And how much sort of variability in that thought process have you had? The last part of your question here there's been quite a lot of variability in that thought process. I guess at this stage, we're probably not in a position to say too much, given where at our negotiations. But that's all the things we're missing. Well, I guess Hayden is that it's temping during a really high price sort of environment like despite that we've had to lock in a large chunk of power at a price that's perhaps a saving on the current product spike, but still above the sort of historical long-term average and I guess we're reticent [ph] to get a feel into that position. That's - that gives you a little more color. Hi. Good morning, all. And Matt, I've got a question for you on the hedge book, if I may. First of all, I presume all the copper hedge in relation to MATSA. So can you just walk me through some of the movements in the hedge book from the September quarter to where it sits today? So I don't have the exact details in front of me, it turns with the start of the quarter and the end of the quarter. But there is actually some DeGrussa QP hedging in there as well. So that has propped up some of the copper book. I'd have to go back to a comparison quarter-on-quarter for you to, unfortunately. Okay. So just looking at your MATSA realized pricing, it sounds like in the December quarter, most of your sales were directly into the hedge at the higher price, is that adding [ph] on in some QP adjustment? It turns out about 40% goes into the longer-term hedging that we did on acquisition. Any other hedging comes through the rolling QP. So I wouldn't have expected that sort of percentage in the December quarter, expected to be higher moving into the March and potentially June quarters because of that hedging at the back end of the year, which has a, call it, 4, 5-month QP. So I'd expect the percentage to be high, but no, not that high in the December quarter. But I can come back to you on some more specifics if we need to. Okay. That's great. Thanks. And just lastly, at Magdalena, when do you intend - what's the time line on moving away from the stock work to the MATSA sell side? Is that next 2 years or more near return? Look, we're largely through it now. So we've really got some remnants coming through pretty much this quarter. So beyond that, we're moving more into the massive sulphide there basically from now. Yes. Look, Magdalena can be challenging in places in terms of ground conditions. We do have a heightened ground support regime in there, and we're constantly reviewing that as well. But what we are seeing, particularly the issues that we saw in late Q1 and Q2, we are moving through that and we are seeing a significant improvement. Overall, it will be something that needs to be managed at Magdalena in the longer term. And some of the work that I mentioned there about higher developed stocks to support basically production. That's one of our key focus areas there to make sure that we can maintain the target production rate at Magdalena. There are no further questions at this time. And that does conclude our conference for today. Thank you for participating. You may now disconnect.
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